Review of the Contract Rights Renewal Undertakings Evidence to the OFT and CC following the request for release from undertakings given by Carlton

Transcription

1 Review of the Contract Rights Renewal Undertakings Evidence to the OFT and CC following the request for release from undertakings given by Carlton Communications Plc and Granada Plc (now ITV Plc) pursuant to section 88 of the Fair Trading Act 1973 Publication date: 2 June 2009

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3 Contents Section Page 1 Executive Summary 1 2 Introduction 5 3 TV Advertising 12 4 Analysis of Market Definition 28 5 Competition Assessment 38 6 Impact of the CRR remedy 52 7 Issues outside the scope of the CRR review 66 8 Recommendations 71 Annex Page 1 Background Information on TV Broadcasting and Regulation 77 2 Major TV sales houses and channel airtime sold 89 3 Discounts off SAP Example from CC Report 92 4 Market Definition Detailed exposition 95 5 Competition Assessment (redacted) 121

4 Executive Summary Section 1 1 Executive Summary Introduction 1.1 The Contract Rights Renewal remedy (the CRR remedy) is part of the undertakings accepted to address competition concerns arising from the proposed merger between Carlton Communications Plc and Granada Plc in Specifically, the CRR remedy was intended to address concerns about ITV s increased market position following the merger. The Competition Commission (CC) concluded that the merger could be expected to operate against the public interest because it would potentially result in: less attractive terms to advertisers or media buyers; a greater degree of price discrimination; and/or changes to the system of selling TV advertising airtime to the advantage of the merged entity. 1.2 In January 2008, the OFT formally launched a review of the CRR remedy, following a number of requests from ITV. The legal test applied in the review is whether the adverse merger effects specified in the CC s Report have diminished so as to justify a variation or removal of the remedy. In 2003, the effects of the merger were not explicitly quantified. Therefore, it has been necessary to make a judgement about the extent to which the merger effects, particularly those in relation to ITV1, still exist and the ongoing need to retain the CRR remedy. 1.3 At the time of the merger, the CC concluded that ITV s market position was enhanced as a result of a loss of competition between Carlton and Granada. This loss of competition was a concern due to a number of unique features associated with ITV1 which could not be replicated sufficiently by other channels, including delivery of reach and mass audiences, the ability to target light viewers and the superior quality of ITV1 s impacts. These factors resulted in the CC concluding that advertisers and media buyers could not substitute away from ITV in the event of discriminatory conduct or attempts by ITV to raise price. 1.4 As part of the review we have considered the definition of the relevant market and examined changes in the market since 2003, assessing whether or not ITV s market position, by virtue of the importance of ITV1 to advertisers/media buyers, has changed. We have re-evaluated the unique characteristics of ITV1 to examine whether the ability of advertisers or media buyers to switch away from ITV1 in the event of a price increase or other conduct has changed. In addition, we have looked at possible distortions introduced by the operation of the CRR remedy. Recommendation 1.5 On the basis of available evidence it is credible to argue that the CRR remedy should be lifted. Evidence suggests that while ITV1 retains unique features, which may result in some advertisers or campaigns being reliant on ITV1, there is a group of advertisers/campaigns which can move away from ITV1 without compromising campaign objectives. Furthermore, the feasibility of switching away from ITV1 to other channels should have increased since 2003, and the group of 1

