Ian Giles and Jacqui Williams write in Competition Law Insight
3 October 2012

This article first appeared in Competition Law Insight on 18 September

Off the Pace? Movies on pay-TV and competition law in fast-moving markets

On 2 August 2012, the UK Competition Commission (CC) released its final report on the movies on pay-TV market investigation (the Report). The Report found that while Sky has market power in relation to the overall UK pay-TV retail market, the rights it holds in movie content (the area that was referred to the CC by the communications regulator, Ofcom) do not give it such an advantage over other retailers of pay-TV services as to lead to an adverse effect on competition (AEC) in the pay-TV retail market in the UK.

What is particularly striking in this investigation is that, prior to the final Report, the CC published revised provisional findings in May 2012, having changed its position from its original provisional findings published nine months earlier when the CC was minded to conclude that Sky’s rights over movie content did lead to an AEC. This begs the question – what changed in a year?

The CC found the market had evolved with consumers now accessing movie content online – in particular, through online providers such as LOVEFiLM and Netflix, as well as Sky’s new online service, Now TV (which allows consumers to view Sky movies online without subscribing to a broader pay-TV package). These developments in online movie access meant the CC accepted that the rights Sky held for premium movie content on pay-TV were no longer capable of distorting consumer choice – and so no AEC.

This article explores the CC’s Report, as well as touching on the broader question of the limitations of competition law investigations in fast-moving markets where market conditions may change more quickly than competition authorities can assess (and, if necessary, remedy) them.

The CC’s investigation

Ofcom referred movies on pay-TV to the CC in August 2010. The reference followed an extensive investigation by Ofcom into the broader pay-TV market, which started a little over three years earlier in March 2007.

Following a reference, the CC is required to determine whether any feature or combination of features of each relevant market prevents, restricts or distorts competition and, if necessary, impose remedies.

The CC’s theory of harm was that control by Sky of movie content for pay-TV in the “first subscription pay-TV window (FSPTW)” could, as a result of its market power in the pay-TV retail market, adversely affect competition between pay-TV retailers, with consequences for both consumers and other pay-TV suppliers.

In assessing this theory of harm, the CC analysed competition at three distinct levels of the market:

• The retail level of supplying pay-TV to consumers. The CC found that the correct market definition is wider than movie content, as subscriber decisions are based upon broader pay-TV packages (including sports and basic pay-TV products). The CC also found that subscription video on demand services (SVOD), such as those provided by LOVEFiLM and Netflix, influence consumer choice in relation to pay-TV and so were part of the relevant market.
  
  It was this latter finding that was critical to the outcome of the investigation. The CC’s analysis found that the expansion of online SVOD providers had altered the dynamic of the market since the provisional findings in 2011. SVOD providers face lower costs and it is easier for consumers to switch to them than to traditional pay-TV providers: both these factors give SVOD providers a significant competitive advantage.
• The wholesale supply of premium movie channels. The CC explored the implications of Sky’s ownership of FSPTW rights, allowing it to sell those rights as a wholesaler to its pay-TV competitors. The CC’s August 2011 provisional findings had concluded that wholesale prices were higher than the competitive level but, since then, Sky has reduced its wholesale prices, undermining this finding (although there is no guarantee prices will remain low after the investigation).
  
  Significantly, the CC’s Report stated that because Sky was constrained at the retail level by online SVOD suppliers, this “implied that the terms of Sky’s wholesale supply of Sky Movies could not in principle cause Sky’s rivals to be at such a disadvantage” – ie the pressure that Sky felt from online SVOD suppliers removed the incentive to disadvantage its rival pay-TV suppliers through higher wholesale prices.
• The acquisition of movie rights from studios. The CC found that the ability of movie studios to issue movie rights in different windows (such as the FSPTW) was a form of price discrimination, leading to FSPTW rights being a “price discrimination market” – ie a subset of the wider sale of movie rights across all “windows”.
  
  The CC explored whether Sky’s historic success in winning all major studio FSPTW rights might give it some upstream power but this concern was not supported by the evidence. Interestingly, the CC viewed the barriers faced by online pay-TV retailers in acquiring FSPTW content as lower than those faced by traditional pay-TV retailers and (perhaps optimistically) foresaw that, in the future, one of the online pay-TV retailers might outbid Sky for FSPTW movie rights.

Market power

The key event that changed the outcome of the investigation – and which resulted in the first CC market investigation to date that found no AEC – was the market expansion of the online SVOD providers. Without this, Sky faced findings that it had market power in relation to the retail pay-TV market and that its wholesale movie prices had been higher than the competitive level.

