The Video Marketplace

CHAPTER FIVE

Does pay TV compete with FTA television or other forms of delivering video entertainment?  This question was one of the most contentious (and as yet unresolved) issues underpinning the ACCC's opposition to the proposed FOXTEL/Australis merger in late 1997.  Under Australian merger law, in order to oppose a merger the ACCC must first define the relevant markets to establish that the merging parties are "in competition" with one another and then demonstrate that the merger will substantially lessen competition in one of those markets.  The ACCC did not accept that FTA and pay TV were in the same market, despite coming to a different view earlier in 1995.  In this chapter, the interrelation between pay TV and other forms of delivering video entertainment is explored in detail.

A COMMON-SENSE APPROACH

At a common sense level, it is obvious that pay TV competes with many other means of distributing often-identical video programming.  As such, it competes with other forms of television, the cinema, video rentals and sales, and increasingly the Internet.  Often these compete directly for the same audiences and advertisers at the same time, in the same home and on the same television set with similar programming.

Pay TV and FTA channels do regard each other as competitors.  The pay TV operators see themselves in vigorous competition with the established, and in their view heavily "subsidised", FTA channels.  The FTA channels, meanwhile, see pay TV as a major threat, which led to their intense lobbying to block pay TV's introduction and subsequent successful efforts to ban and then limit its ability to sell advertising airtime and buy exclusive rights to major sports events.  These actions are consistent with the FTA networks regarding pay TV as a competitor.

In key areas, pay TV operates in a wider market.  The term "pay TV" disguises a number of different types of video programming, which have different competitive relationships with other media.  Pay TV competes with FTA television and the cinema for programme rights, and increasingly for advertising revenues.  News and current affairs can easily be seen as part of a wider market which includes other mass media such as FTA television, print and radio.  A film channel is increasingly competitive with the cinema, parts of FTA television, and video rentals and sales.  Music and youth channels compete with radio, videos and music recordings. ⁽²⁰⁾

These facts, and most importantly the observed behaviour of those in the video market, suggest that no sharp boundary exists between the various forms of video entertainment.

THE ACCC's ANALYSIS

However, the ACCC concluded that pay TV is a separate market from FTA television.  This is because the ACCC, in common with most competition authorities, defines markets in a technical way aimed at assessing the extent to which one form of video entertainment imposes a competitive constraint on another in setting its prices.

The details of the ACCC's approach to market definition are set out in the Revised Merger Guidelines (ACCC, 1996a). ⁽²¹⁾  The ACCC uses market definition as part of its analysis of whether a merger will or is likely to substantially lessen competition under section 50 of the Trade Practices Act.  Crucial to defining the market is the intensity of demand- and supply-side substitution, both among products and among firms.

Under the Merger Guidelines, a "market" is defined as the range of products, which if under the control of one supplier (a hypothetical monopolist) would enable it to raise price profitably 5–10 per cent above the prevailing level. ⁽²²⁾ This means that if all pay TV operators merged they would be able to raise subscription charges above the pre-existing level if pay TV were a self-contained market.  If, on the other hand, pay TV were substitutable in the viewers' eyes for FTA channels and other video entertainment, the hypothetical monopolist of pay TV would not be able to raise its price, since viewers would simply switch over to the FTA channels or other forms of video entertainment.

Using this demand-side analysis, the ACCC blocked the proposed 1997 merger because it found that "there are no services which are substitutable or reasonably substitutable for, or in close competition with, pay TV services in Australia" (ACCC, 1997, para. 44(h)), and that as a result "the pricing behaviour of the suppliers of pay TV services in Australia is not closely constrained otherwise than by the market behaviour of another supplier of pay TV services." (ACCC, 1997, para. 44(k)).  The ACCC offered three principal reasons for its assessment that pay TV has no reasonable substitutes:

1. Pay TV is priced, whereas FTA television is free to viewers and funded by advertisers.  As a result, the competitive constraints which FTA television places on the ability of pay TV operators to raise prices is weak;  moreover, recent evidence shows that the price of one operator's pay TV package responds more directly to the price of another pay TV operator's package than to FTA operators.
2. Pay TV operators offer many channels whereas FTA consists of a handful of separately owned general channels.  FTA television thus leaves unsatisfied demand for video programming and hence does not constrain the actions of pay TV operators.
3. There are high barriers to entry and expansion in the supply of pay TV services (ACCC, 1997, para. 56).  These are alleged to arise from sunk costs, programming costs, conditional access, and various exclusive arrangements.

ASSESSING THE ACCC's ANALYSIS

The ACCC (1996b, para. 5.1) has acknowledged that defining media markets is a difficult task:

It is difficult to distinguish markets in media, not only because they will depend upon the circumstances of each particular case, but also because the rapid growth of alternative forms of service provision means that market boundaries may change and also that new markets may emerge in the near future.

Indeed, within Australian trade practices law, different approaches have been adopted.  Competition enforcement agencies generally define markets very narrowly.  The ACCC is no exception.  For example, advertising markets are usually defined for each medium and sometimes each type of advertising within a medium is defined as a separate market.  The Trade Practices Commission (the predecessor of the ACCC) concluded that radio advertising was a distinct market separate from press and TV advertising (TPC, 1994).  On the other hand, the Trade Practices Tribunal (now the Australian Competition Tribunal), an appellate body, has tended to take a wider view of markets.  In Re Media Council of Australia the advertising market was defined as the national market for advertising space and time in Australia. ⁽²³⁾  The courts are less predictable and it is therefore less easy to generalise.  In the rugby Super League case, which had a direct bearing on the development of pay TV in Australia, the court held that all major sports such as rugby league, rugby union, soccer, AFL and basketball, were in the same market. ⁽²⁴⁾  In other countries, competition authorities have held that individual sports constitute separate markets, and that even the major events or senior leagues of a specific sport are separate from the rest of their sport.

