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Executive summary

1.1 On 4 April 2007, we published the first phase of Ofcom’s financial review of Channel 4, which comprised LEK’s assessment of the Channel 4 Group’s future financial prospects, Channel 4’s submission on its public service contribution and our own analysis of Channel 4’s remit delivery. We also published a Foreword to these reports which set out possible options for next steps in the review.

1.2 This statement sets out our view of the implications of these reports for the Group’s funding and operating model, and for regulatory and Government policy. It also confirms what we intend to do next to address the issues raised.

1.3 In the most likely scenarios, LEK’s analysis of Channel 4’s business model points to declining profits from 2008 onwards. However in these scenarios Channel 4’s cash reserves are more than sufficient to ensure the survival of the core channel until at least 2010, fluctuations in working capital notwithstanding. In more positive scenarios, LEK’s analysis indicates that Channel 4’s business model may be able to deliver stable profits and growing cash balances throughout the period to 2012. This suggests that in LEK's projections there are unlikely to be immediate, intractable financial pressures that would require Channel 4 to make significant reductions in its remit delivery before around 2010.

1.4 From 2010 onwards, LEK suggests that financial pressures on the core channel are likely to grow. The timing and extent of the pressures cannot be predicted with certainty. However, if the programme mix remains unchanged, LEK’s analysis suggests that Channel 4’s commercial performance is likely to deteriorate, as a result of increasing competition for its most profitable programmes, and some ongoing inflation in other programme costs at a time of flat or declining advertising revenues.

1.5 The Group’s digital-only channels, new commercial investments and cost-cutting measures should help to reduce deficits on the core channel. But LEK’s analysis suggests that they will not offset them entirely, resulting in the Group moving into deficit after 2010 (in LEK’s central, most likely case).

1.6 The central question for Ofcom is what impact this might have on Channel 4’s contribution to public service broadcasting (PSB). Our analysis indicates that Channel 4 has changed the way it delivers its remit over time, although it continues to deliver the quantifiable elements of its remit, and consistently meets or exceeds its licence obligations. Channel 4 suggests that changes have been necessary to maintain the channel’s impact in a more competitive environment, but overall they have also had the effect of improving its commercial position by reducing the cost of less profitable elements of its schedule. Recent changes in Channel 4’s output include an increase in hours of current affairs in peak, but a shift from serious factual programming to more accessible and commercial educational output, and reduced spend on programmes in some core PSB genres – news, arts, current affairs and religion. Over the same period, Channel 4’s spend on acquired programmes has increased, partly as a result of increasing competition for those programmes, and its hours of originated programming have declined by 6% since 2001.

1.7 We invited stakeholders to submit evidence to inform our assessment of LEK’s report and our remit analysis. Over 120 individuals and organisations provided responses. We have considered these contributions, which make a number of important points. Variously, stakeholders argue that:

• Channel 4 makes an essential and distinctive contribution to PSB, the independent production sector and the wider creative economy, and short-term and long-term measures to safeguard its contribution should be considered immediately;
• Channel 4’s position in the market is stronger than LEK’s analysis suggests, and there are self-help steps Channel 4 can take to shore up its financial performance. Therefore LEK’s report does not indicate a need for immediate action, and may be too pessimistic about its longer-term prospects;
• The assumption that we asked Channel 4 and LEK to base their forecasts on, that Channel 4’s programme mix remains unchanged, does not reflect the way Channel 4 would respond to financial pressures in practice. In reality Channel 4 has frequently adapted the way it delivers its remit over the years, and can continue to do so if it does face financial pressures in future;
• Even if Channel 4’s funding model will be fundamentally weakened at some point in future, the correct response is to review Channel 4’s role and strategy in the light of broader public service broadcasting objectives, rather than moving immediately to consider options for intervening to prop up its funding model;
• With respect to possible measures to support Channel 4, some advocated allowing Channel 4 to produce some programming in-house while others argued strongly against it; and
• The evidence published in Ofcom’s report on Channel 4’s remit delivery raises concerns about the governance and accountability arrangements for Channel 4.

1.8 Channel 4, in its public response to the first phase of the review, supports much of LEK’s report, but argues that the extent and timing of financial pressures will be closer to LEK’s low case than its central case, based on market trends and Channel 4’s financial performance in 2007 to date. It says it will continue to look at all sensible self-help measures but disputes that significant further cost reductions can be made, without a consequent impact on Channel 4’s public service contribution, commercial performance or ability to invest in new businesses that will establish future profit streams.

1.9 We agree that there is significant uncertainty about the future, both with respect to Channel 4’s financial performance and the options open to it to change its programme mix and strategy in response to changing financial circumstances. We note that LEK believes that cost savings can be made, and consider that in the face of a declining business model any organisation would carefully examine all possible ways of improving efficiency. However we recognise that LEK’s analysis suggests that cost savings will not be sufficient to relieve the growing financial pressures on Channel 4 over the next few years.

