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Consultative Document March 1998 ContentsForeword by the Director General Overview of the key issues for consultation Chapter 2: Overview of technical and market developments This chapter contains a diagram which can be viewed separately. Chapter 3: Gateways to networks: competition and regulatory issues Chapter 4: Subsidy recovery and access charges Chapter 5: Access charges for wholesale interactive service providers Chapter 6: Competitive neutrality in access charges Foreword by the Director General In February I published a Statement and Guidelines setting out how Oftel would approach the task of assessing whether the prices offered for conditional access services for digital television were fair, reasonable and non-discriminatory. This document considers whether that approach should be extended to cover the price of access control services for interactive services. The partners in the British Interactive Broadcasting joint venture have announced their plans for launching interactive services alongside digital television. More recently Cable and Wireless Communications have announced their intention to introduce cable set top boxes which will support interactive services. Other UK cable operators and broadcasters are actively considering their plans for interactive services. The debates and discussions in the UK on the role of interactive services, interactive television, and the impact of the Worldwide Web on television services are part of a broader international debate as convergence becomes a reality that impacts on business plans. In this converged world it is important that we establish a consistent framework across the board. This document is part of that task. As the electronic communications market develops it will give rise to new forms of gateway and with it the possibility that control of significant gateways might be abused in order to gain restrict or prevent competition. In my view it is critical that there are clear rules to ensure that third party service providers are able to use those gateways on fair, reasonable and non-discriminatory terms. This document forms part of Oftel’s continuing work to outline those rules. One of the issues which this raises is whether those who subsidise consumer equipment in order to encourage the take up of new services should be permitted to recover that investment from third parties wishing to gain access to that system. Requiring access by third parties without any provision for subsidy recovery would risk deterring legitimate investment which could be to the benefit of consumers. At the same time, it is clearly not in the interest of consumers if subsidy has the effect of distorting competition whether in consumer equipment or services provided over it. How Oftel should strike the right balance between these considerations is the second main issue considered by this document. I hope you will read and comment on this document. These are new issues for Oftel as they are for the industry. The market is developing all the time. Your input is therefore critical to getting the framework right. DON CRUICKSHANK
This document outlines Oftel’s proposed approach to ensuring that the prices broadcasters and other third-party service providers are required to pay for access to digital television receivers to provide television and interactive services are fair reasonable and non-discriminatory. It seeks views on three related issues. The first issue concerns whether all of part of the investment in the subsidy of consumer equipment should be regarded as investment in network infrastructure which it would be legitimate to take into account in setting access charges for third-party users. Such charges might be applied to conditional access services required for digital television, to access charges to providers of interactive services, or to both. The second issue concerns the extent to which subsidy payments should be regarded as covering the costs of the additional facilities for interactive services (and thus potentially recoverable from charges for access control services) and to what extent they are a common cost between interactive services and television services (and potentially recoverable from charges for access control services or conditional access services). The third set of issues concerns whether the approach Oftel has proposed to take in assessing whether the charges for conditional access services for digital television are fair reasonable and non-discriminatory should be extended to charges for access control services . This includes broadcasters wishing to offer enhanced television services. This has two dimensions:
The initial consultation period will run until 1 May 1998. There will then be a further period until 15 May 1998 during which comments are invited on any submissions made to Oftel during the initial period. Written comments should be submitted to: Lisle Peters Oftel 50 Ludgate Hill London EC4M 7JJ Written comments will be made publicly available in Oftel’s research and intelligence unit except where respondents indicate that their response or parts of it are confidential. Respondents are therefore asked to separate out any confidential material into a confidential annex which is clearly marked as such. In the interests of transparency, respondents are requested to avoid confidentiality markings wherever possible. To assist with photocopying respondents are asked not to spiral bind submissions. Comments on this document can also be sent to Oftel (if they are relatively short) by using the following e-mail address: Confidential responses should not be sent via the Internet. Oftel intends to set up a link between this document on Oftel’s web pages and any comments placed on respondents’ own internet pages. Please contact Cate McLaurin on 0171 634 8752 or e-mail: web.oftel@gtnet.gov.uk to organise this. Recorded messages may be left on Oftel’s Comments Hotline: 0645 600 660 (Calls charged at local rate) Oftel has a free e-mail based mailing list to help people stay informed about the work that it is doing. Each time an Oftel document is published and placed on Oftel’s web site subscribers to the list receive an e-mail informing them about the document.
Overview of the key issues for consultation i This document outlines Oftel’s proposed approach to ensuring that the prices broadcasters and other third-party service providers are required to pay for access to digital television receivers to provide television and interactive services are fair reasonable and non-discriminatory. It seeks views on three related issues. ii The first issue concerns whether all of part of the investment in the subsidy of consumer equipment should be regarded as investment in network infrastructure which it would be legitimate to take into account in setting access charges for third-party users. Such charges might be applied to conditional access services required for digital television, to access control charges to providers of interactive services, or to both. Conditional access and access control services are the services which providers of pay television and interactive services require to offer their services via the consumer’s receiver. iii The second issue concerns the extent to which subsidy payments should be regarded as covering the costs of the additional facilities for interactive services (and thus potentially recoverable from charges for access control services) and to what extent they are a common cost between interactive services and television services (and potentially recoverable from charges for access control services or conditional access services). iv The third set of issues concerns whether the approach Oftel has proposed to take in assessing whether the charges for conditional access services for digital television are fair reasonable and non-discriminatory should be extended to charges for access control services . This includes broadcasters wishing to offer enhanced television services. This has two dimensions: Subsidy recovery v On the issue of what proportion of the total investment should be regarded as investment in network infrastructure. Oftel is seeking comments on:
vi The document also considers the particular issues in relation to BDB. Measures to accelerate consumer take-up of digital terrestrial services are one of the criteria laid down by the Broadcasting Act 1996 for the award of the digital terrestrial multiplexes. This involves marketing as well as subsidy of consumer equipment. As part of its licence bid, British Digital Broadcasting committed itself to paying certain amounts for subsidy of consumer equipment). vii Oftel recognises that there are valid arguments for and against the recovery of the subsidy made under the licence obligations. On the one hand, it could be argued that third parties should not be required to contribute toward meeting commitments made by BDB in its bid for the licence. On the other hand there are also valid arguments that not allowing recovery of this element of the subsidy would have the effect of penalising BDB for having made commitments, and that this approach arbitrarily distinguishes between it and broadcasters who enjoy the benefit of ‘gifted’ digital spectrum. viii Oftel’s preliminary view is that a way through this dilemma could be found if subsidy recovery from third parties were ‘recycled’ to increase the overall total of subsidy – that is it would be ringfenced for spending on subsidy of consumer equipment. Oftel would welcome comments on this view. Approach to assessing whether charges for access control services are fair, reasonable and non-discriminatory ix The document considers whether in assessing whether access control charges are fair and reasonable is should adopt the same the general approach that it has proposed on pricing of conditional access services. These are that:
Subsidy and the relationship between charges for access control and conditional access services x The document also considers two potential approaches to the attribution of subsidy between access control for interactive services and conditional access. The two possible approaches are:
Competitive neutrality in access control charges xi The third and final set of issues concerns competitive neutrality in the pricing framework and whether the approach proposed by Oftel for conditional access charges should be extend to access control charges. The main features of this framework were that:
xii One of the key issues raised in relation to conditional access charges is the importance of common costs These are costs which are not directly caused by any individual set of activities. There are a wide range of ways in which such costs can be recovered from services, giving rise to a wide range of possible pricing structures. An unnecessarily rigid and literal interpretation of the non-discrimination requirement could have the effect of pricing some users off the system who might otherwise have been making use of the system and contributing additional revenue. xiii If a pricing structure is to be competitively neutral it must permit efficient entry by rival service providers. The consultative document considers the issues involved where third-party service providers are seeking to use the BiB system to provide services in competition with BiB itself.