The difficulty of market definition is reflected in the way the ACCC altered its position over the relationship between FTA and pay TV.  In April 1995 the ACCC cleared the programming alliance (the TNC Heads Agreement) between Australis and the FOXTEL shareholders on the grounds that FTA television and pay TV were in the same market.  The Chairman of the ACCC stated that "a central issue before the Commission was whether the free-to-air broadcasters would materially constrain the exercise of any market power arising from the alliance" (Fels, 1996, page 7).  The ACCC concluded that they would, although this was said to be based on "speculative rather than empirical" analysis (Fels, 1996, page 7).  Yet in February 1996 the ACCC alleged that the proposed merger between Australis and FOXTEL would substantially lessen competition, and therefore breach trade practices law on the grounds that new evidence suggested that pay TV and FTA television did not compete.  In less than nine months the ACCC had redefined the market! ⁽²⁵⁾

The ACCC reversal in 1997 was alleged to be the result of "new market evidence".  However, apart from one piece of price analysis, this "market evidence" consisted of legal decisions drawn from other countries, in particular the European Commission merger decision blocking the digital pay TV alliance between Kirch, Bertelsmann and Deutsche Telekom known as MSG Media Services. ⁽²⁶⁾  The reasons, which the EC Commission gave, were, with several exceptions, repeated by the ACCC together with reference to statutory standards/findings of the FCC.

The applicability and relevance of these decisions to Australian pay TV are questionable.  In MSG Media Services the EC Commission's Merger Taskforce examined the proposed digital joint venture between several television companies and Deutsche Telekom, which owned most of Germany's cable networks.  It concluded that pay TV and FTA television did not compete directly, and the premium pay channels did not compete with advertiser-financed TV and public TV.  It based its decision on the fact that the customers differed -- FTA television involves a commercial relationship between network and advertisers, whereas for pay TV the relationship is between operator and subscribers -- and the "conditions of competition" differed -- for FTA television it was audience share and advertising rates, whereas pay TV caters to the interests of target groups and subscriber prices.  This approach has also been followed by UK regulators. ⁽²⁷⁾

Market definitions drawn from cases or regulatory determinations in other jurisdictions cannot be used to define Australian media markets.  In the first place, the market structure and competitive issues considered in these cases are often radically different from those in Australia (Fels, 1996, pages 12–13).  Second, as a purely legal matter, it is a central tenet of the application of trade practices law that market definition must be based on the facts as they exist in Australia in the sectors affected at the time of the merger, and not on market facts as they exist in some foreign country.  Third, the legal standards used to define markets differ as between the countries relied on by the ACCC.  In EC law, the courts use a very focused demand-side substitution test to define a market which effectively excludes supply-side substitutability, whereas supply-side substitutability plays a more significant role in US and Australian tests.  Foreign statutory tests, such as effective competition standards used by the FCC, are based on administrative criteria, which have no bearing on Australian trade practices tests.

Take the first of the above factors.  Table 5.1 shows the vast disparities in pay TV markets in the countries covered by the legal decisions referred to by the ACCC -- the US, Germany and the UK.  As can be seen, the US is a mature market served predominantly by cable networks, with very little direct competition between different pay TV delivery systems.  The UK has more direct competition between cable and satellite with about 30 per cent of homes receiving pay TV, but no direct competition by overlapping cable networks.  Germany has negligible pay TV and a very weak digital satellite platform.

Table 5.1:  Pay TV Penetration:  International Comparisons 1998

	Penetration rate		Delivered by			Total number of subscribers
			Cable	DTH	Other
US	(Jun. 98)	78.2%	65,400,000	9,228,200	*2,006,000	76,634,200
UK	(Oct. 98)	30.1%	2,666,783	4,384,000		7,050,783
Australia	(Dec. 98)	13.9%	575,000	243,000	**87,000	905,000
Italy	(Dec. 98)	6.0%	100,000	1,100,000		1,200,000
Germany	(Oct. 98)	5.9%		1,650,000		1,650,000

* MMDS, SMATV and OVS

** MDS

Sources:  FCC (1998);  New Media Markets;  FOXTEL and relevant European pay TV companies' annual reports.

Furthermore, a close analysis of the reasoning employed in the cases or decisions used by the ACCC, together with the facts as they existed at the time of the 1997 merger proposal, would have probably resulted in its clearance by EU and US authorities.  There are several reasons for this claim.

