132. We believe that there are a number of public interest issues which need to be taken into account in considering whether further regulatory action is required: of these we would argue a key consideration is that of local network competition in telecommunications.

133. The DGFT recently set out three criteria he intends to use in this and similar cases in considering whether to make an MMC reference. The Director said that he would only make an MMC reference where:

a. it seems clear that a business with market power is using that market power in ways that threaten the competitive process or exploit its customers;

b. its market power seems likely to persist; and

c. intervention under competition legislation would be a proportionate response and likely to lead to an improvement in the situation.

134. These criteria seem to us to be highly relevant. We have taken the view that Sky has market power (ie a dominant position). The analysis set out in this submission suggests there are good grounds for considering that its pricing and other practices are tending to hold back the development of the cable companies and therefore are threatening the prospects for competition in pay-TV in both the short and long term, this in turn threatens the competitive process in the telecommunications market.

135. There are good grounds for believing that without intervention the prospects for a competitive market will not improve, and Sky will continue to retain a substantial degree of market power. This has four aspects:

a. no one knows for certain when digital services will be launched in this country or how quickly the 'migration' of existing analogue satellite and cable subscribers to digital will take place. It may well be that that transition will continue into the early years of the next decade. Reliance on an early or rapid transition might prove unwise;

b. the transition to digital services will open up the greater opportunities for new entrants - whether this translates into effective competition will depend in part on perceptions of the robustness of the regulatory framework;

c. while cable companies are gaining a growing share of the UK pay-TV subscriber base, whether and when they overtake Sky as the majority network will depend on their success in achieving penetration (as well as on the growth rate of Sky's DTH business). If the cable companies are constrained into following Sky's pricing strategy and are unable to devise more appropriate marketing strategies to achieve higher penetration this could substantially delay the point at which they achieve parity;

d. the cable companies' growing subscriber base will undoubtedly increase their bargaining power as customers in the wholesale market for premium and other channels - this is not however a guarantee of greater competition in that market. It is possible that the market could take the form of a very few large customers with a single dominant supplier. The safeguards to ensure that opportunities for entry by rival channel suppliers are not forestalled will remain a critical issue.

In our view, appropriate action is essential to maintain the prospect of a competitive market in the future.

136. The Director's third criterion was that regulatory action should be proportionate. In this context DGFT's powers under s.56A of the Act, to accept undertakings in lieu of reference, seem very relevant. Our suggestions on remedies which might be embodied in any undertakings are set out at the end of the relevant sections of the submission and are brought together at the end of this section.

137. Undertakings along the lines suggested would:

• demonstrate to investors and potential investors in the UK telecommunications and pay-TV markets that the framework exists to ensure fair competition. This is important not just to investors in cable, but also to those considering investment in digital terrestrial television and other future services;
• set out for Sky a clear framework in which it can operate.
• provide the basis for a durable settlement between the cable companies and Sky which would avoid the necessity for continuing ad-hoc regulatory intervention and allow both sides to concentrate on improving services and growing their businesses;
• improve the prospects for the development of competition in all parts of the market.
  

138. We appreciate these proposals imply a degree of continuing regulatory oversight however the intention is that they should be effective while minimising the degree of day-to-day regulatory intrusion - once the framework had been put in place the regulator could stand back. We would also note that the existing undertakings and rate card have neither succeeded in enabling the regulator to disengage or in improving the prospects for future competition. The proposals could lay the basis for the regulator to reduce the scope of the undertakings in the medium term (in say 3 to 4 years), but even if this proves not to be the case, a degree of regulatory intervention now, could in our view avoid the need for drastic action later. The transition to digital and other developments offer the potential for greater competition in the future but without action now that potential may not be realised.

SUMMARY OF POSSIBLE REMEDIES

Network Access

139. Conditional access and subscriber management for analogue services: We believe that consideration might also be given to making provision in the undertakings for requirements on the provision of encryption and subscriber management services to third parties. Although it is the subject of a separate RTPA investigation we would not support approval of any licensing agreement between News Datacom and Sky which required the use of the Livingston subscriber management service as a condition of the use of the VideoCrypt encryption system.