The CC came to this conclusion despite finding Sky’s overall profitability to be excessive. Although Sky challenged this, the CC’s exclusion of proposed intangible assets from Sky’s asset base meant the CC found Sky’s return on capital to be too high. This is an area which is likely to cause controversy in future cases, given the conservative approach to inclusion of intangible assets in profitability calculations based on a return on capital in the CC’s draft market investigation guidelines. This will be a particular issue for businesses with low tangible asset bases or where much of the value of the business derives from brand, reputation or intellectual property.

It is notable that, despite finding that Sky had market power in relation to the wider pay-TV market, the CC did not act on these concerns. Arguably, the CC had the power to do so: although Ofcom’s reference related only to competition in the market for movies on pay-TV, the CC’s guidelines give it discretion to look at what it considers to be the relevant market “which may not coincide with the particular goods or services that are described in the reference”. The CC may also consider adverse effects on “different features” from those identified in the reference. This may simply have been a consequence of time constraints: while the CC noted its concerns in relation to Sky’s wider pay-TV retail position, given the statutory two-year limitation on market investigations, a broader investigation was not an option in the time remaining after the concerns initially identified in relation to movies had been dismissed.

However, as is often the case with companies that are seen to possess significant market power, the spotlight is unlikely to move away from Sky’s operations entirely. The CC notes that it is expected that Ofcom will keep a close eye on developments in the sector and the CC does not appear opposed to revisiting the issues covered in this investigation again. However, it seems Ofcom would need to return to square one, particularly after the Competition Appeal Tribunal’s damning ruling in upholding Sky’s appeal against Ofcom’s decision requiring it to offer its premium sports channels at a regulated wholesale price. The Tribunal’s judgment of 8 August held that Ofcom’s core competition concern was unfounded and was highly critical of Ofcom misinterpreting evidence, finding that “a significant number of Ofcom’s pivotal findings of fact [were] inconsistent with the evidence”.

The difficulties of fast-moving markets

The unfolding of this investigation – including the novel publication of revised preliminary findings reappraising critical elements of the CC’s analysis prior to its final Report – highlights the challenge that regulators face when dealing with fast-moving and dynamic markets.

The rate at which developments in the media, technology and telecommunications markets in particular occur inevitably makes it very difficult for an authority to predict the competitive landscape of the future, even within a relatively short timeframe. In this case, it was perhaps inevitable that the competitive arena would change in the five years since Ofcom’s initial investigation.

The CC’s Report is based on the market circumstances at the time of its decision, and its views on whether relevant circumstances are likely to persist. Significantly, it anticipates continued developments, such as an online movie provider being able to win FSPTW movie rights from studios in competition with Sky, and Sky’s high profitability declining, despite no hard evidence that such changes will occur. Indeed,the CC’s own investigation shows that it can fail to anticipate market developments correctly. For example, it did not take into account earlier in its investigation the possible expansion of LOVEFiLM’s services to provide online SVOD, despite clear indications in recent years of the desirability of establishing online on-demand services for broadcasting and/or video content to complement the more traditional ways of viewing content (as was drawn to the CC’s attention in its 2009 Project Kangaroo investigation).

The OFT’s recent proposal to withdraw undertakings given by Yell in relation to Yellow Pages following the CC’s 2007 classified advertising investigation is an example highlighting the need for caution before intervention. The proposal reflects the diminution of the market power of the once ubiquitous printed directories, following growth in internet access and usage by users and advertisers. Should the CC have foreseen how quickly market developments would erode Yellow Pages’ market power, or was it right to take a cautious approach?

The ability of competition authorities to deal with fastmoving markets will vary with the nature of the investigation. In the case of mergers, shorter timeframes – and the need to consider the counterfactual – make merger decisions necessarily speculative, with the OFT/CC merger guidance recognising that the “foreseeable period can sometimes be relatively short”.

This caution chimes with the requirement when considering potential market entry that this should be “timely” – typically taken to mean within two years. The unpredictable nature of fast-moving markets may strengthen the temptation to put faith in market forces over regulatory intervention. But this may lead to failure to act when intervention was required (false negatives), while unjustified interventions (false positives) will occur where the authorities act in relation to arrangements which would otherwise have proven benign or procompetitive.

With longer running cartel or abuse of dominance investigations, the difficulty can simply be that the world turns faster than the investigative process. In a recent speech in the context of the European Commission’s Google investigation, the EU competition commissioner Joaquin Almunia acknowledged this challenge and stated that he strongly believes that “users and competitors would greatly benefit from a quick resolution of the case” – meaning “it is always better to restore competition swiftly in fast-moving markets” than to endure lengthy proceedings.

While there is no easy answer to how authorities best intervene in fast-moving markets, the lesson appears to be that flexibility, and the use of innovative tools such as settlement, may be the best way for authorities to try and keep up with the pace.