MSG Media Services

First, the issue before the EC Commission was an alliance to fund a digital pay TV platform that brought together the monopoly provider of cable which also owned the public telecommunications network (Deutsche Telekom), and the two large media conglomerates which dominate Germany's media (Kirch and Bertelsmann).  The EC Commission held that in the formative stages such a "grand" alliance was not required, and that the risks of the three foreclosing the market to other entrants were substantial.  The EC Commission may or may not have been correct;  yet, three years after the decision, Germany still has no significant analog or digital pay TV sector.  Recently, the EC Commission blocked on competition grounds another attempt by the same parties to resurrect their "digital alliance". ⁽²⁸⁾

Second, while the EC Commission in MSG Media Services concluded that pay TV was a separate market, it also found that cable and satellite pay TV were separate markets.  The EC Commission expressly rejected the view of the parties that cable, satellite and terrestrial frequencies were regarded by consumers as interchangeable because there were differences between the three means of transmission "as far as the technical conditions and financing are concerned".  The EC Commission was clear that cable and satellite do not form part of the same "relevant market":

While terrestrial transmission and satellite television only require the viewer to install an aerial or a satellite dish at his own expense, cable television presupposes the maintenance of a cable network financed by the viewer through cable fees.  It makes a difference to the final consumer whether he has to incur a large amount of expenditure on a one-off basis for one form of transmission (for example, for the satellite receiver) or whether he prefers to incur low-level, regular payments in the form of cable fees.  (MSG Media Services, para. 41)

The ACCC ignored this distinction, even though Australis directly operated pay TV only through MDS and satellite.  Indeed, the Chairman of the ACCC noted that there were significant switching costs which made it difficult for subscribers to substitute between pay TV platforms, and that these incompatibilities were partly responsible for the industry's problems:

Fels told the Bulletin "The Commission acknowledges that the industry has got significant problems:  very heavy losses, customers unable to easily switch between the different offerings of pay TV companies.  There is massive churning, consumers don't get full coverage, only half of the Hollywood movies are available and sport is divided between them, so that Optus offers AFL, FOXTEL rugby league". ⁽²⁹⁾

The EC Commission further decided that cable and satellite were not interchangeable from the programme supplier's point of view given the differences in the costs involved (MSG Media Services, para 42).  If this demand-side "evidence" were used and carried though to its logical conclusion, the proposed merger between FOXTEL (cable) and Australis (satellite and MDS) would not have been blocked because it brought together two companies in separate markets.  (Despite Professor Fels's emphasis of switching costs, these are substantially lower in Australia because viewers do not purchase settop boxes.)

FCC's Effective Competition Standard

The ACCC cited FCC decisions or findings that FTA television does not constrain pay TV, and that cable networks have market power.  The claim that because US cable operators have market power Australian pay TV operators therefore also have market power does not follow, because the market conditions in the two countries differ substantially.  In the US, cable operators have local monopoly franchises of cable delivery and are the sole suppliers of pay TV (and often FTA channels), passing over 90 per cent of all homes. ⁽³⁰⁾  As cable has grown, the principal regulatory issue has been the power of monopoly cable operators to control programming and to raise the price of cable programming.  There has been limited competition from other delivery systems such as Satellite Master Antenna TV (SMATV), Multichannel Microwave Distribution Systems (MMDS), and satellite DTH, which in aggregate serve less than 4 per cent of US television households.  DTH satellite delivery, the new entrant, is now making inroads.  However, to date, most households with satellite dishes have been in areas not served by cable.  Overbuild is limited to only about 180 out of approximately 10 000 cable systems.  This does not describe the Australian pay TV sector in either structure or maturity.

There is little doubt that if the Australian pay TV sector were transposed to the US the FCC would, on current regulatory criteria, find it effectively competitive.  A pay TV operator with an audience share of less than 30 per cent or facing direct competition from other multi-channel video providers is deemed competitive.  In Australia, at the time of the proposed 1997 merger, pay TV operators had shares below 10 per cent, and FOXTEL faced significant head-to-head competition from Optus in a substantial part of its service area.  Also, in the early phase of the development of pay TV, the FCC did regard FTA channels as constraining pay TV.  Finally, the FCC's standard of effective competition is not an antitrust market test but one devised by the US Congress with price regulation as the goal.  The application of this test to a legal finding under the Australian Trade Practices Act is irrelevant.

PRICING

The ACCC regards price as a key factor placing FTA television and pay TV in separate markets.  Because pay TV has a price and FTA television does not, it is alleged that they do not compete.  Specifically, it is claimed that pay TV operators react more to the actions of other pay TV operators, and that the ability of viewers to react to changes in the price of pay TV by switching to FTA does not provide a sufficient constraint on pay TV operators.

Defining and delineating markets on this basis of absolute price differences is simple-minded.  FTA television and pay TV represent an extreme in terms of absolute price differences, and therefore somewhat of a challenge to conventional antitrust analysis.  However, FTA television has a price -- zero -- and there is a price differential between it and pay TV which can be widened and narrowed.  If FTA television offers more desirable programming at zero price, the effective price differential between it and pay TV will narrow and people will substitute away from pay TV to FTA television.  This in turn will cause pay TV either to lower its price and/or to increase the quality of its programming so as to give viewers value for money.  Levy and Pitsch (1985, pages 64–65) tackle this head on:

In order to derive a "price" proxy for broadcast television, quality considerations must be introduced.  When product prices are compared, it is necessary to specify the quality as well as the quantity of product available at a given price.  For example, if two television receivers each cost $400, and were identical except for the fact that one of them had a remote control and the other did not, it would not make economic sense to say that their prices were the same.  By analogy, the quality-adjusted price of broadcast television services becomes lower as the number of stations available increases.