1.10 We also recognise that changes in the way Channel 4 delivers its remit in response to changing financial circumstances are not inherently problematic. Indeed it is a strength of Channel 4’s remit, funding and operating model and regulatory regime that it is possible for the channel to make such changes from year to year. There are three factors, however, that give us cause for concern.

1.11 The first is that LEK’s analysis describes a period of sustained and significant financial pressure, which results in Channel 4’s above-average profits – which have historically funded its uncommercial programming, including much of its remit programming – being largely competed away. We agree that this is not the only plausible scenario – Oliver & Ohlbaum’s work for the BBC provides another, more optimistic one. However, there are also plausible scenarios that are more negative than LEK’s central case, including the scenario prepared by Channel 4 itself. We believe it would be wrong to discount entirely the possibility that significant financial problems could emerge that would affect Channel 4’s ability to deliver its remit within the timeframe covered by LEK’s forecasts.

1.12 Secondly, the most likely outcome of sustained financial pressure would be reduced investment in programming and other activity that supports Channel 4’s delivery of its remit. In the long run this could have a significant impact on Channel 4’s contribution to public service broadcasting. Channel 4 has a certain amount of leeway to change the way it delivers its remit without necessarily undermining its overall PSB contribution. However, recent changes in the way Channel 4 delivers its remit, which have taken place at a time of commercial health for the channel, have already acted to reduce its investment or output in some core PSB genres. Channel 4 has already indicated that its response to financial pressure will be further reductions in its PSB output.

1.13 Our third concern is that it is difficult currently to assess effectively the impact of changes in Channel 4’s programme mix on its overall PSB contribution. Channel 4’s remit is defined relatively loosely, enabling it to interpret the remit in ways that change as its audiences’ needs and its financial circumstances change. However, as we noted in our report on remit delivery, at present we believe there is no framework that fully allows us or Channel 4 to measure the impact of changes in the way it interprets and delivers its remit on public purposes.

1.14 Based on the evidence provided by LEK, Channel 4, stakeholders’ submissions and our analysis of remit delivery, our considered position is as follows:

• It is reasonably likely that Channel 4 will face increased financial pressures in the medium-term;
• These pressures are likely to result in renewed pressure on its remit delivery from around 2010;
• Over time, this pressure could significantly weaken Channel 4’s overall contribution to the purposes of public service broadcasting; and
• In this context, the current monitoring and reporting framework should be significantly developed to measure fully Channel 4’s overall PSB contribution, to assess the impact of particular changes to its programme mix on that overall contribution and to report on these assessments.

1.15 When we published the first phase of the review in April, we set out four options for our next steps:

1. To recommend that further public support for Channel 4 should be ruled out for the foreseeable future;
2. To monitor Channel 4’s financial performance and remit delivery closely, and review the case for future intervention again as and when there is more evidence available;
3. To consider what limited ‘safety net’ measures could be put in place to mitigate this and any medium term risk, and review potential options for more significant intervention at a later date; or
4. To move directly to make a detailed assessment of the options for intervention.

1.16 In the first PSB Review, we stated that a not-for-profit, commercially funded Channel 4 would be an important part of the PSB landscape, and should remain so up to switchover and beyond. The Government’s White Paper on the future of the BBC also restated its support for Channel 4’s public service role and welcomed Channel 4’s moves to strengthen its commitment to providing high quality, diverse public service content across an increasing range of channels and platforms.

1.17 In this context, we believe the analysis set out above rules out the first of our options. It is likely that challenges to Channel 4’s funding and operating model will grow in the medium-term, and that these could pose a risk to its delivery of public purposes. In order to inform the Government’s long-term decision-making with respect to public service broadcasting, we should consider whether those public purposes will remain valid as we move into a digital era. If they do, we should consider all possible options for ensuring they continue to be met, whether by Channel 4 or by some other means.

1.18 Nor do we believe that our fourth option is appropriate. LEK’s evidence suggests that the threats to Channel 4’s PSB contribution are not immediate, and there is no need to act precipitately or without fully considering all the options. Indeed, given that many of the measures would be for Government to take forward, and would require primary legislation, it is not clear that it would be possible to introduce major structural reform quickly.

1.19 Our preferred approach therefore lies between our second and third options, and consideration of the timing of any intervention has been critical in reaching this decision. Our initial assessment of the short-term options available to Ofcom to relieve any financial pressure on Channel 4 suggests that these options are limited. Most of Ofcom’s powers relate to Channel 4’s quotas, for news, current affairs, schools programmes, out-of-London production and original programming; these measures would tend to have the effect of reducing Channel 4’s public service delivery, rather than strengthening it, and so on the face of it are unattractive responses to growing financial pressure.

1.20 Other levers lie in Government’s or Parliament’s hands, and there is a wide range of possible action that could be taken. We have not attempted systematically to identify or evaluate all the options at this stage. However, it is clear that many of them would require primary legislation, and are likely to take several years to consider and implement. In addition, the Government may wish to complete its broader review of funding of PSB before initiating any particular course of action with respect to Channel 4. It has said it intends to complete this review towards the end of switchover, although it has retained the option of conducting an earlier review before the end of the decade.

