Review of ITV Networking Arrangements

Summary

1.1 We have decided, following consultation with stakeholders, that the system of cost sharing between Channel 3 licensees specified in the existing Networking Arrangements should be retained for the moment.

The requirements upon Ofcom

1.2 The ITV Networking Arrangements (the 'NWA') are a set of arrangements between the holders of the 15 regional Channel 3 licences (the 'Channel 3 licensees'). The statutory purpose of the NWA is to enable the Channel 3 licensees, when taken as a whole, to be a nationwide system of services which is capable of competing effectively with other television broadcast services in the UK.

1.3 Ofcom has a statutory duty to carry out a general review of the NWA from time to time under section 293 of the Communications Act 2003 (the 'Act'). Essentially such a review is intended to assess whether the arrangements enable the licensees to meet the statutory objective to provide a competitive, regionalised Channel 3 service. If, following a review, we conclude that modifications to the NWA are necessary, we can require the Channel 3 licensees to give effect to any modifications that we propose.

1.4 In considering whether to propose modifications to the NWA, we are required under Schedule 11 of the Act to consider whether the agreements would, as modified, represent a satisfactory means of achieving their statutory purpose. We must also take account of the likely effect of modified NWA on the ability of the Channel 3 licensees to maintain the quality and range of regional programming and other programming which contributes to the regional character of the services. We may not propose modifications if we consider they are likely to prove prejudicial to the ability of the licensees to comply with their public service or regional programming obligations or if they fail to satisfy certain specified competition tests.

The current review

1.5 During our second review of public service broadcasting ('PSB'), both ITV plc and the non-consolidated licensees ('NCLs') submitted evidence suggesting that the approach used to allocate network costs between the regional licensees was inequitable. Both sides argued that the existing structures provided a significant net benefit to the other group of licensees.

1.6 In the PSB review statement, we noted that the NWA had since their inception in the early 1990s provided different degrees of benefit to the different licensees. We also recognised that the value of the regional licences was in decline and acknowledged that unless all of the regional licensees were willing participants in the network, the existing arrangements would become unsustainable. We said that we would consider the issues identified by the licensees as part of our next review of the NWA.

1.7 We issued a consultation document on the NWA in July 2010. In the consultation, we examined the reports submitted to us separately by ITV plc and NCLs during the PSB review. Using the information contained in these reports, we set out to build up a picture of the cost sharing arrangements between the licensees and evaluate the impact of those arrangements on each party.

1.8 In light of the many complex financial arrangements between the licensees and the licensees' differing views about the status of those arrangements, we first sought to make clear which costs we believed were directly related to the provision of the networked Channel 3 service. In doing so, we differentiated between those costs which we considered to be intrinsic to the provision of a national, networked broadcast service of the kind required by the Act and those which we believed were not sufficiently connected to the network service; in a number of cases costs in this latter category were subject to a separate commercial agreement between licensees.

1.9 We then sought to evaluate those cost sharing arrangements which we considered to be relevant against an appropriate alternative benchmark. The preliminary conclusion that we derived from this analysis suggested that ITV plc's contribution to relevant common costs in 2009 could have been up to £[redacted] more than would be the case under an appropriate alternative cost sharing mechanism. Of this, £[redacted] would have been incurred under the approved NWA.

1.10 Although this analysis had been relatively straightforward, it was unclear to us whether changes to the cost sharing arrangements within the NWA were warranted. For instance, the consolidated Channel 3 ownership structure which existed in 2009, and therefore the relative burden of costs between ITV plc and the other licensees, was not the result of regulatory intervention but of commercial decisions taken by ITV plc's predecessors in full knowledge of the system of cost allocation in place. Beyond this, we were also mindful that the commercial viability of certain licences could be threatened if costs were shared on the basis of the alternative mechanisms identified. This was a particularly important issue in light of the provisions prohibiting us from proposing modifications which are likely to prejudice the ability of licensees to meet their public service obligations.