The way pay TV is priced further indicates that the differences between FTA television and pay TV have been exaggerated.  Pay TV is sold as a bundle of channels for a fixed monthly subscription.  The entry or basic tier consists of 15–28 channels.  The basic subscription is as much a charge for these channels as it is an access fee.  Once the basic tier has been purchased, there are no charges based on hours of viewing or channels watched.  That is, watching the package is "free" and can occur for as long a time as the viewer desires.  Since the viewer will also have access to FTA channels, his or her viewing choice will be based on the same non-price factor -- programme appeal.  It is for this reason that the distinction based on price is misleading.  The decision the viewer faces is whether the bundle of channels provides sufficient value for money in order to justify the fixed access charge.  Once this has been paid, the consumption decision is based on non-price factors for both FTA television and pay TV.  Thus, FTA television competes on two levels:  in the setting of the initial quality benchmark, and hourly in attracting audience share which for both delivery methods is "unpriced".  Obviously this analysis would not apply for PPV formats, which price each programme.  However, PPV has generally been used in Australia only for wrestling and boxing events and concerts, and is not yet a significant aspect of pricing.

A more systematic consideration of the nature of FTA television and pay TV paradoxically shows that FTA television actually has an implicit usage charge whereas pay TV (as opposed to PPV) does not.  FTA television is not costless to viewers at the point of consumption.  Viewers of commercial FTA television have to put up with advertisements, which many dislike, and would be prepared to pay to avoid.  They diminish the value and detract from the enjoyment of a programme.  This is a cost, not in money, but one factored into the viewers' decisions.  Professors Owen and Wildman (1992, page 126) note that FTA television has a "price":

If viewers do not like commercials, then commercial time may be treated as a nonmonetary price that viewers pay to see programs supported by advertising.  As with monetary prices, we can draw demand curves relating the size of a program's audience to the price viewers pay in terms of the amount of advertising time inserted into the program.

The "price" of FTA television can also be varied.  If the number and crassness of advertisements increase in any hour, the disutility to FTA television viewers will increase. ⁽³¹⁾  This is particularly the case in Australia, where advertisements are both greater in number and are more intrusive since, unlike in the UK, they do not occur in natural breaks in a programme.  FTA television is therefore "priced" and the actions of FTA broadcasters can influence this price by changing the volume, scheduling and quality of advertising.

The reliance of antitrust analysis on observed prices is unreliable.  Consumers do not make purchase decisions solely on the basis of observed prices.  They use the full cost of products or services which incorporate other elements, such as transport and transaction costs, and (most important) the quality of the product.  In many economic transactions involving highly differentiated goods and services, the "full" or "quality adjusted price" which influences consumer decisions is not registered in the market.  The quality-adjusted price is the observed price adjusted for perceived quality differences.  For example, designer jeans sell at a higher price than usual brands of jeans because consumers perceive these to be of a higher quality.  But this does not mean that there is no competitive constraint between designer jeans and other brands.  Indeed, it is more likely that an increase in the relative price of designer jeans, whether due to an increase in the actual price or a reduction in perceived quality, will cause consumers to switch away from designer jeans to other standard brands.  It is important to note that, for an effective competitive constraint between these two products to exist, it is not necessary for all consumers to switch, but only that sufficient numbers do so.

As indicated a number of times, crucial to assessing the competitive relationship between FTA television and pay TV is the degree of supply-side substitution between the two, especially in the early phases of development of pay TV.  If FTA channels provide high-quality programming attractive to viewers, then the take-up and pricing of pay TV will, other things being equal, be lower.  In more technical parlance, the residual demand curve facing pay TV operators alters as a result of the actions not only of other pay TV operators but also of FTA television channels.  Their actions can reduce or increase demand, and twist the demand curve facing an individual pay operator.

The strength of supply-side responses depends on programme scheduling and regulatory factors.  If FTA channels feel that pay TV operators are making sufficient inroads into their audiences, affecting advertising revenues, then they will induce counter-scheduling against pay TV programming.  Moreover, they compete for high-rating material, such as sport and other mass appeal programming.  By acquiring such premium programming and scheduling it against, say, a pay sport channel, FTA broadcasters can affect not only the price of a sports channel but the pay TV operator's total subscriber numbers and penetration rate.

The ACCC has accepted that there is a relationship and possible competitive constraint between FTA television and pay TV:

... suppliers of pay TV services must supply programming content of sufficient high quality to attract subscribers prepared to pay monthly subscription fees to view such programming.  (ACCC, 1997, para. 44 (i))

The EC Commission in MSG Media Services similarly noted that pay TV would have greater difficulties in Germany because the FTA services there broadcast more imported US material and films than in other countries in Europe.  In Bertelsmann/Kirch/Premiere the EC Commission spent considerable time examining the relationship between FTA television and pay TV, reaffirming its previous conclusion that they were in separate markets but acknowledging that the wide availability and quality of FTA television (on average 30 channels in Germany) would affect the demand for pay TV.  Interestingly, the EC Commission expressed concern that Bertelsmann and Kirch, which had significant interests in FTA television, might co-ordinate to switch programming over to pay TV.

Within the strict confines of antitrust analysis, then, the enquiry must extend beyond price analyses. ⁽³²⁾  Tests such as the price elevation test must take into account changes or prospective changes in product quality (that is, supply-side substitutability).  This is especially so in the video entertainment markets, where quality differentiation is the essence of competition.  In an extensive analysis of US cable rate regulation, Hazlett and Spitzer (1997) showed that when basic cable rates were regulated, viewer ratings fell substantially, indicating that quality had fallen in subscribers' eyes.  When they were unregulated, price increases were driven by quality upgrades.  This meant that quality changes are routinely made by pay TV operators to adjust the real price facing the subscriber.  If one is regulated, the other is adjusted to the detriment of the viewer.