5 Executive Summary advertisers/campaigns that can switch may be sufficiently large to ensure that any attempt by ITV1 to raise overall prices would be rendered unprofitable. 1.6 However, there is still uncertainty about the size of the group which can switch away from ITV1, partly because there may be barriers which limit the amount of spend that media buyers could switch following a price rise on ITV1. In addition, since ITV1 could still be more efficient at delivering mass audiences quickly there may be concern about removing the CRR remedy if ITV can identify and set higher prices for dependent advertisers requiring this feature. 1.7 Whilst undue price discrimination seems unlikely under the current trading mechanism, the possibility exists that, absent the CRR remedy, ITV may be able to change the way that it trades advertising airtime such that price discrimination becomes feasible. In particular, ITV could potentially target advertisers who are reliant on fast, mass cover by increasing peak time prices. Although there would be some risk to ITV with this strategy, it is likely that demand for these impacts will be less price sensitive than demand for ITV1 impacts generally, given the importance of peak time impacts for delivering fast mass audiences. 1.8 Ofcom believes that there is a strong case for easing the burden of CRR regulation on ITV1 where market forces can provide a credible constraint on ITV s pricing. However, concerns remain such that the CC may wish to consider implementing safeguards (or alternatives to the CRR remedy) that continue to protect advertisers dependent on ITV1 for the quick delivery of mass audiences, but only if it is clear that competitive forces will not provide sufficient protection. 1.9 Given the distortion to ITV s incentives to invest in high definition and time shifted variants of ITV1 Ofcom believes the undertakings should be redefined to link them to all linear channels which contain the same content as ITV1, regardless of the platform or method of delivery 1.10 In addition, Ofcom believes that there is a need for ongoing monitoring of the advertising sector to understand the impact of amending the CRR remedy, recognising that it may be necessary to commence a market investigation of the advertising sector sometime in the future. Market definition 1.11 At the time of the Carlton-Granada merger, the CC defined a market for TV advertising in the UK. We do not believe that market definition has changed since the merger. However, we recognise that internet display advertising, which has some similar characteristics to TV advertising, has grown in recent years, and may become a sufficiently close substitute to be considered part of the same economic market as TV advertising in the future. In addition, we acknowledge that within the relatively broad market of TV advertising there may be sufficient qualitative differences between the advertising impacts delivered by ITV and other broadcasters that not all products within the market will be perfect substitutes. Competition assessment 1.12 We have examined a number of indicators of competition - market shares, pricing metrics, profitability, barriers to entry and expansion, buyer power and substitutability. Overall they support the proposition that ITV s market position has weakened since Whilst some are difficult to interpret (given the influence of the 2

6 Executive Summary CRR remedy itself) other indicators such as buyer power, SOCI and substitutability indicate that ITV s market position has decreased Examination of the evidence on substitutability, in particular, suggests that while ITV1 retains some unique features (primarily associated with delivery of mass audience programming) which may leave some advertisers or campaigns reliant on ITV1, there should be a growing group for which ITV1 is substitutable. This group is able to switch away from ITV1 to other broadcasters channels without compromising their campaign objectives (either in terms of price or quality). Furthermore, the spend associated with these advertisers/campaigns may be sufficiently large such that any attempt by ITV1 to raise prices would be rendered unprofitable During the course of the review, very little evidence was provided to enable us to quantify precisely how much spend is represented by the group able to switch away from ITV1 and we note that the group will vary with the nature of the campaign and/or product being sold. However, although we do not know the size of the group, ITV s evidence suggests that only a small amount of revenue needs to switch before a price increase would become unprofitable for ITV Concerns have also been raised about the ability of media buyers and advertisers to switch away any spend (even if impacts are substitutable) due to barriers to switching. Evidence on these barriers remains limited, nonetheless, examples of switching have been observed and we have no reason to believe that that these examples could not be replicated more widely Finally, while price discrimination seems unlikely under the current trading mechanism, the possibility exists that, absent the CRR remedy, ITV may be able to change the way that it trades its advertising airtime making price discrimination. As a result, we have concerns that ITV may be able to target and set excessive prices for impacts which are necessary to deliver fast mass cover, e.g. peak time impacts. Distortions 1.17 We have considered a number of possible distortions arising from the CRR remedy. ITV has stressed that it faces perverse programme investment incentives and the remedy limits its ability to optimise its advertising inventory given the ability of advertisers to simply roll over their existing contracts. Whilst Ofcom has some sympathy with ITV s position, it is not clear that these effects are driven by the CRR remedy (although it may be that the remedy reinforces the effects) Of greater concern to Ofcom are potential distortions that affect the wider market. Although it is credible that media buyers possess countervailing buyer power, as suggested by the level of buyer-side concentration, media buyers do not appear willing to exert their negotiating power. Ofcom believes that the CRR remedy has affected the way in which contracts are negotiated and may have reduced incentives to move away from existing protected contracts (for instance, by moving more money out of ITV1 than is provided for under the ratchet). Therefore, it may be the case that the CRR remedy itself is affecting media buyers willingness, or ability, to exert countervailing buyer power. This is concerning because, if material, while the CRR remedy exists reliance on the remedy will not decline In addition we conclude that the CRR remedy has adverse investment incentives for ITV and particularly on ITV s incentives to launch an ITV1HD or an ITV1+1 service. 3