Introduction 1.1 This document seeks views on Oftel’s proposed approach to two related issues concerning the prices broadcasters and other third-party service providers are required to pay for access to digital television receivers to provide television and interactive services. 1.2 The first issue concerns whether all of part of the investment in the subsidy of consumer equipment should be regarded as investment in network infrastructure which it would be legitimate to take into account in setting access charges for third-party users (ie conditional access charges and/or charges for access control). Such charges might be applied to conditional access services required for digital television, to access charges to providers of interactive services, or to both. 1.3 The second set of issues concerns whether the approach set out in Oftel’s Statement Guidelines on charges for conditional access for digital television for assessing whether the charges for conditional access services for digital television are fair reasonable and non-discriminatory should be extended to charges for access control services. This includes broadcasters wishing to offer enhanced television services. This has two dimensions:
1.4 Subject to the outcome of this consultation, Oftel intends to produce a consolidated set of guidelines on the access charges for digital television receivers. Objectives 1.5 Underlying the approach set out in this document are the following general objectives. These are to ensure that :
Structure of this document 1.6 This document begins with two chapters (Chapters 2 and 3) which are intended to provide the general reader with an overview of the technical, commercial, competition and regulatory issues which provide the context for the specific discussion of pricing issues in Chapters 4 to 6. Related documents 1.7 While Oftel has sought to make this document self-contained, discussion of issues which have been discussed in earlier documents has inevitably had to be abbreviated. There are a number of documents which are relevant to the proposals in this document. These are:
Overview of technical and market developments Introduction 2.1 This section gives a brief and very simplified overview of:
Digital television technology 2.2 Digital television involves turning the picture and sound (together with any accompanying data) into a series of 1s and 0s. This information is then ‘compressed’ using special software so that unnecessary information is removed. Compression allows a number of services to be broadcast on the same frequency. The process of combining services on a single frequency is called multiplexing. The receiver contains a computer which sorts out the service the viewer is watching from the available services in the multiplex, it then takes the compressed information and reconstructs the original picture, sound etc. 2.3 Digital television receivers may differ in their degree of technical complexity. The simplest receivers might only offer reception of free-to-air television services broadcast in the clear together with some text services (these are processed by an ‘MHEG decoder’). Receivers built to offer pay television services would need to include a smart card reader and other technical facilities to offer pay television services. As an additional security feature such receivers are likely to include modems to enable the receiver to contact the conditional access system. 2.4 In digital television there is no longer a link between a given frequency and a particular service. This means that the receiver will need to include navigation software to enable the consumer to tune to the service they wish to see. Most receivers are likely to include an Electronic Programme Guide (EPG) which will enable consumers to access information about the range of available services, to select (and where necessary, pay for) the services they want. The EPG will provide a user interface which can also be used as the interface for accessing interactive services. 2.5 As the number of functions performed by the receiver increases it requires more memory and processing power and the operating software to manage the different tasks it performs. The receiver is also likely to require requires the ability to receive and interpret a set of instructions transmitted to it. This is done by the Application Programme Interface (API). The API interprets a set of commands telling it, for instance, where to display a graphic or other object on the screen. The API is also intended to be ‘hardware-independent’ – that is to allow the same applications to run on different receiver designs without the need for the application to be rewritten for each one. New services 2.6 This increased technical sophistication in turn creates possibilities for new kinds of television service and for using the receiver in new ways:
2.7 This document uses the term interactive services to describe these new services. This term covers two forms of interactivity. The first is where viewers use the remote control to click to applications which are included in the broadcast stream – for example an advertiser offering mortgages might include a computer program to enable the viewer to input the size of the mortgage they want and its period and the program would calculate the monthly payments. The second form of interactivity is where the modem is used to call a remote server. At its simplest this interaction might involve the user pressing a button on the screen to request an advertiser to send further information. At its more complicated the viewer might make an online purchase using a credit or payment card. 2.8 Examples of the sort of services which might be offered include:
2.9 This convergence between broadcasting, IT and telecommunications means that consumers will be able to buy a television receiver which also has the processing power and communications facilities similar to a basic PC. A number of organisations are seeking to exploit the potential of these technological developments. Many commentators believe that the main commercial opportunities opened up by such devices may lie in the ability to extend the television experience through, for example, offering the ability to respond instantly to an advert; direct links to a broadcaster or advertiser’s web site; or the ability to call up further information broadcast alongside the sound and picture. The term enhanced television services is used in this document to distinguish these services from basic television services ie sound, picture and text. Technical facilities used by television and interactive services 2.10 Different kinds of service will make differing demands on the technical facilities offered by the receiver. For television services this might include:
2.11 Similarly interactive services are likely to differ in their demands they make on the resources of the receiver. The different possibilities include:
2.12 The distinction between interactive and television services is an important one in the analysis set out in this document. That said, Oftel recognises that increasingly broadcasters may be doing both, and in the relatively near future all television services may involve interactive elements. Arguably at that point the distinction may be of little practical relevance. However, in the early years of digital television there may well be some broadcasters who do not offer interactive services. Such broadcasters could legitimately argue that they should not be required to pay for the features and facilities necessary to support interactivity. For this reason Oftel has felt it important to retain the analytical distinction between television and interactive services. Market developments 2.13 Digital satellite services have been launched in the USA and other countries in Europe. The UK is unique in that 1998 will see the launch of digital services across three different delivery mechanisms: satellite, cable and digital terrestrial. BskyB has announced plans to launch digital services in June. The BBC and other broadcasters are also planning the launch of digital satellite services. A number of cable companies are planning to launch digital television services at the same time. British Digital Broadcasting and the other broadcasters involved in the launch of digital terrestrial television (British Digital Broadcasting has been granted the licence for three of the six multiplexes. The BBC, ITV, Channel 4 have been gifted two multiplexes between them. The licence for the third multiplex has been awarded to S4C Digital Networks (SDN) consortium with an obligation to carry Channel 5 services across the UK and S4C services in Wales. Most of the capacity on the non-BDB multiplexes will be used for free-to-air transmissions – including simulcasting of analogue broadcasts. However, it may be that some of this capacity will be used for pay television services. 2.14 At the same time a number of organisations are planning to launch TV-based interactive services. These include British Interactive Broadcasting (BiB) the proposed joint venture between BSkyB, BT, Midland Bank and Matsushita. At the time of writing the competition issues raised by the joint venture were under consideration by the European Commission (DGIV) under Article 85 of the Treaty of Rome. Business models 2.15 BiB will use satellite transponders to broadcast a stream of video, still pictures and text in a continuous cycle – this ‘carousel’ approach is the same as that used for present day teletext services, but the high bandwidth means the pages can contain richer information (eg better graphics and video clips) and consumers will be able to move more quickly between the pages. Consumers will be able interact with the BiB servers, using the modem and the ‘return path’ over the switched telephone network, to make purchases, request information etc. The combination of high bandwidth for data delivery and the modem return path will give consumers much of the look and feel of full interactive online services. 2.16 Consumers will be able to access an interactive shopping mall or content pages held on the BiB servers (or potentially others on other secure servers equipped with the necessary software). There is the potential for the modem and the switched telephone network to be used to deliver data to the consumer, but it is envisaged that broadcast delivery will be the primary route to reach the consumer. 2.17 Under this model users will not pay to connect to BiB, instead BiB plans to earn revenue by providing wholesale services to advertisers, retailers and other service providers who want to use the BiB ‘interactive domain’ to reach consumers. BiB may also provide retail services in its own right. 2.18 The Internet-via-TV device (eg WebTV or NetStation) offers a rather different model for future developments. These devices provide the ability to use the Worldwide Web and to send email. Such devices currently simply use the television screen to display Web pages received via a modem. The next generation are likely to be integrated with the receiver. They may well use a combination of data delivered by broadcast transmission and data delivered via the modem using the telephone network. 2.19 The provider of the Internet-via-TV box also provides a service in ‘caching’ the most popular Web pages at its servers and doing some reprocessing and translation where this is not done by the software in the box itself. The consumer pays a subscription for this service which may or may not include Internet access as well (the document therefore makes the distinction between the Internet-via-TV service and the internet access service). When the viewer goes online, calls from the box are routed via the internet access provider to the ‘proxy’ server operated by the Internet-via-TV provider, the viewer is then free to access the full range of sites on the World Wide Web. Under the Internet-via-TV model the consumer pays through a monthly subscription for the Internet-via-TV service – and may also opt to pay for internet access at the same time or separately if they already have internet access via a PC. Conditional access, access control and interactive services 2.20 There are no controls over the data or applications which may be downloaded from the internet using a PC and modem. Any risk from downloading defective software or viruses is borne by the consumer. However, in pay television there are important security issues:
2.21 In the BiB model there are two principal control mechanisms aimed at dealing with these concerns:
2.22 Both of these mechanisms give the system operator the ability to control access to the system by third party broadcasters and other service providers. For this reason, the services which third parties require in order to use the system to offer interactive services are referred to as access control services. 2.23 It is proposed that this role in maintaining system security will be carried out by Sky Subscriber Services Limited (SSSL). SSSL will provide access control services to BiB and to other wholesale service providers. In addition, SSSL will act as agent to BiB in recovering any investment in the subsidy of consumer equipment that is eligible for recovery from third parties – whether broadcasters of interactive service providers. Click here to view the diagram of the BiB system. 2.24 Television services might involve interactive elements requiring both conditional access and access control services. For example:
Potential gateways and bottlenecks 2.25 At least for the early generations of digital television there is likely to be only one EPG installed in the receiver designed to work with the television services provided by a particular pay television operator. Similarly different system operators may have different APIs (or different versions of the same API). Control of the EPG and of the API give the system operator a further gatekeeper role. 2.26 There are five major gatekeeper roles enabling the system operator to control who has access to the receiver and what services they can offer:
Control of gateways (or ‘bottlenecks’) raises a number of competition and regulatory issues. These are discussed in the next section. Terminology The following terms are used in this document:
Gateways to telecommunications networks: competition and regulatory issues Introduction 3.1 A major issue raised by these developments is the potential for the creation of new gateways to or within telecommunications networks and for the abuse of gateway control. Such abuse might take the form of exploitative pricing for use of the gateway or behaviour leading to the distortion, restriction or prevention of competition in a related market. 3.2 This section considers the competition and regulatory issues concerning access to telecommunications networks and the circumstances in which regulatory intervention might be necessary to require controllers of significant gateways to provide access to third parties. It also sets out the approach Oftel intends to take in relation to British Interactive Broadcasting and other prospective developments in the UK. General issues 3.3 Control of a gateway may give rise to the risk of anti-competitive and/or exploitative behaviour where:
3.4 The likelihood that these criteria being met would depend on the ability of others to reproduce or bypass that gateway. This is likely to be more difficult where there are other barriers to entry such as:
3.5 Where the gateway is owned by an organisation which is also a service provider in the retail market (ie the firm is ‘vertically integrated’) or is linked to a service provider, there are issues about whether, and on what terms, third parties may gain access to the gateway. Potential for distortion of competition? 3.6 The control over a gateway, if abused, could lead to restriction, distortion or prevention of competition in other markets. In the context of digital television and other digital TV-based services, competition in services provided to the customer might be distorted if, for example:
Competition issues in relation to subsidy of consumer equipment 3.7 Companies introducing digital services might wish to subsidise the upfront costs to the consumer of acquiring receivers in order to accelerate the take up of new products and services. these companies may also wish to make subsidy available only on certain conditions, some of which might limit competition and, ultimately be against the long term interest of the consumer. Potential benefits from the provision of subsidy need therefore to be weighed against any adverse impact of restrictive agreements on competition. 3.8 In certain circumstances a subsidy for consumer equipment will be given in return for the consumer agreeing to purchase services provided by the subsidising company. The subsidising company is also likely to have some mechanism to ensure that it controls access by other service providers in order to ensure that its investment is not undermined by competitors seeking to sell substitute services without having to bear any of the cost of the investment in subsidy. Such arrangements might for example involve exclusive use of the subsidised equipment which would potentially raise competition issues depending on the significance of the gateway. These competition concerns might also be strengthened if such exclusive arrangements served to enhance any first mover advantage or any advantage deriving from the control of key Intellectual Property Rights. 3.9 There is also the potential that the payment of subsidy might be used to influence the design of the consumer equipment in order to secure or maintain a commercial advantage for the subsidising organisation in the provision of services to the receiver. This could then distort competition in both the markets for services and consumer equipment. Regulatory implications 3.10 There are two potential responses to the risk that control of a bottleneck gateway could be used in ways which had an anti-competitive effect. The normal course of anti-trust competition law is to take action only where a dominant position has been established and there is evidence of abuse leading to anti-competitive effects. This is known as ex-post action (ie after the event). However, in telecommunications regulation ex-ante rules (ie before the event) have played a crucial role. This reflects duties placed upon telecommunications regulators to promote and maintain competition. Ex-ante rules may, in particular, be necessary because the nature of the market is such that action after the event may be ineffective in restoring competition. It may also be necessary to impose such rules where there appears to be a likelihood that a dominant position could be achieved in order to safeguard competition by forestalling undue concentration in the market. The regulatory framework: extension of the conditional access regime 3.11 The Advanced Television Standards Directive covers the supply of technical conditional access services for digital television services. The major provision is a requirement that such services should be provided to broadcasters on a fair reasonable and non-discriminatory basis. The Directive leaves the terms ‘broadcaster’ and ‘television services’ undefined. The UK Government announced in November 1996 that it would bring forward proposals to ensure that all access services would be covered by the regulatory framework, and the rights provided to broadcasters would be extended to other third party users. This policy was implemented in the proposals for the modification of the Telecommunications Services Licence which came into effect on 31 December 1997. 3.12 The requirements on access control are subject to a ‘trigger’. This is intended to ensure that the scope of regulation is not extended unnecessarily while putting in place the framework to enable swift and direct action if problems emerge, or are likely to emerge in relation to systems which constitute significant gateways. The access control requirements will only be triggered if alternative supply of access control services could only be obtained at an uneconomic cost either to the service provider requiring access control, or to the end-user receiving the services to which access is controlled. British Interactive Broadcasting 3.13 The proposed British Interactive Broadcasting (BiB) joint venture raises many of the issues discussed in this chapter. The system operated by SSSL which provides access control services to is likely to be a significant gateway due to the linkage with pay television and the fact that consumers will face relatively substantial switching costs (even after subsidy). 3.14 The central concern of the UK and European competition authorities has been to ensure that the framework exists so that competing wholesale service providers can enter the market to compete with BiB. The access control system operated by SSSL will fall to be regulated by the access control provisions of the Telecommunications Services Licence. Oftel’s current expectation is that the main access control provisions of the licence, in particular the obligation to supply access control services on fair, reasonable and non-discriminatory terms, will be triggered. 3.15 It is important to emphasise that prices, terms and conditions for access control services will fall within the scope of the regulatory framework; it is not the current intention to regulate the services provided by wholesale service providers to retail service providers or indeed the services provided to retail customers. If successful, the regulation of the access control gateway will facilitate competition at the wholesale and retail level and obviate the need for further regulatory intervention. 3.16 Oftel’s aim in publishing these guidelines at this point is to ensure that all interested parties, including the BiB partners and those who may wish to enter the market as wholesale service providers are clear on the rules which will apply. Internet-via-TV 3.17 There are two important differences between the Internet-via-TV model, as Oftel understands it, and the BiB model:
3.18 The Internet-via-TV model involves a gateway which could be of significance in the future depending on its position in the market. However at this stage regulatory intervention to secure access by third party broadcasters and content providers on fair, reasonable and non-discriminatory terms would be seem likely to be unnecessary so long as it is the case that:
3.19 There is the possibility that a third, hybrid, model might emerge which would involve subsidy from both a pay-TV operator and from a web service provider. The pay-TV operator might wish to recover its share of the subsidy from other broadcasters in the form of conditional access charges whereas the web-via TV provider might recover its share of the subsidy from the customer in the form of ongoing charges. 3.20 Potentially this would mean that the issue of charges to broadcasters and other service providers for interactive services would not arise. In this scenario, Oftel would simply concern itself with oversight of conditional access services for television. 3.21 More broadly, Oftel’s remit extends to competition issues in the internet access market. In this area one of Oftel’s ongoing concerns would be to ensure that market power in one market (such as pay television) is not leveraged into a related market such as Internet access. Exclusive agreements to provide internet access and/or restrictions on the customer’s ability to purchase internet access on an unbundled basis would be likely to raise competition issues which Oftel would need to consider. 3.22 A related issue to be considered might be the impact on the consumer equipment market. Oftel recognises that in the development of digital services it will be important for manufacturers to achieve economies of scale. A contract with one service provider to produce Internet-via-TV device might, at least in the initial launch period, result in lower equipment prices than contracts with a number of rival service providers for different types of equipment. However, these considerations would need to be set against potential longer term effects, and in particular the ability for rival equipment/service providers to enter the market. Oftel would welcome comments on the issues raised in this chapter.