A RADICAL VIEW OF THE ACCC's MERGER TEST

The use of price competition as the sole basis for determining market definition in technologically dynamic industries such as pay TV can and has been questioned (FTC, 1997).  The so-called 5 per cent test used by the ACCC (and indeed other competition regulators) results in an excessively narrow market definition, and in identification of market power where none may genuinely exist.  This is often a deliberate enforcement tactic that gives regulators latitude, and has often been the grounds for complaints that merger decisions are arbitrary and often not supported by adequate reasoning.  Notwithstanding this, in the hi-tech, fast developing communications sector the focus on instantaneous price adjustments as the competitive weapon is misdirected.  New products are "experience goods" which must be used in order for consumers to evaluate properly their price-performance characteristics.  It follows that the boundaries of the markets are unknown and certainly fuzzy.  As consumers (viewers) are trialling a new product, a price increase of 5 per cent or even 25 per cent may not immediately induce substitution.  Since these markets are also buffeted by a constant flow of new products with changing specifications and quality characteristics, the static (point-in-time) approach of the ACCC to market definition is rendered obsolete.

In the light of these concerns, some commentators have argued for a radical revision of market definition tests to give them greater practical relevance and to reflect commercial reality.  Professors Jorde and Teece (1992, page 8) have advocated that the market definition tests used in merger analysis be recast solely in terms of non-price competition:

the pertinent question to ask is whether a change in the performance attributes of one commodity would induce substitution to or from another.  If the answer is affirmative, then the differentiated products, even if based on alternative technologies, should be included in the relevant product market.

Such a test might ask whether consumers would shift to other products to defeat a 25 per cent lowering of quality in any key performance attribute or whether a new product exhibiting a 25 per cent improvement in a key performance attribute would draw sufficient customers from the old product.  If so, the substitute products would be included in the relevant market.  Advocates of attribute-based market definition also propose a longer time-period within which to evaluate consumer and supplier reaction.  The ACCC's test for market definition and indeed for assessing the competitive constraints that operate on firms is unduly narrow.  Often the market is defined in terms of price reactions which occur instantaneously or within a year, and the assessment of the merger takes a limited timeframe.  Again, Professors Jorde and Teece (1992) propose four years, as compared with the one or two years used by the US Merger Guidelines.

THE NUMBER OF CHANNELS

The ACCC also stated that a significant factor in distinguishing FTA television and pay TV markets was the number of channels.  It argued that, because FTA television had fewer channels, it did not compete and, therefore, did not effectively constrain the ability of pay TV operators to raise prices above the competitive level.

The ACCC's argument was illustrated by the following example.  Assume that the government decides to give away a limited number of pencils with the balance sold by a private-sector monopolist.  Would the fact that a limited number of pencils are given away free constrain the monopolist's ability to charge above competitive prices for his private-sector pencils?  The ACCC answer was "no" and that therefore, in antitrust terms, there were two separate markets:  one for free pencils, and one for paid-for pencils.

This example is misleading and erroneous for several reasons.

First, it wrongly characterises the nature of television as an economic product.  Once a limited number of pencils are given away, they are unavailable to other potential consumers unless a secondary market develops.  The same is not true of FTA television.  As discussed in Chapter 4, FTA television is a public good.  Once a FTA television channel is broadcast it is available to all.  Those who want to watch it can do so without any supply constraint.  Unlike the pencil example, where there is a separate market for pay pencils, there is no separate market for pay TV.  Rather, there is only one television market with differentiated products at varying prices.  People commit themselves to additional pay TV charges because they want greater variety in programming.  Pay TV substitutes for FTA television because people replace their FTA viewing (or other activities) with watching pay TV.

The pencil example also exaggerates the difference between pay TV and FTA television in terms of their respective capacity to satisfy the viewers' demand for video programming. ⁽³³⁾  This is best illustrated by data from the UK, since ratings for pay TV channels are not yet available in Australia.  In the UK, over a decade of experience with pay TV led in 1997 to five FTA television channels supplying 35 000 hours of programming, with an 88 per cent viewing share and (apart from the new Channel 5) a 100 per cent reach, compared with over 60 pay TV channels broadcasting nearly 300 000 hours to 25 per cent of TV homes attracting less than 12 per cent of total viewing.  These statistics show that despite the existence of only five FTA television channels, the take-up and audience of pay TV was relatively small.  They show that approximately 75 per cent of TV homes in the UK do not regard pay TV as sufficiently attractive to satisfy their demand for video programming, and also that the "punching power" of FTA television far exceeds the number of channels.  On the last point, note that 60 pay TV channels attract only 12 per cent of the viewing -- substantially less than the average FTA channel, and only slightly larger than Channel 4 which, under the Broadcasting Act 1990, is constrained to be a minority channel.  Put another way, one minority FTA channel satisfies far more demand for video programming than the entire UK pay TV sector with its 60 channels and massive volume of programming.

FTA television is not the minnow among the sharks of pay channels, as the ACCC argued.  The audience size and impact of FTA television is large compared with pay TV, and is therefore a major force in satisfying the demand for video programming.  Simply put, viewers do not demand channels -- they demand and watch programmes.  As a working assumption, the unit of analysis should be viewer hours or audience share.