7 Executive Summary Wider issues 1.20 During the course of the CRR review, a number of stakeholders raised potential competition issues that do not fall within the legal scope of the CRR review and which they claimed should be addressed through a market investigation. These issues mostly related to the wider market position of ITV (as opposed to ITV1) and ITV s ability to leverage its position across its portfolio of channels in the sale of airtime. In addition, concerns were raised about: Channel 4 s negotiating strength in the sale of TV advertising airtime and its price premium; aspects of the underlying trading mechanism, including agency deals, share of broadcast arrangements and the SAP mechanism; and ITV s dealings with the non-consolidated licensees i.e. stv, UTV and Channel There are a number of reasons why Ofcom does not believe that a market investigation is appropriate at this time: Potential problems around the market strength of the wider ITV family of channels may be better addressed using Ofcom s sectoral powers, including the Airtime Sales Rules. The presence of the CRR remedy itself has a major effect on the operation of the market and it is not clear which issues result from the remedy or underlying market issues. In addition the willingness of media buyers to exert countervailing buyer power may be limited due to the operation of the CRR remedy. The same issues have not been consistently raised and no strong evidence of consumer detriment has been presented (i.e. we have no clear understanding of the problem or likely remedy required). The TV broadcasting sector is currently facing a period of potential upheaval. There has been a severe reduction in advertising expenditure given the current economic climate and this is expected to continue for at least this calendar year. In addition the ongoing Digital Britain review increases uncertainty about the TV sector and TV advertising. Conducting a market investigation in this environment might be considered premature That said, Ofcom believes that it is important to closely monitor any stakeholder concerns and market developments, particularly in the light of any changes resulting from the CRR review and other changes in market structure. We recognise that it may be necessary to commence a market investigation of the TV advertising sector in due course. Indeed, the possibility of re-regulation associated with such a market investigation provides an important safeguard if the CRR remedy is eased or removed, though we also recognise that this threat is not always sufficient to discipline behaviour in a market 4

8 Introduction Section 2 2 Introduction Purpose of report 2.1 On 30 January 2008, the OFT announced that it had started a review of the Contract Rights Renewal remedy (the CRR remedy) in partnership with Ofcom This report sets out Ofcom s views and analysis considering whether there has been a relevant change of circumstances such that it is appropriate to remove or vary the CRR remedy. In particular, this report considers the following: the operation of the UK s TV advertising sector; the relevant market(s) for TV advertising; ITV s market position and the state of competition within the relevant market; other issues raised by stakeholders, which do not fall in the scope of the CRR review; and whether, by reason of a change of circumstances, the CRR remedy is no longer appropriate and, if so, whether ITV plc should either be released from the CRR remedy or the CRR remedy varied or superseded by a new remedy. 2.3 The information contained in this document reflects submissions from stakeholders, as well as Ofcom s knowledge and experience of the UK TV advertising sector. 2.4 The OFT is responsible for advising the CC, under section 88(4) Fair Trading Act 1973 ( FTA73 ), on the request from ITV plc for release from the undertakings accepted by the Secretary of State for Trade and Industry in October Responsibility for these undertakings was transferred to the CC by SI No. 2004/2181 The Enterprise Act 2002 (Enforcement Undertakings and Orders) Order CC s findings in respect of advertising airtime 2.5 On 11 March 2003, the Secretary of State for Trade and Industry (Secretary of State) referred the proposed merger between Carlton Communications Plc ( Carlton ) and Granada Plc ( Granada ) to the CC for investigation and report under the merger provisions of the FTA73. In October 2003, the CC published a report ( CC s Report ) on their inquiry into the proposed merger between Carlton and Granada ( the 2003 merger ) The CC concluded, among other things, that Carlton and Granada competed in the sale of advertising airtime in the UK and the 2003 merger might be expected to operate against the public interest because it would potentially result in: less attractive terms to advertisers or media buyers; 1 See 2 Competition Commission, Carlton Communications Plc and Granada Plc: A report on the proposed merger, October These parties subsequently merged to form ITV plc. 5