Subsidy recovery and access charges Introduction 4.1 Conditional access and access control are the mechanisms through which access to the receiver is controlled and charges for the use of the system can be levied. In considering whether charges for these services are fair, reasonable and non-discriminatory, there are three basic sets of issues Oftel would need to consider:
4.2 The second and third issues are considered in the following chapters. This chapter considers the approach Oftel might take to the issues of whether it would be fair and reasonable to require broadcasters and other third-party service providers to contribute via access charges to all or part of the investment in the subsidy of consumer equipment. It also considers the particular issues raised in the context of digital terrestrial television where some or all of the subsidy may be made in fulfilling commitments made in bids for multiplex licences. 4.3 This chapter considers how Oftel might assess the total amount of investment which would be eligible for recovery from access charges in respect of digital television, as well as interactive services. The issues about the relationship between the charges for particular categories of service are discussed in the next chapter. 4.4 The discussion and proposals in this document have in part been prompted by two related developments. The first of these has been the BiB joint venture where the subsidy of the consumer equipment is an integral part of the joint ventrure’s business model. The second development has been the award of multiplex licences for digital terrestrial television. British Digital Broadcasting and S4C Digital Networks have been awarded the licences for the multiplexes not granted to the existing terrestrial broadcasters One of the criteria for the award of the licences laid down by the Broadcasting Act 1996, is the measures to promote the take up of digital terrestrial television, including the provision of subsidy for consumer equipment. 4.5 The extensive discussion of the issues raised by subsidy reflects the need for Oftel to take account of developments in the market in considering how to carry out its responsibilities for the regulation of conditional access and access control services. The relative brevity of the discussion of other tariffing approaches should not be taken as implying any view on Oftel’s part on the respective merits of different approaches. Subsidy as investment in network infrastructure 4.6 In assessing whether access charges are fair and reasonable and non-discriminatory, Oftel has to take into account all relevant costs that are efficiently-incurred. If legitimate and efficiently-incurred costs were not fully taken into account there would be a danger that the terms of competition could be distorted because charges to third parties did not fully reflect the costs of providing the services. The owner of the system on the other hand would bear these costs and wish to recover them from its customers. This could lead to efficient and legitimate investment being deterred. 4.7 This in turn raises the issue of how investment in subsidy of consumer equipment should be treated. On the one hand there appear to be circumstances in which investment in the subsidy of consumer equipment should be regarded, either in whole or in part, as comparable to investment in network infrastructure. On the other hand there are also circumstances in which the investment is then recovered through payments made by the consumer. Proportion of subsidy to be regarded as investment in network infrastructure 4.8 There are three sets of factors which are relevant in considering what proportion of the total subsidy should be regarded as investment in network infrastructure:
Contractual commitments by the consumer 4.9 The linking of the subsidy of consumer equipment to contractual commitments by the customer has parallels in mobile telephony. Mobile phone operators make incentive payments to service providers. These are frequently used by service providers to subsidise the cost of the handset. Oftel considered the issue of whether such payments could be attributed as costs to incoming calls (ie charges paid by other operators for interconnection) in the Consultative Document Prices of Calls to Mobile Phones (March 1997). A similar issue is raised here. 4.10 An important issue for Oftel in this context, is the need to ensure that the regulatory framework does not distort the choice of tariffing arrangements by artificially making some more attractive than others. Possible tariff arrangements might include:
4.11 A further consideration to be taken into account here is the potential impact of tie-ins on entry into the market. Tie-ins are likely to have the effect of making market entry more difficult. It would clearly not be appropriate for third parties to be expected to contribute to the costs of an arrangement from which they were not beneficiaries. 4.12 Oftel’s preliminary view is that where all or part of the subsidy is tied to contracts guaranteeing future revenues, the proportion recoverable from third parties through access charges should be adjusted to reflect the value of the benefit derived from the tie-in. 4.13 Against this, it has been argued that even if they do not benefit from the subsidy at the point of sale, third parties may nevertheless benefit from being able to subsequently persuade such consumers to take their services. In Oftel’s view the major objection to this argument is that the fact that a consumer has agreed to take the services of one service provider means that they are less likely to take the services from a competitor. Similar considerations might also apply to long term contracts. 4.14 The issues concerning the valuation of this benefit are discussed below at paragraphs 4.26 to 4.35. 4.15 An alternative possibility is that subsidy would be made available to consumers on the condition that they took any pay television service – ie the receipt of subsidy would not be restricted to subscribers to a specified service (or services) from one operator. The issues involved in attributing the benefit where there are more than one pay-TV operator are discussed below. 4.16 Particular issues would be raised in relation to BiB were the purchase of consumer equipment subsidised by BiB to be made subject to the requirement to subscribe to either BSkyB specifically, or to an unspecified pay-TV service(which would be likely in most cases to be a BSkyB services). The general principle which would apply is that the abatement of the subsidy should reflect the value of the tie-in to the provider of the subsidy. In this case however, the benefit of the tie-in would accrue to BSkyB (and possibly other pay-TV operators) BiB is proposing to recover most of the subsidy cost from interactive services. This raises two issues:
4.17 The first of these questions is being considered by DGIV and is therefore not covered by this consultation. On the second issue, Oftel’s view, subject to consultation, is that third-party service providers should not have to contribute to the costs of a tie-in arrangement of which they are not the beneficiaries, this would apply irrespective of whether the arrangements between BiB and BSkyB provide for BiB to recover that benefit from BSkyB. The value of the subsidy recoverable from third-party service providers should therefore be abated to reflect the benefit derived from the tie-in. 4.18 Once the value of the subsidy had been adjusted to reflect the benefit to providers of pay television services, the remainder would be potentially recoverable from access charges for television, interactive services. Other terms and conditions 4.19 The conditions attached to the payment of subsidy may also confer a non-revenue benefit – such as the consumer’s name and address and other personal details. In Oftel’s view third party service providers should be able to enjoy the same benefit or alternatively (if this is not possible) arrangements should be made which confer an equivalent benefit so that third parties are able to compete on equal terms. Oftel would welcome comments on its preliminary view that:
Competitive neutrality between manufacturers in the provision of subsidy 4.20 For the initial launch of digital television services pay television operators have invited consumer equipment manufacturers to tender against a specification supplied by the pay television operator. Contracts have been awarded – or are in the process of being awarded to a small number of manufacturers. This process has the objective of ensuring that:
4.21 While such arrangements may well be necessary and expedient for the launch of digital television services, it is doubtful that they are in the longer term interests of the competition in that they could inhibit innovation, limit the scope for competition through product differentiation, and limit consumer choice. 4.22 Organisations investing in the subsidy of consumer equipment have incentives to encourage diversity of supply and a multi-design environment; like residential consumers they stand to benefit from competition between manufacturers in the form of lower costs and improved product quality and performance. At the same time, these incentives may offset by strong incentives to pursue competitive advantage in the provision of services to the consumer by constraining the design of consumer equipment in important ways – for example by discouraging the inclusion of a common interface, alternative electronic programme guides or user interfaces. 4.23 In broad terms, Oftel would wish to see that subsidy was provided in such a way that it did not prevent manufacturers from including additional hardware or software features and pricing accordingly. A parallel may be drawn with the position in the mobile telephone equipment market where the consumer is able to choose between a basic phone at £9.99 or pay more for one which is smaller and/or has additional features. 4.24 At the same time Oftel recognises that there may be good reasons why system operators would not necessarily subsidise all equipment from all manufacturers. System operators might for example wish to maximise the impact of subsidy by concentrating on set top boxes as opposed to integrated televisions: a £100 subsidy which reduces the price of a set top box from £300 to £200 might well have more impact than the same amount of subsidy which reduces the price of an integrated television from £700 to £600 (all figures are purely for illustration). 4.25 Oftel’s preliminary view is that it should retain the ability to disallow recovery of all or part of the subsidy where its provision had been made subject to conditions which could have the effect of restricting, distorting, or preventing competition in consumer equipment or services provided over it. Oftel would welcome views on its proposed approach to restrictions placed on consumer equipment manufacturers as a condition of the provision of subsidy and on its preliminary view is that it should retain the ability to disallow all or part of the subsidy where it’s provision had been made subject to conditions which could have the effect of restricting, distorting, or preventing competition in consumer equipment or services provided over it. Valuation of the benefit derived from conditions attached to the payment of subsidy 4.26 The general principle proposed by Oftel is that where the consumer must agree to purchase other services in order to receive subsidised equipment (a ‘consumer tie-in’) the amount of the subsidy eligible for recovery via access charges to third parties should be reduced to reflect the value of that tie-in to the party providing the subsidy (see discussion paragraphs 4.9 to 4.18 above). That value would be the revenues resulting from the extra customer less the relevant costs. 4.27 Oftel recognises that, in order to avoid double-counting, it would be necessary to ensure that the calculation by which the value of the subsidy investment is depreciated took account of the abatement which had already taken place. 4.28 The value of the tie-in should be assessed over the ‘life’ of the customer and not just over the length of the contractual tie-in. This would raise the question of how to estimate the ‘life’ of a customer with subsidised equipment. The absence of data on the means that it is difficult to estimate the expected ‘life’ digital pay television customers. Oftel’s initial view is that at present the best available reference point on which to base such an estimate is the data for analogue direct-to-home satellite customers. These estimates would of course be reviewed as more market data becomes available as digital services become established. 4.29 The estimate of the benefit from a tie-in would need to be based on the estimated ‘life’ of a subsidised customer. It is possible that, by reducing the consumer’s apparent investment in the equipment, subsidy of consumer equipment might make consumers more willing to consider switching to other pay-TV suppliers or cancelling their subscriptions. Subsidised consumers might then have a shorter ‘life’ than unsubsidised. However, subsidy has been a feature of the UK pay television market for some time now to such extent that it might be reasonable to assume that most pay-TV subscribers had received an initial subsidy. This would mean that there would be little difference between the ‘life’ of an average customer and the ‘life’ of a subsidised customer. Oftel would welcome views on whether it would be reasonable to take this approach. 4.30 It is possible that the condition attached to the purchase of subsidised equipment is that the customer subscribes to pay television services from a choice of operators. For example if there were two available sets of services customers might opt to subscribe to one or other – or possibly both. 4.31 In principle, the approach Oftel proposes to take where there are two or more pay-TV operators who stand to benefit from a tie-in would be as follows:
4.32 As discussed earlier in this chapter Oftel would take into account the benefit to BSkyB of a pay television tie-in as a condition of purchasing a receiver subsidised by BiB. There are particular issues raised in relation to BSkyB because BSkyB (‘BSkyB Wholesale’) supplies programming to other delivery mechanisms (eg cable and digital terrestrial) as well as to BSkyB’s own direct-to-home retail arm (BSkyB Retail). 4.33 The value of the tie-in depends on the profitability of the additional sales which BSkyB makes as a result of offering the tie-in. BSkyB Retail benefits from every additional sale that is made as a consequence of the tie-in, and its profitability is increased by the addition of each customer gained as a result of the tie-in. BSkyB Wholesale’s position is rather different. While there are also additional benefits flowing to BSkyB Wholesale which should be taken into account adjustments would need to be made to the calculation to reflect the fact that some of the customers won by BSkyB Retail because of the subsidy will have migrated from other systems, notably cable. The only benefit of the tie-in to BSkyB Wholesale is from those sales that would not have occurred, on any delivery system, without the tie in. 4.34 Oftel’s preliminary view is that the approach to valuing the benefit from any consumer tie-in with BSkyB’s television services is that the value would be the sum of:
4.35 This in turn raises the issue of whether account should be taken of the costs of encouraging BSkyB’s existing analogue customers to move to digital. Essentially this would involve taking a view on what would be likely to happen if there were no move to encourage these customers to move, and whether, in any event make it necessary for BSkyB to move to digital in order to prevent customers moving to rival delivery mechanisms (or to new entrant pay-TV operators). Oftel would welcome views on the methodology for valuing the benefit from a contractual tie-in and in particular on:
Valuing non-revenue benefits 4.36 Non-revenue benefits could present considerable valuation problems. The Director General would need to take a view on what was requisite and proportionate in the circumstances. Digital terrestrial television 4.37 This is a convenient place to consider the issues raised in the context of digital terrestrial television. Measures to accelerate consumer take-up of digital terrestrial services are one of the criteria laid down by the Broadcasting Act 1996 for the award of the digital terrestrial multiplexes. This primarily involves marketing and subsidy of consumer equipment. As part of its licence bid, British Digital Broadcasting committed itself to paying certain amounts for subsidy of consumer equipment). 4.38 Oftel recognises that there are valid arguments for and against the recovery of the subsidy made under the licence obligations. On the one hand, it could be argued that third parties should not be required to contribute toward meeting commitments made by BDB in its bid for the licence. On the other hand there are also valid arguments that not allowing recovery of this element of the subsidy would have the effect of penalising BDB for having made commitments, and that this approach arbitrarily distinguishes between it and broadcasters who enjoy the benefit of ‘gifted’ digital spectrum. 4.39 Oftel’s preliminary view is that a way through this dilemma could be found if subsidy recovery from third parties were ‘recycled’ to increase the overall total of subsidy – that is it would be ringfenced for spending on subsidy of consumer equipment. Oftel would welcome comments on this view. (It is recognised that the recycling process could have a number of iterations with the ringfenced sum reducing each time). 4.40 BDB may also wish to:
In Oftel’s initial view, it would be legitimate for charges for the use of additional facilities in the receiver to reflect any subsidy investment in providing those facilities. Neither do there appear to be objections in principle to third parties contributing to subsidies additional to those under made BDB’s licence obligations. Free-to-air broadcasters 4.41 Free-to-air broadcasters broadcasting ‘in the clear’ will not require use of the descrambling/scrambling facilities, but may require the use of the additional facilities if they wish to offer enhanced television services (eg interactive advertising). Oftel would take the view that it would not be unfair or unreasonable for access charges for such broadcasters to contain an appropriate contribution to the cost of providing these additional facilities. Oftel would welcome comments on whether, where part of the subsidy paid by BDB under its licence obligations is then recovered from third parties, that amount should be ringfenced for spending on subsidy of consumer equipment.