There are other reasons to be suspicious of the ACCC's focus on the number of channels.  As already noted in Chapter 3, the competitive interaction between FTA television and pay TV audiences is conditioned by several features peculiar to television, namely:

1. viewers can watch only one programme at a time;
2. an expansion in the number of and variety of programmes/channels does not increase aggregate television viewing, but serves to fragment existing audiences; ⁽³⁴⁾  and
3. the competitive impact between channels varies around the clock, e.g., peak and off-peak.

So viewers have a limited amount of time to watch programmes, and can watch only one programme at any one time.  These physical constraints make television different from other markets.  The audience for a specific channel at any one time depends on the type of programming available at that time from all channels.  The fact that the viewer has a choice of two or 60 programmes in a given hour still does not enable him or her to watch more than one programme. ⁽³⁵⁾  FTA television can compete effectively at a point in time because it addresses the same audience.  Moreover, competition which takes place in peak hours has more impact overall because that is where pay TV and FTA channels seek to maximise their audiences and generate most of their revenues.  These factors mean that competition takes place hour by hour, is more pronounced during peak viewing hours, ⁽³⁶⁾ and one channel's gain in audience (and hence revenue) is another's loss.

The attempt to analyse the market in terms of number of channels is highly suspect for another reason.  In a newly developing pay TV industry, the battleground between different video delivery formats tends to be confined to a few specific and identifiable categories of programming -- the "drivers" or "killer applications" (movies and sport).  Both FTA and pay TV compete intensely for the high-rating programming critical to financial success.  In Australia, among the highest rated programmes on FTA channels are football programmes (Rugby League and AFL) and movies (ABA, 1996).  These are the programmes which are considered the main reason why subscribers take pay TV.  In the UK, sport is the single most important type of programming responsible for increasing pay TV take-up and its financial success.  It has greatly assisted in transforming BSkyB from a company losing £2 million a day to a highly profitable venture and one of the UK's largest listed companies.

THE EMPIRICAL EVIDENCE

As noted, the ACCC's case rested essentially on legal decisions drawn from other jurisdictions.  There is little hard statistical evidence directly on the way FTA television constrains the pricing decisions of pay TV operators, apart from several US studies.

US Studies

In proceedings prior to the enactment of the US Cable Act 1992, attention focused on whether broadcast television was a source of competition to cable TV.  This was part of the review of the previous effective competition standard administered by the FCC, which required four FTA channels for a cable pay TV franchise to be regarded as competitive.  Two studies undertaken in 1990 provide interesting evidence of the competitive relationship between broadcast and pay TV in the US.  Dertouzos and Wildman (1990) and Crandall (1990) found that cable networks in the US facing competition from five or more FTA channels had fewer subscribers, carried more channels in the basic tier, and had a lower price per basic channel than cable networks facing fewer channels. ⁽³⁷⁾  A more recent study by Crandall and Furchtgott-Roth (1996, pages 96–97) using panel data for 1992 confirmed this finding but with one modification:

Our model revealed that the demand for cable services is sensitive to the number of broadcast channels available to households without cable service. ... As the number of competing channels increases, demand for each type of cable service decreases.  We found that the competitive effect of broadcast signals continues for all number of signals.

No doubt these studies have problems and can be criticised.  Nonetheless, where the issue has been examined empirically, evidence has been found that pay TV and FTA television compete, and that the effect is significant. ⁽³⁸⁾

Australian Evidence

The ACCC claimed that the way Australis's prices altered in 1995 when faced with competition from FOXTEL and Optus Vision was evidence that pay TV was a self-contained market.  The evidence does not support this interpretation.

When Australis launched Galaxy in 1995 it charged a monthly subscription of $49.95 and an installation charge of $299.  In June, with FOXTEL and Optus Vision launches several months off, Australis reduced its installation charge to $99.00.  When Optus Vision launched in September, it undercut Australis's installation ($29.95) and monthly subscription, as did FOXTEL, which offered Galaxy core programming as part of its package (installation charge of $19.95) when it launched in October 1995.  Australis matched FOXTEL's charges in November.  Thus, within a six-month period Australis, in the face of increased competition, reduced its installation charge by 93 per cent and its monthly subscription by 20 per cent.

While this is evidence that pay TV operators react to one another's prices, it does not support the claim that pay TV operators can unilaterally set prices without competitive constraint.  First, the scale of the reduction suggests that Australis got its initial pricing grotesquely wrong.  Indeed, its take-up was 81 per cent below its forecast figure for October 1995.  When prices were lowered in November, take-up accelerated significantly.  Second, within three months Australis had increased its installation charge, and monthly subscriptions were significantly higher than those of FOXTEL or Optus Vision on a like-for-like basis.  Australis's installation charge at May 1997 was $49.95 for both MDS and DTH, Austar $49.95 for MDS and $199 for satellite DTH, and East Coast $199 for MDS.  Cable installation charges were considerably lower at $29.95 for both FOXTEL and Optus Vision.  Thus, around the time of the proposed merger between Australis and FOXTEL in 1997, Australis's installation charges were 67 per cent higher than either FOXTEL or Optus Vision.

