CONTENTS
Preface
The Author
Glossary
Chapter Two: The Pay TV Picture
- More Choice and Diversity
- Packaging and Pricing
- Delivery
- The Operators
Chapter Three: A Brief History
- The Beginning
- Satellite TV
- The Race to Cable
- Programming
- The Battle with FTA Television
- Pay TV Finances
Chapter Four: A Model of Dynamic Competition
- The Basics
- Competition and Programme Costs
- Programming Choice
- Competitive Pay TV Systems
- Facilities-based Competition
- Entry Assistance
- Closed Networks and Competition
- Broadband Entry Strategies
- Overbuild and Economic Efficiency
- The Regulatory Game
- Conclusions
Chapter Five: The Video Marketplace
- A Common-sense Approach
- The ACCC's Analysis
- Assessing the ACCC's Analysis
- Pricing
- A Radical View of the ACCC's Merger Test
- The Number of Channels
- The Empirical Evidence
- Concluding Observations
Chapter Six: The Foxtel/Australis Merger
- The Legal Framework
- The Impact of the Merger on the Pay TV Sector
- Telecommunications Competition
- Concluding Remarks
Chapter Seven: Policy Implications
References
PREFACE
This book examines in detail an important period in the early development of pay TV in Australia. The decision of the Australian Competition and Consumer Commission (ACCC) to block the proposed merger between FOXTEL and Australis in late 1997 is analysed in detail, using the same framework as that employed by the ACCC itself. The conclusion is that the ACCC failed to demonstrate that the merger would substantially lessen competition, as it was legally required to do to justify its decision to block the merger.
The book is intended as a contribution to the understanding both of competition in the pay TV sector and of Australian merger policy in the communications sector. It is hoped that its adoption of a combative style to discuss such a controversial topic will stimulate public debate on communications and competition policies.
I am grateful for the helpful comments provided by three anonymous referees on earlier drafts, but remain responsible for any shortcomings in the final draft. Although the book draws partly on research originally commissioned for FOXTEL Management Pty Limited, the views expressed are solely my own and not those of those mentioned above.
GLOSSARY
ABA: The Australian Broadcasting Authority: the broadcasting regulator.
ACCC: The Australian Competition and Consumer Commission, responsible for enforcing the Trade Practices Act 1974.
Analog transmission: A method of broadcasting based on wave patterns. Asymmetric regulation: Regulation which imposes heavier obligations on, or restricts or prohibits a sector or line of business of, the largest operator. This regulation is often defended as a necessary transitional requirement to foster competition with incumbent telecommunications operators.
Basic cable: The first tier of pay TV channels offered with the minimum subscription.
Broadband network: Communications network that operates over a wide frequency range and is able to deliver multiple signals.
CAS: Conditional Access System: the encryption system for pay TV.
Communications satellite: Any earth-orbiting spacecraft that provides communication over long distances by reflecting or relaying radio-frequency signals from earth. They receive signals from one ground station, amplify them, and then retransmit them at a different frequency to multiple reception sites such as parabolic dish antennas fixed to houses.
Convergence: Term frequently but loosely used to describe the process of merging computing, broadcasting and telecommunications to create one sector offering multimedia services.
Digital transmission: A transmission of data in encoded binary form as zeroes and ones. Digital signals have a number of advantages over analog signals. They are less prone to distortion and interference, are easily encrypted and compressed and therefore require less bandwidth than analog.
Dish: Colloquialism for a parabolic reflector dish antenna (solid or mesh) used to retrieve satellite messages.
DTH: Direct to home: the delivery of television services using a receiver dish mounted on the subscriber's property.
Economies of scale: These are present when unit costs fall as output increases. Economies of scope: These are present if the costs associated with producing two products together are less than the combined costs associated with producing each product separately.
Facilities-based competition: Direct competition between network infrastructure operators.
FCC: Federal Communications Commission: the federal government regulator of the US communications industry.
Fibre optics: The transmission of light through fibres or thin rods of glass. Signals are digitally coded into pulses of light and transmitted over great distances by slender glass fibres. A fibre cable may contain up to 50 fibre pairs, each pair carrying up to 4000 voice circuits. This uses frequencies thousands of times higher than radio to carry much larger volumes of information.