1.21 Therefore, it could be at least 2011-12 before any long-term policy for continued delivery of public purposes is in place. Given uncertainty in Channel 4’s financial prospects towards the end of this period, it may be appropriate for Government to consider Channel 4’s requests for short-term support during this period. In our assessment, and subject to the application of any relevant competition rules, short-term measures would be appropriate if they helped Channel 4 avoid making reductions in its public service delivery in response to uncertainty about its financial position. Such measures would in our view need to have the following characteristics:

• They would provide support during the transitional period, between now and (roughly) 2011-12;
• Their impact could be quantified, and known to Channel 4, with a reasonable degree of certainty;
• Channel 4 would be able to demonstrate how they would help the core channel continue to deliver its remit;
• They would not have any lasting consequences or implications that might prejudge the Government’s longer-term policy for Channel 4.

1.22 With respect to our next steps in the financial review, and based on the timetable summarised above, we have reached three conclusions:

• Monitoring of Channel 4’s financial performance and public service delivery should be significantly enhanced;
• We should start work on evaluating options for medium- to long-term intervention to secure public purposes in the context of the next PSB Review, which we are proposing to bring forward to begin later this year; and
• The Channel 4 Board should publicly articulate its own vision of the Group’s future public service role, governance and funding, to inform our PSB Review and the Government’s longer-term decision-making.

1.23 First, there is a case for significantly developing the ways in which Channel 4’s financial performance and public service delivery are monitored. If the commercial environment proves less challenging than LEK expects, or Channel 4’s commercial businesses deliver larger or earlier returns than anticipated, the need for intervention may be reduced or changed. But if financial pressures emerge more quickly than LEK expects, our analysis suggests that the most immediate impact might be on Channel 4’s public service contribution. To understand fully the impact of pressures on Channel 4’s public service model therefore requires an understanding over time of both its financial performance and its public service delivery.

1.24 The Channel 4 Board also has an interest in such an enhanced monitoring regime. In recent years it has become more important for public bodies to have systems in place to measure their impact and the return on public investment in their activities, and public service broadcasters have been part of this trend. It would not be appropriate for Channel 4 to have a governance process as elaborate as the BBC’s, given its different status and funding model. Nonetheless, it seems to us that further mechanisms that enable the Board to assess the Group’s current and future public service contribution would be of value as it develops the Group’s public service strategy during a period of increased financial uncertainty. We anticipate that the work underway within Channel 4 to assess its public value, including a basket of measures addressing the different aspects of its remit delivery, will provide the foundation for these mechanisms.

1.25 We therefore intend to work with Channel 4 to put a monitoring process in place, for its financial performance and its public service delivery. We believe that this will support the Channel 4 Board in setting expectations for the Group’s public service delivery, and monitoring performance against those expectations, as well as providing information that we and Government will need to make future policy. We should be clear that the purpose of such a process is not for Ofcom to take on any greater role in approving Channel 4’s remit delivery, nor for Ofcom or Government to set Channel 4’s strategy. Those functions remain the responsibility of the Channel 4 Board. Development of the monitoring regime should be geared to helping the Board operate effectively and transparently, and should not hinder its capacity for timely and independent action.

1.26 The Channel 4 Board should take the lead on developing the specific elements of this monitoring process, which should be rigorous and objective, but not unduly complex or cumbersome. Its core elements could include:

• An enhanced framework for measuring Channel 4’s PSB contribution and assessing the impact of changes to the way it delivers its remit;
• Published reports from Channel 4 on its remit delivery and its plans for the future, using this framework;
• Reports from Channel 4 to Government and Ofcom about its financial performance and future prospects; and
• Analysis of the links between Channel 4’s financial performance and prospects and its likely future remit delivery.

1.27 Second, we should start work on evaluating options for medium- to long-term intervention, to inform Government’s and Parliament’s decision-making. We have already announced that we will bring forward the start of the next full PSB Review to late 2007, and as one element of that Review will carry out an assessment of the full range of options for the future of Channel 4.

1.28 There are a number of possible long-term outcomes, with different implications for Channel 4’s remit, funding and accountability processes. These options need careful consideration, and given that it is likely to take some time to identify and implement the most appropriate solution, we believe we should start this work sooner rather than later. We believe that it will be important for Government to make decisions about Channel 4’s future role in the context of a wider strategy for the delivery of PSB in a digital age. For these reasons, we believe it will be most effective to carry out our assessment as part of the next PSB Review.

1.29 Finally, it will be important during this period for the Channel 4 Board to articulate publicly its vision of the Group’s role and strategy, particularly with respect to its future contribution to public service purposes, to inform our assessment and Government’s decision-making. As we consider the scope for our next PSB Review, we would welcome further input from the Board on issues such as: its plans for Channel 4’s role and remit in a digital age; its preferred funding and operational model; the resources required to deliver this model; and the nature of accountability arrangements, appropriate for the preferred approach. This thinking would inform both our own PSB Review and the Government’s thinking about Channel 4’s role in the wider PSB ecology.

The full document is available below

• Channel 4 Financial Review - Statement [pdf]
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