A similar picture emerges from an analysis of subscription charges.  At the time of the proposed 1997 merger, the price of the basic package varied within the range $29.95–$49.95.  However, the number of channels offered varied considerably.  FOXTEL offered 28 channels, including Galaxy core programming, in its basic package for $42.95 per month, compared with Australis's 15 channels at $49.95.  Such a wide disparity in price structure between the different pay TV operators would not be easy to explain if they were operating in the same market.  The implicit price per channel in each operator's basic (entry-level) package can be used as a proxy for the quality-adjusted price.  On this basis, the cheapest package was Optus's Gateway, which cost subscribers 66 cents per channel, compared with $1.87 for FOXTEL and $3.33 for Galaxy.  If, on the other hand, Optus Vision's Super Deluxe package is used, which at 27 channels had one fewer than FOXTEL's basic tier, the price of each cable-delivered channel was almost identical at $1.88.  Thus Galaxy was priced at least 80 per cent higher than FOXTEL's basic tier and more than 400 per cent higher than Optus Vision's Gateway.

Figure 5.2:  Monthly Price per Channel of Basic Packages, May 1998

Source:  FOXTEL

These data appear to tell a different story from that presented by the ACCC.  First, while Australis did react to competition from FOXTEL and Optus Vision, this was short-lived, and in the end Australis's position was rendered commercially unviable.  Second, the larger differences between the pay TV operators in terms of price and the quantity and quality of programming appear to indicate that at the time they operated in regional markets.  Australis's high price/fewer channels service was not competitive with the larger and cheaper packages offered by the cable operators, and explains its strategy to withdraw from cabled areas.  Finally, the price differentials provide some evidence that FTA channels may have an influence on pay TV charges.  The regional operators Austar and ECTV were able to levy considerably higher charges than Optus and FOXTEL.  These operators faced less competition from FTA channels.  As the managing director of Austar commented at the time of the proposed merger:

"We do well in markets where there are less than three commercial TV channels", says Austar managing director, John Porter. ... "That is a demonstration of the fact we are competing with the free-to-air channels, we are in the same market for entertainment.  We're competing against free-to-air, against video".  (quoted in Brewster, 1997)

CONCLUDING OBSERVATIONS

The ACCC failed to make any rigorous case that the market did not include other forms of video entertainment.  It prevaricated as to the relevant market, holding first that FTA television and pay TV were in the same market and then that they were not.  This was so even within the narrow confines of merger analysis under Australian trade practices law.  Furthermore, its analysis of market definition was entirely hypothetical, based as it was on legal judgments and regulatory decisions from other countries.  The hard evidence relied on by the ACCC was weak, and insufficient to indicate that FOXTEL even reacted over the period under consideration to Australis's pricing.  It was increasingly apparent that Australis was an "ineffective competitor" progressively retreating to a separate geographic market where cable was not present due to its inability to compete with the greater programme offering of cable operators.  Further, in terms of defining the relevant market for trade practices purposes, the ACCC seized on only one area of competition -- price competition -- ignoring the fact that in the initial phase of product introduction non-price factors are of critical importance and play a greater role in the competitive interaction between communications companies.

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ENDNOTES

20.  The impact of television extends beyond video programming.  As live television coverage of sport increases, television competes directly with attendance at the match.  Recent empirical studies in the UK indicate that this effect can be significant, with live television coverage, whether on pay TV or FTA television, of UK league football depressing attendances by 5–10 per cent (Case Associates, 1997a, and Baimbridge, Cameron & Dawson, 1995).  Of course, the critical question is whether gate prices affect pay TV prices for televised matches.  Clearly, as the sector moves to PPV there will be a direct relationship between gate prices and PPV prices.

21.  These mirror the influential US Department of Justice/Federal Trade Commission, Horizontal Merger Guidelines 1997.  Also see EC Commission (1998).

22.  ACCC (1996a, paras 5.46 and 5.47).  This is sometimes called the "hypothetical monopolist test".  Ideally market definition should be examined by statistical analysis to find whether the quantity demanded of a product is price elastic in the sense that an increase in price leads to more than a proportionate fall in the quantity demanded, thus lowering the supplier's profits.  This finding would establish that consumers had choice of substitutable products to which they could turn to defeat any unilateral attempt to increase price.

23.  Re Media Council of Australia (1996) ATPR 41–497.

24.  Burchett J, News Ltd v Australian Rugby League Ltd (1996) ATPR 41–466.

25.  In October 1998 with the proposed acquisition of 25 per cent share of FOXTEL by PBL (the controlling owner of FTA Channel 9) the ACCC was actively reconsidering its position:

Acting ACCC Chairman Mr Allan Asher confirmed yesterday that the Commission was particularly interested in whether there were any "identifiable market overlaps that may raise issues under section 50 of the Trade Practices Act or section 45".  "We have been getting some more information from them," he said.  "We are waiting to understand the way that the commercial transactions operate in this sector."  Section 50 of the Act outlaws mergers which "substantially lessen competition" while section 45 prohibits agreements between businesses that have "the purpose or effect of substantially lessening competition in a particular market".  The ACCC last year opposed the merger of FOXTEL and Australis Media on the basis that the merger would substantially lessen competition and, at that time, eschewed FOXTEL's argument that the pay-TV sector was part of the wider television market.  "The point there was in the past we had seen them as separate markets," Mr Asher said.  However, he pointed out that "the notion of convergence" in technology had raised the need for the ACCC to take a fresh look at the television market.  "Digital is highly relevant," he said.  (Burke, 1998)

The ACCC cleared the acquisition in December 1998, reaffirming its view that pay and FTA television were in separate markets.