9 Introduction a greater degree of price discrimination; and/or changes to the system of selling TV advertising airtime to the advantage of the merged entity In order to remedy or prevent the adverse effects to the public interest outlined in the CC s Report, pursuant to a request by the Secretary of State, the OFT consulted with Carlton and Granada with a view to obtaining from them undertakings pursuant to section 88(1) of the FTA73. Following this consultation, Carlton and Granada gave undertakings to the Secretary of State pursuant to section 88(2) of the FTA73 on 14 November 2003 ( the Carlton and Granada merger undertakings ) 4. Summary of the CRR remedy 2.8 A key part of the Carlton and Granada merger undertakings was a mechanism designed, for the duration of the remedy, to give all advertisers and media buyers who had a contract with Carlton or Granada at the time of the 2003 merger the fall back option of renewing the terms of their 2003 contracts. Where that contract includes a specified share of broadcast, the CRR remedy provides that this share would vary in direct proportion to ITV s share of commercial impacts (SOCI), subject to a cap at the initial share. The main features of the CRR remedy can be summarised as follows: ITV is obliged to offer advertisers and media buyers the right to renew their contract on the same terms and conditions as that contained in their 2003 protected contracts. Thus, there would be no increase in the share of advertiser s or media buyer s TV advertising spend that they commit to ITV1 (known as share of broadcast or SOB commitments) and no reduction in the discounts they receive; ITV is required to ensure that any terms included in new ITV1 contracts are fair and reasonable; advertisers and media buyers have the right to reduce automatically the proportion of their ITV1 SOB commitments if ITV1 s audiences shrink whilst maintaining all of the other existing terms and conditions (including discounts) under the protected contract ( Audience Ratchet Mechanism or ARM); ITV is prohibited from changing the existing airtime sales system and the way in which they offer commercial airtime for sale; and advertisers and media buyers have the right to bring contractual disputes to an independent adjudicator (the CRR Adjudicator). ITV s request for a review 2.9 During 2006, ITV made repeated requests for the OFT to conduct a review of the CRR remedy. ITV sent the OFT (and Ofcom) a detailed written submission in October CC Report, paragraph The text of the CRR undertakings is available from the CRR Adjudicator s website: 6

10 Introduction 2.10 In 2007, following further written submissions from ITV and dialogue with Ofcom, the OFT decided to conduct a review of the CRR remedy. On 6 September 2007, the OFT announced that it would start a review of the CRR remedy (in partnership with Ofcom) in January On the 30 January 2008, the OFT published the following statement by ITV which summarised ITV s reasons for requesting a review of the CRR remedy: CRR was adopted in November It was devised as a remedy to deal with the loss of competition within ITV caused by the merger of Carlton and Granada. As is widely recognized, the period since 2003 has been one of profound change for the UK television industry resulting in ITV1's share of NAR falling below 40 per cent for the first time ever in 2007 and causing Ofcom to bring forward its PSB review. The period has also seen significant changes in the supply of and demand for TV advertising, transforming the landscape for ITV and its customers. In this changed environment, CRR is constraining ITV's ability to respond to market changes and causing unintended distortions in ITV1 scheduling and programming. CRR has now been in place for five 'deal rounds' without review. That is far longer than was envisaged originally. The changes that have occurred since 2003 and the unintended distortions that CRR is creating make it appropriate for CRR to be reviewed. ITV looks forward to working with the OFT and Ofcom throughout the review process. Scope of the CRR review 2.12 This review considers whether the CRR remedy remains appropriate or whether there has been a relevant change of circumstances since the 2003 merger such that the CRR remedy should be varied, released or superseded The review is limited to the following parts of the Carlton and Granada merger undertakings which relate to the CRR remedy: clauses 5-11 and Annex 1 which relate to the sale of commercial airtime; clauses and Annexes 2 and 3 which relate to adjudication; and clauses which relate to the interpretation of words and expressions used in the undertakings This review is not considering other aspects of the Carlton and Granada merger undertakings which govern the relationship between Carlton and Granada and the other regional channel 3 service licensees (as licensed pursuant to section 14(6) of the Broadcasting Act 1990 (as amended)) not controlled by Carlton or Granada 6. 5 OFT press release, 13/08, 30 January Details of the Channel 3 license holders, including those channel 3 licences not currently controlled are given in Annex 1. 7