Fixed network: Permanent communications path between two points. Usually refers to wire networks.
FTA television: Free-to-air television: broadcast channels which are intended to be received by viewers free of charge at the point of consumption. In Australia these include the three commercial networks (Channels 7, 9 and 10), and the government-owned ABC and SBS.
HFC: Hybrid fibre cable: combination of fibre optic and copper coaxial cables to deliver large amounts of data.
Interconnection: The connection of separate telecommunications networks.
Market: In trade practices law, a market is defined (under s 4E of the Trade Practices Act 1974) to include goods and services that are substitutable or otherwise competitive with one another in response to changes in their relative prices.
Market power: The ability to raise prices profitably above the competitive level without being constrained by the actions of competitors or potential competitors.
MDS: Multi-point distribution system: a radiocommunications system providing point-to-multipoint line-of-sight transmission using microwave transmitters. Operates on the frequencies 2.0–2.4 GHz.
Microwave: Wireless transmissions at very high frequency providing telecommunications links (including television distribution) between two places. Depends on line of sight.
Natural monopoly: Industries where the costs of production are minimised by using only one firm.
Overbuild: Direct competition between cable networks in the same geographical area.
Pay TV: Used generically to describe any channel offered for a monthly subscription.
Platform: The technical network for delivering pay TV.
PPV: Pay per view: payment made for individual programmes as opposed to a monthly subscription for a whole channel or group of channels.
PTO: Public telecommunications operator: a network operator with powers granted by the state to enable it to install its systems on public and private land, property, etc.
Public good: A public good is one of which the consumption by one consumer or viewer does not detract or diminish the consumption by another consumer or viewer.
Sunk costs: Those investment costs which have no value outside their existing use.
Terrestrial television: Television broadcasting using land-based transmitters broadcasting to conventional television aerials within the line of sight.
TNC (Telstra News Corporation) Heads: A programme-sharing agreement between Australis and FOXTEL giving the latter the Galaxy programme package of Australis.
CHAPTER ONE
This book examines in detail the decision of the Australian Competition and Consumer Commission (ACCC) in 1997 to block the proposed merger between FOXTEL and Australis, two pay TV operators. It concludes that the ACCC did not make out its case that the proposed merger would lead to a substantial lessening of competition, as required under Australian trade practices law to justify the blocking of a merger. Since much of the discussion is based on technical legal and economic analysis covering a wide range of issues, a summary of the arguments underpinning this conclusion is set out here.
In May 1998, Australis, the pioneer of Australian pay TV, went into receivership after years of financial difficulties, and despite several financial restructures and two attempted mergers with FOXTEL. On both these occasions, the ACCC concluded that a merger between FOXTEL and Australis would breach trade practices law by substantially lessening competition.
The ACCC's decision in 1997 to block the FOXTEL/Australis merger followed a series of investigations by the ACCC into the pay TV sector. In 1995 the ACCC concluded that pay TV and free-to-air (FTA) television were in the same market and competed with one another. On this basis it approved a programme-sharing arrangement (the so-called TNC Heads) which gave FOXTEL access to Australis's core package of programmes, arguing that competition from FTA television channels would act as an effective competitive constraint on FOXTEL. In early 1996 it opposed the proposed merger between FOXTEL and Australis on the grounds that the merged entity would have given a monopoly of satellite television in view of the barrier to entry created by the government's moratorium on new satellite channels until 1 July 1997. When the government's satellite limit was removed, the parties believed that the impediments to a merger had been lifted. However, the ACCC then altered its position, arguing that the market was much narrower and consists of pay TV only, and that the reduction from three pay TV operators to two in the metropolitan areas would breach Australian competition law.
Even if the ACCC's about-face on market definition is ignored, its conclusion that pay TV was a separate, well-defined market was entirely hypothetical. The evidence that the ACCC relied on was weak, resting for the most part on legal decisions of regulatory bodies in Europe and the US which themselves had been criticised. Further, in defining the market the ACCC seized on only one area of competition -- price competition -- and ignored the fact that in the initial phase of a product's introduction non-price factors play a greater role in the competitive interaction between firms. This is certainly the case for pay TV, where the programme choice and diverse programme scheduling of different television operators represent the essence of the competitive pressures that firms exert on one another.