26.  MSG Media Services Case IV/M.469.  This was an alliance between Bertelsmann, Taurus (owned by the Kirch Gruppe) and Deutsche Telekom (called MSG Media Service Gesellschaft für Abwicklung von Pay-TV und verbundenen Diensreo) to develop "technical and administrative services" (conditional access, subscriber management, decoder boxes) for a new digital pay TV service for Germany.  See also Nordic Satellite Distribution Case IV/M.490 1996 which follows this line of reasoning.

27.  The UK Office of Fair Trading (OFT, 1996) mirrored the EC Commission's finding that pay TV is a separate market, and that premium channels may constitute a distinct market.  The OFT found that BSkyB had a dominant position in the supply of the key movies and premium sport channels.  The OFT regarded the degree of substitution between pay TV and FTA television channels as insufficient to constrain the wholesale price of BSkyB's premium channels.  It concluded that there was evidence that BSkyB had exercised its market power, based largely on the finding that BSkyB had earned "excess profits" consistent with the OFT's observation that there were barriers to entry caused by limited analog satellite transponder capacity.  Note that the OFT was effectively attributing its finding of market power to barriers to entry in the satellite transponder market, and suggested that the practices of the satellite operator (SES of Luxembourg) be investigated by the European Commission.  See also the uncompromising views of the UK Office of Telecommunications concerning the impact of BSkyB channel pricing and bundling practice on UK cable networks, and its submission to the broadcast regulator that the participation of BSkyB as a shareholder in the successful bidding consortium for the new digital terrestrial licences be blocked (Oftel, 1996 & 1997).  Under pressure from Oftel and Brussels, the Independent Television Commission forced BSkyB to withdraw from the consortium and to modify its programme supply arrangements.  See also MMC (1999).

28.  Bertelsmann/Kirch/Premiere Case No. IV/M.993 (1998) and Deutsche Telekom/Betaresearch Case No. IV/M.1027 (1998).  Also see discussion in Veljanovski (1999b) and McCallum (1999).

29.  The Bulletin (1997, page 23).

30.  For recent analysis of US pay TV and its regulation see Johnson (1994), Crandall & Furchtgott-Roth (1996) and Hazlett & Spitzer (1997).

31.  AGB McNair conducted face-to-face interviews with 1000 respondents in October 1992 on the subject of FTA television and pay TV.  The strongest response on FTA television was from the statement "There is too much advertising on existing commercial television", with strong agreement from 67 per cent of respondents.  When asked if they would be happy to pay to view without advertising, a total of 36 per cent of respondents were in either mild or strong agreement.

32.  This is recognised in the ACCC's Merger Guidelines:

5.50 The price elevation test does not require that all products included in the market should have the same price.  Within a market, there can be product differentiation.  The relevant question is the degree of constraint imposed on the price and output decisions of the merged firm.  As Wilcox J. stated in Australian Meat Holdings:

the existence of price differentials between different products, reflecting differences in quality or other characteristics of the products, does not by itself place the products in different markets.  The test of whether or not there are different markets is based on what happens (or would happen) on either the demand or the supply side in response to a change in relative price.  [AMH (1988) ATPR 40-876, at 49,480.]

33.  FTA television will always create excess demand for identical programming because programmes are free.  This follows from the economist's principle of a negatively sloped demand curve.  The cheaper something is, the more people want it.  Thus, it is not surprising that people should be dissatisfied with the FTA television service and possibly be attracted to pay TV when it becomes available.  But on this point it should be noted that (a) only a small fraction of viewers subscribe to pay TV when it is made available, and (b) the level of churn (annual gross disconnection) is often very high for new cable operators.  In the UK, churn figures of 40 per cent are common and sometimes exceed 60 per cent.  So while there may be unsatisfied demand in a FTA television system, there is a high degree of dissatisfied demand when people pay.

34.  The evidence shows that this is also the case for Australia, although viewing increases.  It is also the case that viewing in general has remained stable with regional variations, with some cities in Australia experiencing decline and others a modest increase;  see ABA (1996) and BTCE (1991).

35.  Ignoring time shifting using VCRs and "channel surfing".

36.  There will also be competition between television programmes at different times.  But this can be expected to be more limited given the viewers' other commitments and limited flexibility.

37.  A study by the US Federal Trade Commission (1992) looked at the competitive relationship in the other direction -- the impact of cable on broadcast TV audiences.  The study found that for each percentage point increase in the number of homes passed by cable, there was a decrease of one half of a percentage point in audience share to local broadcast stations.

38.  US studies of the price sensitivity of basic pay TV (defined as the retransmission of FTA channels) range widely from 0.8 to 3.75, i.e., anything from no sensitivity to highly elastic demand implying considerable substitution.  The upper range of the estimates suggests pay TV competes with other products, although these studies usually do not identify which products.  It is also the case that premium channels are treated in the US as part of a wider market competing with video sales, rentals and, to some extent, cinema.  Studies from the US show that duopolistic competition between cable systems leads to basic cable rates 20 per cent lower than monopoly markets (Hazlett & Spitzer, 1997, pages 27–33).  The ACCC also noted that pay TV operators face competition from other industries (e.g., cinema, video and FTA) in movies since movie studios sell rights on a staggered or windowed basis.