Access control charges Introduction 5.1 Having assessed whether the costs to be recovered from third parties were legitimate and efficiently-incurred it would then be necessary to assess whether the pricing framework was fair, reasonable and non-discriminatory. The major issue considered in this chapter is that of the relationship between prices for conditional access services for basic television (that is, scrambling and descrambling of video and audio signals) and access control charges in respect of interactive including the facilities need for enhanced television services. 5.2 The consultative document on the pricing of conditional access services for digital television sets out how Oftel would intend to approach this task in the context of basic television services. This chapter sets out Oftel’s view of how this approach might be extended to other access control services. The consultative document on pricing of conditional access services for television services 5.3 The chief tests Oftel proposes to use in assessing whether prices for conditional services for digital television were fair, reasonable and non-discriminatory, are that:
5.4 One of the key issues raised in relation to conditional access charges is the importance of common costs These are costs which are not directly caused by any individual set of activities. There are a wide range of ways in which such costs can be recovered from services, giving rise to a wide range of possible pricing structures. 5.5 Oftel has argued that the regulatory framework should permit conditional access operators to distinguish between different types of broadcaster in arriving at pricing strategies which make most efficient use of the system. An unnecessarily rigid and literal interpretation of non-discriminatory could have the effect of pricing some users off the system who might otherwise have been making use of the system and contributing additional revenue – such an outcome would result in increased costs for the remaining users. 5.6 Flexibility in pricing will be equally, if not more important, in relation to interactive services. However, such an approach could potentially give rise to the possibility of pricing schemes with extreme variations in prices with some categories of broadcaster or third-party service provider being charged at incremental cost and others at stand alone cost. Oftel would not wish to preclude from the outset charges for any particular category of broadcaster at or around incremental cost. In certain circumstances such charging arrangements may be economically efficient. Nevertheless Oftel also recognises that concepts of equity and proportionality are implicit within the term ‘fair, reasonable and non-discriminatory’ and these could be relevant if pricing schemes were to involve extreme disparities between different categories of broadcaster or third-party service provider. 5.7 Oftel’s initial view is that the approach outlined in the consultative document on pricing of conditional access services for basic television can be extended to access control services required to provide enhanced television services, data and interactive services. Oftel would welcome comments on its initial view that the approach outlined in the consultative document (summarised in paragraph 5.3 above) on pricing of conditional access services for basic television can be extended to access control services. Subsidy and the relationship between charges for access control and conditional access services 5.8 This following paragraphs consider the issue of the extent to which system operators should be free to determine the relative proportions of subsidy recoverable from either access control or conditional access services. 5.9 The element which is a common cost could in principle be distributed between the two types of services in a range of ways. In theory this could involve recovering all of the subsidy cost from one service and none from another. The chapter considers whether system operators should be free to decide on the balance of subsidy recovery between different categories of service – or whether Oftel should set floors and ceilings for the proportions recoverable from different services. Background 5.10 In Chapter 4 Oftel set out its view that, where the consumer is required to enter into a contract for services in order to be able to purchase subsidised equipment, the value of the subsidy recoverable from third parties (via access control or conditional access charges) should be abated to reflect the benefit derived from the tie-in. This would mean that where there is a tie-in with pay television services interactive service providers would not be required to contribute towards that element of the subsidy. 5.11 Chapter 4 also noted that DGIV were considering the competition implications of the subsidy arrangements proposed by BiB and whether the proposal to recover most proposed subsidy from interactive services would have a distorting effect on competition. General approach to pricing 5.12 Setting aside subsidy for one moment, Oftel’s general approach in considering the relationship between the prices for access control services and the prices for conditional access services would start from the principle that there should be no cross-subsidy (in either direction) between conditional access services for digital television and access control services. This means that charges for both categories of services would need to fall between the stand alone cost and the incremental cost; access control charges for interactive services would need to cover the costs of, for example: the use of the access control system and smart card, the testing and validation of applications and the authentication of the application on reception by the conditional access system. 5.13 The ceiling for the charges for each service would be the cost of a system which provided all of the necessary facilities for that service. The incremental cost would be the cost of adding the facilities necessary to provide the additional services given that the other services are already being supplied. Treatment of subsidy costs 5.14 Where the consumer equipment has been subsidised it would also be necessary to take into account the amount of the subsidy (appropriately adjusted as necessary). This raises the issue of the apportionment of the subsidy between the basic receiver and the additional facilities needed for interactive services. 5.15 It may be that the effect of the abatement of the subsidy recoverable from third parties to reflect the valuation of the benefit derived from consumer tie-ins has a significant impact on the amount of subsidy to be recovered and that the distribution between access control and conditional access services ceases to be a major concern. However, should this not prove the case Oftel would need to consider what approach to take. 5.16 One option would be to give system operators complete flexibility to decide which pricing structures to adopt. Where these gave rise to competition concerns action could be taken on a case-by-case basis. 5.17 This approach could lead to extreme distributions – potentially all of the costs might be recovered from one type of service, and none from the other. In a fully competitive market this would not generally be of concern: if the provider of the subsidy correctly judged the market it would recover its investment, but if it misjudged the market service providers would not use the system, and it would be forced to adjust its charging structures or risk losing money. However, it is arguable that the presence of significant gateways (the access control and conditional access system) means that the controllers of those gateways may have a degree of market power – that is the ability to set prices independently of customers or competitors. 5.18 A second option would be for the Director General to use his judgement of what was fair and reasonable to set out the floors and ceilings which should apply. 5.19 It is plausible that a subsidy provider would offer less subsidy for a TV-only box than for a box which also supported interactivity – and that the difference would be about the level of the incremental cost of the additional facilities to support interactivity. If this was a reasonable assumption to make it might in turn be then reasonable to deem that the subsidy cost is first of all attributable to the incremental costs of providing the additional service and that any remainder should be treated as a common cost. Example (all figures are purely for illustration):
5.21 There is a risk that such rules could have the effect of distorting the market. Limits on the proportion of subsidy which could be recovered from different types of service could result in providers of subsidy investing less in subsidy than they might otherwise have done. On the other hand, by creating a greater degree of certainty among service providers the effect of such rules might be to encourage more investment in new services than would otherwise have been the case. Oftel would welcome views on the two possible approaches outlined above which are:
Costs of additional facilities for interactive services or television 5.22 It has been suggested to Oftel that the additional costs of supporting interactivity (a modem, additional memory etc) are of the order of £60. It would require an extra £60 subsidy to sell an interactive receiver at the same price point as a basic receiver. There is similarly an additional cost for upgrading an interactive services-only set top box so that it is also able to receive and process digital TV video and audio signals, as well as descrambling pay television services. It has been suggested that these additional costs might be of the order of 20% of the total cost. Oftel would welcome submissions on the additional costs of adding either interactivity or television reception to a single-purpose box.
Competitive neutrality in access charges 6.1 A fundamental part of Oftel’s approach to the interpretation of ‘fair, reasonable and non-discriminatory’ is that the pricing framework should be competitively neutral – ie that it has not material effect on the terms of competition of players in the market. 6.2 In the consultative document and Statement on Pricing of Conditional Access services Oftel considered the issues raised in ensuring competitive neutrality in the pricing of conditional access. It is worth recalling that discussion because many of the same issues are raised in this context. The starting points for the discussion on conditional access were that while services would differ in the technical complexity of the facilities they required, a large element of the cost of operating the conditional access system were was that Oftel has already set out its approach in relation to the pricing of common costs which could not be directly attributed to any one set of activities. The preponderance of common costs meant that there was no one way to set a price for a particular activity. 6.3 This difficulty is compounded by the fact that the same or similar technical services might be required for commercially very different purposes: in particular a free-to-air broadcaster might require conditional access to ensure that its broadcasts could only be received in a given geographical area. This raised the issue of whether non-discrimination required that the free-to-air broadcaster paid the same as a subscription broadcaster for the same service. Such an approach would seem likely to result in free-to-air broadcasters being priced off the system. This in turn raised the issue of the degree of flexibility conditional access providers should have to be able to discriminate between different types of customer. 6.4 A number of possible pricing approaches have been proposed to this problem. These include basing prices on:
6.5 It is not for Oftel to mandate any one method or combination of methods. The issue for Oftel is how it might distinguish between discrimination which was legitimate and discrimination which could have an anti-competitive effect. The guidelines on conditional access pricing set out the methodology Oftel would use in the event of it being called on to investigate a complaint, to assess whether the prices offered did or did not constitute undue discrimination. To do this it would look at what prices were being offered to comparable broadcasters for the same or similar services. The categories Oftel’s proposes to use for comparing prices offered for conditional access services:
6.6 Similar issues arise in relation to access control charges. There is a need to permit flexibility in setting prices for different categories of service whilst at the same time ensuring that comparable users requiring the same or similar services should be treated in a comparable way. Oftel’s view is that the same principle and approach that it proposed for assessing conditional access charges should also apply in relation to other access charges. 6.7 Broadcasters may require conditional access services on their own or they may require access control services on their own, or they may require both. Broadcasters and interactive services providers may require similar access control services to offer services which compete in the retail market. For example:
In these circumstances the aim of achieving competitive neutrality would appear to require that the different types of service provider pay comparable charges for the same or similar access control service. 6.8 As noted in Chapter 2 different interactive services are likely to require different levels of access control services. This could range in complexity from, for example:
6.9 The same access control service (such as the validation of interactive applications) may be needed for commercially very different purposes. For example a ‘hotlink’ to a content page associated with an educational programme or a television advert would require the same technical facilities as a link between a television advert and the advertiser’s home page. Other examples of very commercially very different transactions which requiring similar technical services might be:
In these kind of circumstances it would be likely to be economically more efficient for the system operator to differentiate between the prices offered to different users for similar service. 6.10 Oftel’s preliminary view is that approach it would take to issues of discrimination in access control charges would be similar to that taken in relation to conditional access charges. That is, it would establish whether comparable users were paying comparable charges for the same or similar services. However, it seems likely that different categories would be appropriate. 6.11 There are also issues here about the extent to which discrimination is feasible between different types of service and the extent to which it is permissible. While it might be economically more efficient to distinguish between different types of service the extent to which it is feasible for system operators to do this may well be limited by the capabilities of the system and commercial considerations: for example the ability to adopt revenue-based pricing would require the ability to track the transactions made by the system. This would clearly be a complex task and in addition third party users might have concerns about the use of such a monitoring facility. Similar issues would be raised where there was an attempt to distinguish between different types of transaction. This does not necessarily preclude the adoption of such pricing approaches, but Oftel recognises the technical and commercial difficulties which might be raised. 6.12 At this stage, it may only be possible for system operators to distinguish between local interactive applications, and applications which involve remote interactivity. However, Oftel would not in principle preclude discrimination within these categories. 6.13 Oftel’s preliminary view is that the appropriate categories for it to use in assessing comparability between purchasers of access control services might be as follows:
6.14 It is important to stress that categories bound the areas within which the ability to discriminate would be subject to the requirement that such discrimination is objectively justifiable. The fact that discrimination between categories is permissible does not imply that system operators would be required to discriminate to this level. 6.15 There may also be good arguments for considering whether further distinctions might be made within the transactional services category, for example between high and low value transactions. This would in turn raise the issues of whether the pricing structure might have a distorting effect on pricing decisions. It might instead be necessary to distinguish between different types of service provider eg financial services, travel services etc. Oftel would welcome views on its proposal that the principle that comparable operators requiring the same or similar services should be treated in a comparable way should apply to access control charges as well as to charges for conditional access services. Oftel would welcome comments on its initial proposals on the possible categories of service which would be relevant in assessing comparability. 6.16 The most advanced proposals for the deployment of interactive services have come from British Interactive Broadcasting. This discussion therefore focuses on the issues raised by BiB. For the purposes of this discussion this document distinguishes between two entities:
SSSL would provide access control services to BiB ServicesCo and to other wholesale service providers. Acting on behalf of BiB BoxCo, it would seek to recover via these charges the investment made by BiB in the subsidy of consumer equipment. 6.17 The requirement for competitive neutrality is of particular importance where a system operator has links with a with a wholesale service provider and is also offering service to third parties who will compete with the service provider in downstream markets. In television services this concerns the prices for conditional access services offered by an integrated pay-TV operator to a third party broadcaster. In interactive services the issues centre on the access charges sought by the system operator (ie SSSL) to other providers of wholesale interactive services who would be competing with its own wholesale services operation (ie BiB ServicesCo). A key objective for Oftel is to ensure that such providers are not unfairly hindered from entering the market. 6.18 Such alternative wholesale service providers might seek to replicate the full range of interactive services. Alternatively they might concentrate on one area of activity – for example home shopping, interactive advertising, or online travel agency. This section considers the issues involved in ensuring that the pricing structure (including the mechanism for subsidy recovery) is competitively neutral as between wholesale service providers – whether ‘niche entrants’ or otherwise 6.19 Oftel’s view is that it is of fundamental importance that third parties including broadcasters wanting to enter the market to offer interactive and enhanced TV services should not be unreasonably prevented from doing so. Oftel would take the view that the total price paid by the new entrant proportionate to the scale of its activities. A pricing structure which had the effect of requiring that a new entrant would have to be able to replicate all of the BiB ServiceCo’s activities from ‘Day One’ would be likely to prove a barrier to entry by efficient operators and would be unlikely to be acceptable. More acceptable options might include:
These different pricing options would involve differing apportionments of risk between the wholesale service provider and system operator. Oftel would expect the prices to reflect the relative level of risk. Where the system operator bore all of the risk Oftel would expect that it would be appropriately rewarded. Equally, where it transferred some of that risk to the third party (eg where the third party contracted for a fixed level of transactions) Oftel would expect that transfer to be reflected in the pricing. Oftel would welcome comments on its view that:
Interrelationship of wholesale and retail prices 6.20 Paragraph 3.15 indicated that Oftel would not wish to become involved in regulating the prices charged by BiB ServicesCo to retailers and retail service providers. However, there is the potential that competition issues could arise where the prices set by BiB BoxCo for access control services were set at a level at which BiB ServicesCo was not profitable. BiB as a whole would be profitable while third-party wholesale service providers were either forced to exit the market or were deterred from entering it. Cost structure 6.21 It has been pointed out that the system operator’s costs (of which investment in subsidy is the major element) will be payable ‘up front’ and it will therefore have very large fixed costs, whereas a third-party entrant using its system may only have variable charges to pay. It could be argued that the pricing structure should be such that the system operator and third parties should face a similar cost structure. 6.22 Oftel recognises that in view of the fixed nature of the cost structure faced by the system operator, it may wish to offer a pricing structure which enables it to reduce its risk by sharing it with others. It may well, for example, offer more attractive terms where a wholesale service provider agrees to a long term agreement for a fixed quantity of services. Oftel’s preliminary view is that it would have no objection to this in principle provided that any discount reflected the costs saved by the system operator as the result of reducing the risk it bears. 6.23 Oftel would take a similar view to comparable arrangements – such as the use of bank guarantees – which resulted in cost savings due to a reduction in the level of risk borne by the system operator. 6.24 Oftel’s view is that there could be concerns if the system operator required third-party users to enter into long term fixed contracts obliging them to meet future commitments. The question of whether a particular agreement was acceptable would need to be considered in the light of the circumstances – eg the proposed length of the agreement and the nature of any future obligations. Oftel would welcome comments on its preliminary view that:
Lump sum payments 6.25 Linked with this is the issue of whether the system operator would be able to require a lump sum payment of the appropriate contribution to previously-incurred costs – a form of joining fee – or conversely whether it might be required to offer ‘easy payments’ or ‘pay as you go’. 6.26 Again, where the third-party user opted to make a lump sum payment, Oftel would expect any savings in cost to be reflected in discounts. Conversely, ‘pay as you go’ charges would reflect the additional financing and other charges. 6.27 Oftel would not necessarily object if the system operator were to offer only a lump sum alternative. Put another way, it would not necessarily be appropriate for Oftel to require it to offer payment by installments. This would depend on the circumstances. Oftel would however be concerned that such a payment scheme should not function as a deterrent to entry and that such payments should only be in respect of costs already incurred by the system operator as opposed to anticipated costs it has not yet incurred. Oftel would welcome comments on its views that:
Depreciation methods 6.28 In order to calculate the access charges at any point in time it is necessary to take account of the extent to which [subsidy] [investment] has already been recovered A number of methods could be used to calculate the gross subsidy figure but the simplest method would be to depreciate the gross figure over a period equal to the expected life of the equipment. Because of the way in which volumes of services – and therefore potential contributors to subsidy recovery might be expected to grow over time, it might be appropriate to profile the depreciation charges to smooth out prices in the early years. Cost of capital 6.29 The Consultative Document on the pricing of conditional access services for digital television set out Oftel’s basic approach to the assessment of cost of capital where there is a degree of specific risk which would not be taken fully into account through the normal Capital Asset Pricing Methodology used by regulatory authorities in determining firms’ cost of capital. This is reproduced at Annex 1. 6.30 In this context there is a further issue to be considered. The costs of establishing the system, particularly the investment in the subsidy of consumer equipment, are potentially recoverable from both conditional access services for digital television or access control services. 6.31 There are considerable uncertainties over the launch of digital television eg uncertainties over the speed of consumer take up etc. Nevertheless it seems reasonable to take the view that it is relatively less risky than interactive services – services which are new and unfamiliar to the consumer and where service providers are still working to develop business models. 6.32 The riskiness of BiB BoxCo and therefore the appropriate cost of capital will depend on the degree of flexibility it has in choosing where to recover its investment. If it were the case that the relative levels of charges could be renegotiated, then this would reduce BiB BoxCo’s level of risk – at the extreme if interactive services did not take off then it would still be able to recover the residual proportion of the subsidy investment (ie the residual following adjustment of the total subsidy level to reflect the value of the consumer tie-in, and the deduction of the subsidy attributable to facilities interactive services, as well as depreciation) from television services. The level of risk would therefore be closer to that of television services. 6.33 This would in turn have implications for access charges in that the maximum allowable revenues would be set at a lower level reflecting the fact that the levels of risk for the combined business (ie television and interactive services) are lower than they would be for interactivity alone. It should also be noted that, by the same token combined business would have a higher level of risk than the television-related conditional access business on its own. 6.34 Conversely if it is restricted in its ability to determine where to recover its investment then there is a proportion of its investment which would have to be written-off in the event of the failure of interactive services to take off. The riskiness of this proportion of its investment would be at a higher level appropriate to interactive services. 6.35 BiB have indicated that BiB BoxCo would not be able to vary the distribution between interactive services and television services – this would remain fixed at 90:10. Recovery of 90 per cent of the investment is therefore linked to the success of interactive services. At the extreme if interactive services did not take off 90 per cent of the investment would have to be written off. 6.36 Oftel would stress that the scenarios used in this discussion have been chosen purely to express the argument in the clearest terms – they do not in any way represent an Oftel view of the prospects for this market. 6.37 In view of the level of risk Oftel would expect that the expected rates of return which investors would reasonably look for from in the event of the project being successful would be comparable to the hurdle rates used in innovative capital projects. 6.38 However, there are two issues which would need to be considered:
6.39 Oftel’s view, subject to consultation would be that in estimating the cost of capital either for conditional access services or interactive services, it should take the approach that the risks of both businesses were diversifiable across the combined business and that it should it should assume that these risks had been diversified. The assumed cost of capital for either category of services would reflect the level of risk for the combined business. Oftel would welcome views on its proposed approach which would be to
Annex I Cost of capital Introduction 1 A firm’s cost of capital can be defined as the rate of return that could be earned in the capital market on securities of equivalent risk. In general, the higher the riskiness of the firm's activities, the higher its cost of capital, since investors typically require compensation for greater risk. For a firm financed by debt and equity, the cost of capital will be a weighted average of its cost of capital from both sources. The following paragraphs describe the general techniques used to derive the cost of equity and debt. Cost of equity 2 Two main methods are typically used to establish a firm’s cost of equity. The most widely used model for estimating the equity cost of capital is the Capital Asset Pricing Model (CAPM). The basic premise of this model is that investors require a higher expected rate of return on any investment in order to compensate them for a higher risk of returns on that investment (as measured by the variability of those returns). 3 Investors are assumed to be able to reduce risks by holding diversified portfolios of equities. However, there is a degree of systematic risk inherent in even the most diversified portfolio of shares, since the value of the whole stock market can rise or fall, reflecting the risk inherent in the general economy. 4 This non-diversifiable risk cannot be eliminated by holding shares in a large number of companies, and is therefore a component of the cost of equity. If the risk-free rate is that rate of return which investors would be able to earn with certainty, the market risk premium is that additional return that investors would require in order to compensate them for holding a share whose returns moved in line with those of the stock market as a whole. 5 Returns on shares in some companies will fluctuate in step with, but more widely than, returns to the stock market as a whole. Returns on other types of shares will fluctuate in step with, but less widely than, the stock market as a whole. Others still could move against the market. The degree of correlation between returns on shares in one company and returns on the stock market as a whole can be estimated using dividend and share price data and is captured in a coefficient known as the company’s Beta. A company showing higher than average non-diversifiable risk will have a Beta coefficient in excess of one, while a company showing lower than average non-diversifiable risk will have a Beta less than one. 6 The cost of equity to the firm can then be calculated according to the basic CAPM formula: Re = Rf + Beta.[E(Rm) – Rf], : where Re is the cost of equity finance, Rf is the risk-free rate of return, Beta is the degree of correlation between returns on the company's shares and returns on the stock market as a whole, E(Rm) is the expected return on the market and E(Rm) – Rf is the expected market risk premium or excess return to equities. 7 This calculation can be done in real or nominal terms. The two should have identical implications for measuring the financial performance of the enterprise, provided that the inflation rate assumed in the financial forecasts is the same as that implied by the difference between the estimated real and nominal cost of capital. 8 One criticism often levelled at the CAPM is that the calculation of the equity premium is based on historic excess returns on equities rather than the returns that investors expected to achieve. Since investors base their decisions today on expectations of returns and their variability in the future, it would appear preferable to look at expectations directly. This is particularly important in the light of evidence that suggests that the risk premium varies over time, so that estimates of historic excess returns may not be a reliable guide to excess returns required in the near future. Cost of debt 9 In the absence of specific information on the interest rates being paid by the firm in question, the pre-tax cost of debt is typically calculated by adding a small corporate risk premium to an estimate of the risk-free rate of return, as proxied by the return on government debt used in the CAPM calculation. Specific risk 10 In the case of conditional access there are the additional risks that are not reflected in the Beta coefficient. Oftel recognises that it will be necessary to take these risks into account in assessing whether the level of the projected cashflows were fair and reasonable having regard to probability of the investment succeeding or failing. If a group of investors are investing in a series of projects of which they estimate that a given proportion will be failures, then the successful projects will need to earn sufficient revenues not only to cover their own costs but also to cover the costs of the failures. Examples of such projects would include oil exploration and film production where it is usually expected that some projects will fail. 11 Strictly speaking the approach Oftel proposes is not to adjust the cost of capital derived from the CAPM methodology, but instead to calculate the expected revenues which would result in the project representing a ‘fair bet’ for investors. A ‘fair bet’ is one where, if the bet were repeated a sufficient number of times the gamblers would get their stake back. Suppose that a bet was offered on the toss of a £1 coin so that if successful the players would make £2 and if unsuccessful they would lose their stake. This would give a return of 100% to the successful player. A return of 100% might in isolation seem very attractive, but the 50% probability of losing the investment altogether must be taken into account. The expected outcome of this bet, if played out a number of times, would be for each of the players to end up with their stake money and no more – that is, no return would be made, even though a return of 100% was possible on any individual bet. 12 In the context of project investment, the notion of a ‘fair bet’ would be that, averaged over a number of projects, investors would cover their costs including the cost of capital. high returns might be made in some outcomes, but the expected value of cashflows – after factoring in all possible outcomes, with their associated probabilities – would result in returns equal to the cost of capital.
Glossary Access control services. The services which third parties require in order to use the system to offer interactive services. Application Programme Interface (API) Software in the receiver which interprets a set of commands telling it, for instance, where to display a graphic or other object on the screen. The API also allows the same applications to run on different receiver designs without the need for the application to be rewritten for each one. Beta The co-efficient which measures the degree of correlation between the returns on shares in a particular company and returns on the stock market as a whole. In the Capital Asset Pricing Model, the higher a firm’s Beta, the greater the systematic riskiness of an investment in that firm’s shares (a Beta coefficient of one implying that the firm is of average risk). Common costs Costs that are incurred in the supply of all or a group of services provided by the firm and cannot be directly attributed to any one service. Cost of capital A firm’s cost of capital can be defined as the rate of return that could be earned in the capital market on securities of equivalent risk. In general, the higher the riskiness of the firm's activities, the higher its cost of capital, since investors typically require compensation for greater risk. For a firm financed by debt and equity, the cost of capital will be a weighted average of its cost of capital from both source. DGIV This acronym is short for Directorate General IV of the European Commission which is responsible for enforcing the competition provisions of the Treaty of Rome. Electronic Programme Guide (EPG) Software in the receiver which takes data on programmes and displays these in the form of an on-screen guide. the guide displays information about what is on now and next on each channel as well as future programmes. Viewers may also be able to use the on-screen menus to order pay per-vie services or to access interactive services. Enhanced television services Television services which include interactive applications as well as audio and video. The term is used in this document to distinguish these services from basic television services ie sound, picture and text. Free-to-air television service A television service which can be received in a given area without charge to the viewer. Some free-to-air services may be broadcast in scrambled form in order to limit access to viewers in a specific geographic area. Other free-to-air services may be broadcast in the clear – ie unscrambled . Incremental costs The costs that arise asa result of the provision of the ‘increment’. So long as revenue exceeds incremental costs, the firm improves its profitability by providing the increment. Interactive services This term covers two forms of interactivity. The first is where viewers use the remote control to click to applications, which are included in the broadcast stream. The second form of interactivity is where the modem is used to communicate with a remote server. In-the-clear television service Television services that are broadcast without scrambling and are thus, accessible by all viewers within the reception area who have the necessary equipment. In-the-clear services are a sub-set of free-to-air services. Pay-per-view television service A television service where the viewer pays to watch a specific event (eg a sporting event, or film). Existing pay-per-view systems require the viewer to ring a customer management centre; impulse pay-per-view systems will enable viewers to purchase the right to see an event using an on-screen menu and their remote control and be authorised immediately. Stand-alone costs The costs to a firm of providing a service if it produces only that service and no other. Subscription television service A television service which is purchased by subscription (as opposed to pay-per-view or free-to-air). Subscription television services are usually classified into a basic tier of general news and entertainment channels and premium services (sports and films). System The computers and associated software and software interfaces which provide the facilities and arrangements for enabling transactions etc. System operator The organisation which has overall responsibility for managing the system and in particular for its security. Wholesale service provider The organisation which provides the computer servers, needed for the playout of video and data and the reception and processing of responses from consumers via modem. The wholesale service provider might also provide other services to retailers and retail service providers such as design and writing applications. Wholesale interactive services The ability to offer
retail goods and services to the end customer rather than the goods
or services themselves. |
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