The proposed merger was unlikely to substantially lessen competition, for two further reasons related to the ACCC's prior approval of the TNC Heads. The ACCC had worked itself into an inconsistent position. Either it was right to approve the programming arrangement between FOXTEL and Australis, or it was wrong to do so. The ACCC's subsequent decision to block the merger implied that it believed that its earlier decision was wrong, even though the ACCC seemed to accept that without the agreement FOXTEL would not have entered the pay TV sector due to a lack of sufficiently attractive programming. But (and more important) if the ACCC regretted approving the TNC Heads it followed that the merger would not have substantially lessened competition because the damage had already been done. This is because, irrespective of market definition, the approval of the FOXTEL/Australis programming deal effectively gave FOXTEL access to core Australis programming and, as such, the merger would not have increased the programme offering of FOXTEL or Australis. Thus, the principal concern of the ACCC -- that the merger would enable FOXTEL to have better programming -- had already come about with ACCC approval.
The second reason why the proposed merger was unlikely to substantially lessen competition again relates to the ACCC's approval of the programme-sharing arrangement. By reversing its position, the ACCC could not then argue that three competitors were viable. This is because it approved the FOXTEL/Australis programming deal on the grounds that FOXTEL would not be able to enter as an effective competitor without access to Australis programming. If as a result of this Australis found it could not compete with FOXTEL (and Optus Vision), then this was a competitive, not an anti-competitive, outcome. The market had indicated that only two and not three pay TV operators competing for subscribers in the major cities of Australia were viable (see Table 1.1). This was true irrespective of whether the market was defined narrowly (pay TV only) or widely (pay TV and FTA television).
For these reasons the merger of Australis with FOXTEL could not reasonably be said to substantially lessen competition. Reinforcing this conclusion was the fact that, prior to the merger, Australis had effectively withdrawn from competing head-to-head with the cable operators. It thus was not in the same geographic market as FOXTEL or Optus Vision, and therefore was not an effective competitor.
Summary of Main Points
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Table 1.1: The Main Participants Australis Media Limited. Australia's first pay TV operator and holder of Satellite Licence B. Australis was listed on the Australian Stock Exchange with Lenfest and TCI (US cable operators) as major shareholders but was eventually controlled by US bondholders. It broadcast the Galaxy programme package using satellite and MDS, and also licensed part of this programme package to FOXTEL and to regional pay TV operators Austar and ECTV. Australis went into receivership in May 1998. FOXTEL. Australia's largest pay TV operator. FOXTEL is a partnership between Telstra (50 per cent), News Limited (25 per cent), and Publishing and Broadcasting Limited (25 per cent). FOXTEL provides a pay TV service over leased capacity on Telstra Multimedia's broadband network and in 1998 expanded to satellite delivery. Optus Vision. Pay TV operator wholly owned by Cable & Wireless Optus. It provides pay TV over Cable & Wireless Optus's broadband cable network. Telstra Corporation. Australia's largest communications company, which owns and operates the public switched telecommunications network, and a cable broadband network which delivers FOXTEL. Telstra was (until 1997) wholly owned by the Commonwealth of Australia. In 1997, 33 per cent was sold to the public, and the government plans to sell further tranches. Cable & Wireless Optus Limited. Australia's second telecommunications operator, previously known as Optus Communications. Cable & Wireless Optus has built a broadband network designed to carry both pay TV and telecommunications services, and is Australia's second largest mobile telephone operator. Optus was a private company owned by Cable & Wireless (49 per cent), Mayne Nickless (25 per cent), and AMP (10.3 per cent). In 1998 it was floated as Cable & Wireless Optus, which increased Cable & Wireless Communication's stake to 53 per cent. News. The Australian arm of News Corporation Limited, a listed media company controlled by the Murdoch family with extensive Australian and international media interests, including newspapers (The Australian, The Times, The Sun), television (Fox Network in the USA) and pay TV (25 per cent stake in FOXTEL, 40 per cent stake in BSkyB in the UK, and Star TV in Asia). Publishing and Broadcasting Limited (PBL). A media company listed on the Australian Stock Exchange and controlled by the Packer family with interests in newspapers, magazines, Channel 9, and pay TV with a 25 per cent holding in FOXTEL. Until 1997 PBL held a minority shareholding in Optus Vision. Austar. An MDS and satellite pay TV operator serving