11 Introduction Legal framework 2.15 The Carlton and Granada merger undertakings were accepted by the Secretary of State under section 88 of the FTA73. Under the Enterprise Act 2002 (EA02) power to supersede, vary or release undertakings under section 88 passed from the Secretary of State to the CC, subject to designation of the relevant undertakings by an Order made by the Secretary of State. The Carlton and Granada merger undertakings were so designated in The Enterprise Act 2002 (Enforcement Undertakings and Orders) Order Under section 88(4) FTA73 as amended by Schedule 24, paragraph 16(1) (6) of the EA02, the OFT is required: (i) to keep under review the carrying out of that undertaking, and from time to time to consider whether, by reason of any change of circumstances, the undertakings are no longer appropriate and either the relevant parties can be released from the undertakings or the undertakings need to be varied or superseded by a new undertaking and, (ii) if it appears to the OFT that any person can be so released or that an undertaking needs to be varied or superseded to give such advice to the CC as is thought proper in the circumstances. The CC then decides whether to act upon the advice and, if appropriate, seek revised undertakings The OFT is therefore required to consider from time to time whether merger undertakings such as the CRR remedy should be varied, revoked or superseded in the light of any changes of circumstances. Assessment of the adverse effects to the public interest 2.18 In order to assess whether there has been a relevant change of circumstances it is necessary to consider the degree to which the adverse effects to the public interest specified in the CC s Report remain. This requires an analysis of how the competitive landscape has changed since the 2003 merger and in particular whether the market position of ITV1 and ITV has changed The analysis will examine the overall position of ITV, in addition to the position of ITV1. We note that at the time of the merger the market position of the combined Carlton/Granada entity was exhibited through ITV1 alone, as ITV2 airtime was jointly owned and sold by the parties prior to the merger and also, at that time, ITV2 and ITV News were considered relatively insignificant 8. This position is also reflected in the degree to which the CC s Report used both the terms ITV and ITV1 without distinguishing between them. Indeed, the fact that the scope of the CRR remedy was limited to ITV1 further supports this position The limited scope of the CRR remedy prevents any extension of the remedy to cover other ITV digital channels 9 but it does not prevent the CRR review examining the market position of the combined Carlton/Granada sales house, in addition to that of ITV1. While contracts for ITV1 and the ITV digital channels are entered into separately (a necessary requirement of the CRR remedy), the channels remain under common ownership, with all airtime being sold by the ITV sales house. Therefore, we would not expect the ITV digital channels to exert any competitive 7 S.I. 2004/ In 2003, ITV2 had a 1.6 % share of adult impacts and a []. In the same period, ITV News had a 0.2% share of adult impacts. It is also worth noting that ITV3, ITV4 and ITV s other digital channels were launched post-merger. 9 That is, ITV2, ITV3, ITV4, CITV and Men & Motors 8

12 Introduction constraint on ITV1. As a result, our analysis includes an examination of the overall market position of ITV and, where relevant, also examines the individual position of ITV1, as this is the focus of the CRR remedy The CC presented its conclusions on the adverse effects to the public interest based on a series of factors which suggested that advertisers and media buyers could not switch away from ITV 10. These factors were set out in the CC s Report 11 and included certain must have features of ITV. However, the CC did not attempt to quantify the merger effects. Instead, its conclusions on the adverse effects to the public interest were generally based on a qualitative assessment of the market dynamics Given that the CC did not quantify the merger effects with precision, in reaching a decision as to whether there has been a relevant change of circumstances, Ofcom has needed to consider a wide range of indicators in order to assess whether the market position of ITV1 and/or ITV has changed such that the adverse effects to the public interest identified by the CC no longer remain. These indicators include the following: market shares; pricing; barriers to entry/expansion; countervailing buyer power; substitutability; and the other quality features of ITV1. These are discussed in detail in Section 5. Other factors 2.23 It should be noted that that the CRR review is limited to examining the adverse effects to the public interest identified by the CC as a result of the 2003 merger and does not extend to wider competition concerns (e.g. possible issues surrounding the advertising trading mechanism or the sale of non-itv1 advertising). Such concerns, if identified, would need to be addressed using alternative legal powers 12. Key steps taken during the review 2.24 The OFT announced the launch of the CRR review in January 2008 and published a Statement of Issues on 13 February This Statement of Issues set out the key areas which would be considered as part of the review, including: developments in the market for TV advertising; market definition; competition between broadcasters; barriers to entry/expansion; and the effectiveness of the CRR remedy to date The OFT and Ofcom met with key stakeholders during February and March The stakeholders included media buyers, advertisers, TV sales houses, and trade bodies In addition to expressing views during meetings, a wide range of stakeholders also made written submissions in relation to the matters set out in the Statement of Issues. Some stakeholders also raised matters which were not covered by the Statement of Issues and which were outside of the scope of the CRR review. Information on these wider issues is provided in Section 7 of this report In order to obtain additional data and clarification on matters raised in written submissions, the OFT issued information requests to ITV on 28 April 2008, and to other stakeholders between the 6th and 19th May Which at the time of the merger was synonymous with ITV1. 11 See paragraphs and of the CC s Report. 12 Such as such as section 131 of the EA02 which relates to market investigation references; ex post competition enforcement under the Competition Act 1998; or the Communications Act