The Rate Card

140. On the rate card there are three issue, ensuring non-discriminatory pricing, the link between the Sky wholesale price and the DTH retail price, and discounts:

Ensuring non-discriminatory pricing: In our view, given Sky's position in both the market for the wholesale supply of programming and the retail-distribution market, non-discriminatory pricing based on accounting separation is a key safeguard against abuse and should be a central part any undertakings. Oftel has considerable experience in this area and would be happy to assist. Our experience in telecommunications suggests that for it to be effective accounting separation should involve:

• the publication of the accounts at regular intervals (every 6 months). We believe that publication of the accounts ensures that the accounting separation arrangements are subject to informed scrutiny by the industry a process which yields essential information to the regulator;
• independent audit to regulatory standards;
• clear ground rules on the attribution of costs;
• clear transfer charges;
• provision for modification of the arrangements in the light of experience.
  

We believe that the obligation not to discriminate in favour of the retail business should not be dependent on the production of separate accounts.

Linkage between wholesale price and DTH price: Our view is that non-discriminatory wholesale prices per channel (based on a proper distribution of costs) provides the right basis to go forward. This would also provide a baseline against which issues of predatory pricing might be judged should they ever arise.

Discounts: our view is that at the very least the incentive arrangements should not involve a penalty for promoting the sale of basic-only services. We would suggest that consideration be given to discounts relating to the levels of premium subscribers - expressed either in absolute terms or as a percentage of homes marketed (as distinct from basic sales). We believe that a discount per channel would be most in line with the objective of preventing channel bundling - we would not support the continuation of a channel carriage discount.

Security of supply and other contractual terms

141. The issues here appear to be, the length of contracts, provision for price review, consistency of content, provisions for independent arbitration and advertising avails:

Length of contract: we suggest that the undertaking provide for a minimum contract length or even a rolling contract;

Price review and consistency of supply: the undertakings a should make provision to secure a degree of predictability as to the timing and amount of price increases and a degree of predictability and consistency of channel content. This should not inhibit Sky's ability to offer genuinely additional services;

Independent arbitration: the suggestions on length of contract and price review etc. will depend on appropriate arrangements for independent arbitration.

Advertising: our view would be that Sky should provide ad avails in line with standard industry practice. Arrangements for independent technical assessment could be put in place to deal with any questions as to the technical capability of the cable operator to make the necessary insertions.

Channel packaging

142. On channel packaging the key issues seem to be bundling of premium with other channels, cross-advertising, the terms of supply of Sky News and Sky One, the restrictions on the ability to sell premium channels on a stand-alone basis, and the exclusive wholesale distribution arrangements for third party channels:

Bundling: the contract withe the cable companies should explicitly provide for separate purchase of individual channels or for certain channels not to be carried.

Advertising: we would suggest that the undertakings require Sky not to cross-promote channels if the cable operator does not have the ability to opt out from them. These opt-outs could provide the ad avails suggested above. the same provision should apply to offers restricted to Sky DTH subscribers.

Obligation to provide Sky One and Sky News to all basic subscribers: it may be that this issue can be simply addressed by unbundling ie specifically providing for the cable operators to be able not to take specific channels if they do not wish to do so (this assumes that the real strength of Sky's bargaining position lies in its premium programming). There may well however be a need for the undertakings to make provision for independent arbitration where this cannot be resolved (this might for example settle that the proportion of guaranteed subscribers be in line with standard industry practice);

Wholesale distribution of third party channels: we support the OFT's effort to require that Disney should not be supplied in the wholesale market exclusively through Sky. There must however be a question mark over the effectiveness of this without a requirement on Sky to unbundle.

Office for Telecommunications, February 1996

Go to next section of this document