1.11 Taking these factors into account, we set out three options for sharing costs within the NWA; maintaining the status quo position; full implementation of an appropriate alternative cost sharing mechanism; or the development of an alternative mechanism designed to identify the level at which it would be 'efficient' for the smaller licensees to contribute to network costs based on what a theoretical new entrant might be prepared to pay. It was not clear to us, however, that the latter two options could in practice be implemented in such a way as to satisfy the requirements of Schedule 11 of the Act. In particular we were concerned that these options, which were likely to require larger contributions to the Network Programme Budget ('NPB') from the smaller licensees, could adversely affect the ability of those licensees to fund regional programming. Consequently, it was our preliminary view that only the status quo was likely to be compliant with the current statutory framework for NWA.

Consultation responses

1.12 We received two responses to our consultation document one from ITV plc and one collectively submitted on behalf of the NCLs. Although both sets of licensees have expressed reservations about our analysis and proposals, in their responses they have each confirmed that they broadly preferred the status quo position outlined in option 1.

1.13 In their response, the NCLs maintained that the focus of our review had been too narrow. They considered that we ought to have taken account of the broad range of financial relationships between the licensees, particularly those enabling network content to be shown on ITV plc's digital channels. They did not believe that there were any "workable or desirable" alternatives to the status quo.

1.14 ITV plc, in contrast, considered there were good reasons to support option 3. Nevertheless, given our view that a profit based analysis would not provide a sufficiently robust basis for cost sharing arrangements, ITV plc was concerned that the work required to determine efficient contribution levels could be significant if Ofcom believed that modelling based on a theoretical new entrant was necessary. In light of this and "in the interests of looking forward to try to establish the basis for a new and more sustainable arrangement for Channel 3," ITV plc confirmed that it did not intend "to press actively" for a change to the existing cost sharing arrangements at present.

Our conclusions and next steps

1.15 In light of the responses we have received from the licensees and our own analysis, we consider that it is appropriate to retain the existing system of cost allocation in the NWA for the time being.

1.16 It is clear, however, that the NWA were devised in and for the broadcasting landscape of the early 1990s, when it was possible to sustain a networked national Channel 3 service based on a federation of regional services under different ownership. However, over time, erosion in the value of PSB status and changes in the ownership structure, combined with the inability of licensees to achieve a consensus on change has, as we noted in the consultation document, placed considerable tensions on the existing system.

1.17 In our last PSB review we noted that,

"the new licensing period from 2014 onwards allows a review of the regulatory assets allocated to the Channel 3 licence and the potentially attractive opportunity of a reassignment of regulatory assets to ensure that their value is maximised."

1.18 As part of this process, we have a duty under section 229 of the Act to submit a report to the Secretary of State by June 2012 giving our opinion on whether the licensees will be able to contribute to the fulfilment of the purposes of public service television broadcasting at a commercially sustainable cost in the next licensing period. In giving our opinion, we must consider the effects of arrangements that would allow for a renewal of the relevant licences and of the conditions included in the relevant regulatory regimes. We must also include in that report any recommendations that we consider should be made to the Secretary of State for the exercise of his powers under the Act, including his power under section 230 of the Act to suspend the right to renew the existing regional Channel 3 licences.

1.19 Any order under section 230 suspending the right of renewal must apply to all the regional Channel 3 licensees, or none of them it cannot differentiate between the licensees. Hence, in determining whether or not to recommend the exercise of the Secretary of State's power under section 230, we will have to consider whether the licensees as a group are able to sustain cost-sharing arrangements under the NWA which will enable them to contribute to the public service broadcasting remit of a competitive Channel 3 service in the future.

1.20 Although in this review we have concluded that it would not be appropriate to change the existing cost sharing arrangements in the NWA at this time, we are unclear that the Channel 3 service as currently configured will be sustainable in the next licence period, i.e. enable the licensees (taken as a whole) to be a nationwide system of services which is able to compete efficiently with other television programme services provided in the UK. In particular, we think the licensees need to consider whether the networking arrangements should be extended beyond the current linear standard definition version of ITV1. It may, for example, be appropriate that future arrangements should look to include other closely related services such as ITV1 HD and/or ITV1+1 and to reassess the cost sharing arrangements needed to support the Channel 3 service (or set of services). We would strongly encourage licensees to begin a dialogue now to consider how they would develop robust arrangements which will be sufficient to underpin a competitive set of PSB services at a commercially sustainable cost in the next licensing period.