13 Introduction 2.28 On 1 May 2008, ITV made a presentation to the OFT and Ofcom on the need for a market review, citing problems with the underlying trading model, the increased competitive constraint that TV advertising was facing from internet advertising; and that ITV is no longer in a position of market power. Following a request from Ofcom, ITV declined to provide further information to support their case for a market review On 16 June 2008, ITV made another presentation to the OFT and Ofcom outlining how the substitutability of ITV1 has changed significantly since In order to test ITV s analysis the OFT issued further information requests to ITV and other stakeholders in June and July On 23 July 2008, ITV submitted a note summarising its views on the key detriments arising from the CRR remedy. On 31 July 2008, ITV also provided further evidence and analysis on the substitutability of ITV1 airtime, including a survey conducted by an independent research firm into advertiser/media buyer switching behaviour In November 2008, the OFT sought further information from key stakeholders on the substitutability analysis provided by ITV and the types of campaigns which were reliant on ITV On 15 January 2009, the OFT published for consultation its provisional recommendation to the CC (the consultation ) proposing that: at a minimum, the remedy should be extended to include impacts achieved on +1 and HD versions of ITV1; and it would be appropriate to ease the CRR remedy, but retain some safeguards to prevent ITV from discriminating against those advertisers which still heavily rely on ITV As well as holding a presentation for media buyers and advertisers on 20 January 2008, OFT and Ofcom also met individually with a number of stakeholders during February and March Stakeholders (including ITV) also provided written responses to the OFT s consultation During the course of March and April, further information was also sought from ITV and some other stakeholders seeking further information on their submissions or arguments presented. Structure of the report 2.35 Ofcom has divided this report into the following sections: Section 3: provides an overview of the TV advertising sector and the negotiation of TV advertising contracts. Section 4: discusses market definition. A detailed exposition of market definition can be found in Annex 4. Section 5: sets out our assessment on the changes in ITV and ITV1 s market position since 2003, and the ability for media buyers and advertisers to substitute away from ITV1. A detailed competition analysis can be found in Annex 5. 10

14 Introduction Section 6: considers the potential distortions arising from the CRR remedy and its impact on ITV and the wider TV advertising sector. Section 7: summarises any issues raised during the review process which are outside the scope of the CRR review. Section 8: outlines our recommendations for the future of the CRR remedy There are 5 Annexes to this document: Annex 1: Background information on TV broadcasting and regulation. Annex 2: Major TV sales houses and channel airtime sold. Annex 3: Discounts off SAP Example from CC Report Annex 4: Market definition. Annex 5: Competition assessment. 11