non-metropolitan regions. Austar is controlled by UIH Asia/Pacific Communications, an international pay TV operator with interests in the US, Europe and Asia. Prior to the receivership of Australis it was an "Australis franchisee" carrying Galaxy programming to its subscribers by satellite and MDS. It now also carries Optus Vision movie programming. East Coast TV (ECTV). A regional MDS and satellite pay TV operator serving Newcastle, Gosford, Wollongong and Tasmania. Acquired by Austar after the receivership of Australis. ECTV held Satellite Licence A. Australian Competition and Consumer Commission (ACCC). The federal government's competition and consumer protection regulator chaired by Professor Allan Fels. The ACCC has regulatory responsibilities for general competition law and telecommunications competition regulation under the Trade Practices Act 1974. |
Subsequent events have confirmed that the acquisition of Australis's assets by FOXTEL would not have materially enhanced the competitive position of FOXTEL. The assets and subscribers of Australis had minimal value. Indeed, the ACCC approved FOXTEL's subsequent acquisition of Australis's satellite settop boxes, thus allowing it to secure most of Australis's satellite subscribers. And, paradoxically, the ACCC's intervention in the merger which forced Australis into receivership benefited FOXTEL by relieving it of the onerous costs of the programming deal with Australis which was extinguished when Australis collapsed. Thus, notwithstanding the high-profile intervention of the ACCC, much of what would have been achieved by the merger subsequently occurred with the ACCC's approval, and FOXTEL has continued to add subscribers, outgrowing Optus Vision by about two to one.
This underscores the belief amongst many informed commentators that the ACCC's intervention had little to do with pay TV, but stemmed predominantly from its concerns about the impact of the proposed merger on C&W Optus's telecommunications business. C&W Optus, which owns Optus Vision, built a broadband cable network designed to carry both pay TV and telecommunications services. It thus offered facilities-based competition to Telstra's local networks which the ACCC was intent on preserving. It was strenuously argued by the ACCC (and Optus) that any weakening of Optus Vision's pay TV business would adversely affect C&W Optus's ability to compete with Telstra, thus weakening competition in the telecommunications sector. This claim rested on two factual propositions: that the merger between FOXTEL and Australis had anti-competitive consequences in the pay TV sector, and that there was a "close link" between the take-up of pay TV and the take-up of local telephony services: specifically, that pay TV attracts or "pulls through" telephone customers, so that a reduction in the growth in pay TV for Optus Vision would detrimentally affect C&W Optus's telephony business.
These arguments advanced by the ACCC fall at the first hurdle. As is shown in Chapter 5, there is no strong evidence of a cable TV-led "pull-through" of telephony. Second, it was irrelevant. If the merger had substantial anti-competitive effects in the pay TV sector, then that should have been sufficient to block it. There was no need to expand the assessment to its alleged impact on local telephony. The proposition that a merger between two pay TV operators which do not provide telephony, and one (Australis) which was incapable of so doing, should be blocked because it would have an indirect effect on the telephony business of the parent company of a competitor to these pay TV operators appeared to many to stretch legal and economic analysis beyond credibility. The ACCC argued a strong link between the related markets of pay TV and telephony whilst at the same time concluding that pay TV and FTA television were not substitutable. Indeed, statements by the Chairman of the ACCC, Professor Allan Fels, a highly regarded economist and experienced regulator, that the merger would seriously jeopardise competition in telecommunications markets because the Australian shareholders of Optus said they "would pull the plug" if the merger went ahead, seemed to many not only as uncharacteristically influenced by self-serving Optus threats but as confirming that the real focus of the ACCC was the protection of a competitor (Optus) rather than maintaining competition in pay TV. (1) It is therefore understandable that the ACCC was widely criticised at the time for being prepared to sacrifice pay TV to the interests of promoting telecommunications competition. As The Bulletin (1997) observed at the time:
Australia's pay TV industry is the free market system in free fall. Already, the players have flushed away some $3 billion -- a figure approaching the losses of the State Bank of South Australia. The expected entertainment-led bonanza has become a bloodbath ... but behind the scenes there is a much bigger game at stake -- the emerging battle for the telephone dollar. To Fels, the public interest in terms of a healthily competitive phone system is worth a hell of a lot more than public amusement in the form of a few extra TV programs.
This passage from The Bulletin also highlights the way the pay TV and telecommunications sectors developed under the umbrella of government regulation. At the time of the proposed merger in 1997, Australia's pay TV sector had two unique features: two overlapping broadband networks owned by C&W Optus and Telstra (in addition to Telstra's copper wire telephone network) in metropolitan areas, and four major pay TV operators (FOXTEL, Optus Vision, Australis and Austar) using different methods of delivery (two new cable networks and satellite/MDS) on an exclusive basis. This level of competition between operators and platforms, particularly the existence of two overlapping broadband cable networks, was not found elsewhere. The government's policy of promoting such competition through asymmetric regulation was seen by many as the source of the pay TV sector's difficulties. In hard commercial terms, there was too much competition! In order for the industry to be viable, with shareholders able to see over the mountain of massive losses, some operators would have to go out of business or merge. It is therefore not surprising that, by 1998, many had called for the rationalisation and re-organisation of pay TV.
While the ACCC was ready to accept that competitive pressures and government policy were responsible for Australis's eventual collapse, it chose to ignore the implications of this for the assessment of the merger. The ACCC refused to consider the possibility that competition between four operators and four delivery platforms was not economically viable. It rather addressed a range of narrow demand-side competitive concerns even though it accepted that Australis was not a viable competitor and that there would be rationalisation of the industry. It also adopted a highly bifurcated approach to the treatment of cost considerations (that is, economic efficiency): these were ignored where they pointed to industry rationalisation but highlighted where they suggested a disadvantage to C&W Optus as a result of the merger. Yet the ACCC's own merger guidelines require that broader economic efficiency be taken into account when assessing a merger. For some reason, these were ignored despite the mounting concern that the industry had become overcapitalised.
Under Australian competition law, known as trade practices legislation, the ACCC is charged with ensuring that a merger does not lead to a substantial lessening of competition. The term "competition" in economics and trade practices law is an effects-based test concerned with sustainable competitive pressures between products and firms which constrain the ability of one firm or group of firms unilaterally to raise prices above the competitive level. It is not understood as endorsing a market structure where there are more rather than fewer firms, or where the number of firms cannot be reduced through merger. Rather, the ACCC is charged with ensuring that competitive pressures as defined above are not substantially weakened. The wider public policy concern is that the ACCC was engaged in some old-fashioned industrial re-engineering designed to assist a firm which was seen as crucial to developing competition in local telephony rather than pay TV. Although the regulator's tasks in today's fast-moving communications sector are not easily reconciled, the ACCC's decision to oppose the proposed merger between Australis and FOXTEL in 1997 nonetheless appears to have overstepped the mark and to take irrelevant considerations into account. While not all commentators will agree with these conclusions, this study seeks to set out rigorously a competitive analysis of the pay TV market using the same framework as Australian competition law so that the reader can evaluate the relative merits of the ACCC's and this study's conclusions.
The discussion is organised as follows. Chapters 2 and 3 provide an overview of the pay TV sector at the end of 1998, and its development. Chapter 4 outlines some economic concepts and provides an analysis of competitive pressures in pay TV and the way it is delivered, as a backdrop to the discussion of the ACCC's analysis. Chapter 5 examines in detail the question as to whether pay TV is a self-contained market, or competes in a wider market for video entertainment which includes FTA channels and (possibly) other means of delivering video programming. Chapter 6 closely and critically examines the grounds cited by the ACCC in rejecting the proposed merger between FOXTEL and Australis in 1997 under the Trade Practices Act 1974. The final chapter looks at some of the wider policy implications of the ACCC's interventions in the pay TV sector.
ENDNOTES
1. Professor Fels, interview with Michael Pascoe, Channel 9, Sunday, 24 May 1998.
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