15 TV Advertising Section 3 3 TV Advertising Introduction 3.1 TV advertising is an important feature of many consumer-focused markets. It can have a role in informing consumers of new products or reminding consumers about existing products. It can play a role in informing consumers about key features of particular products and be used as a way of differentiating one product from another in a particular economic market. Ultimately, advertising is aimed at shaping consumer preferences, although the precise ways in which this can be achieved are subject to much debate in the academic literature. 3.2 In this section we: a) explain the importance of TV advertising to advertisers; and b) describe the nature of the market for TV advertising in the UK, and (in broad terms), how it operates. The UK advertising sector 3.3 It is clear from the large sums of money spent on advertising in the UK that it is seen as an effective way of marketing goods and services, based on a belief that advertising is able to influence the purchasing decisions that consumers make. Table 3.1: Total UK Advertising Expenditure million e 2 Current Prices 15,026 15,237 15,782 16,813 17,243 17,360 18,053 % change yr-on-yr Source: The Advertising Statistics Yearbook 2008; Advertising Association - Forecast of Advertising Expenditure to Q Notes (1) Includes expenditure on national and regional newspapers, consumer and business magazines, television, radio, outdoor, direct mail, cinema, internet, directories and production costs; (2) Estimated current published data does not include directory advertising revenues as these figures are not expected to be published until June Chart 3.1 below provides an overview of the proportion of total advertising spend accounted for by each medium in both 2003 and This comparison shows that television, direct mail and radio advertising expenditure have declined slightly during the period, with spend on outdoor and cinema advertising remaining fairly constant. In contrast, there has been significant growth in advertising on the internet while press advertising (which includes all forms of advertising in newspapers, magazines, business & professional publications and directories) has fallen significantly. Even so, in 2008 press advertising continued to account for the largest share with 34.7% of total UK advertising spend. TV advertising accounted for the second largest share with 23.2%, followed by internet advertising with 20.1%, then direct mail with 12.4%. The smallest proportions were accounted for by outdoor with 5.7%, radio with 2.8% and cinema advertising with 1% of total UK advertising spend. 12

16 TV Advertising Chart 3.1: Percentage split of UK advertising spend across different mediums Cinema Radio 1% 3.5% Outdoor 5.3% Direct Mail 16.7% 2003 Internet 3.1% Press 45.20% Cinema 1% Radio 2.8% Internet 20.1% 2008 Press 34.7% Television 25.1% Outdoor 5.7% Direct Mail 12.4% Television 23.2% Source: Advertising Association's Quarterly Survey of Advertising Expenditure (Q4 2008) Note: Figures include agency commission, but exclude production costs and directory advertising revenue. Figures on directory advertising are only available on an annual basis, and are not published until June 2009 when the AA's issues its Advertising Statistics Yearbook Advertising can be split into display and classified advertising. Classified advertisements are generally grouped within a publication or featured on the internet under headings classifying the product or service being offered. These adverts are usually text-based and can consist of as little as the type of item being sold and a telephone number to call for further information. Generally no pictures or other graphics are featured within the advertisement, though a logo may occasionally be included. Press (62%) and internet (31%) advertising account for a significant proportion of all classified advertising A sub-category of classified advertising is found on the internet: search-driven advertising. Search advertising is delivered by means of a keyword search and accounts for the bulk of internet advertising (58%) 14. Search engines identify key words and use these as the basis for directing an advertising message to the searcher or potential customer. 3.7 Display advertising is advertising that combines text with other graphical information, such as logos, photographs, diagrams, moving images, location maps etc and may include audio elements. One third of display advertising revenues are accounted for by TV advertising and nearly a further third of revenues arise from spending on press advertising. The remaining revenues can be attributed to other forms of advertising including radio (4%), the internet (5%), cinema (1.7%) Between 2001 and 2008 television advertising generally grew faster than overall display advertising as the data in Tables 3.2 and 3.3 demonstrates. However, the significant fall in expenditure on TV advertising between meant that in 2008, TV s share of total display advertising at 33.2% was not that much greater than in 2003 when it stood at 32.5%. Internet display advertising also grew significantly over 13 Advertising Statistics Yearbook Table 16.2, Advertising Statistics Yearbook Advertising Statistics Yearbook

17 TV Advertising this period, however, it continues to represent a relatively small proportion of display advertising. Table 3.2: Display Advertising Expenditure million Current Prices 10,955 11,168 11,441 11,981 12,106 11,966 12,116 11,491 % change yr-on-yr Source: The Advertising Statistics Yearbook 2008, Advertising Association - Forecast of Advertising Expenditure to Q Notes: (1) Based on available data excludes directory advertising revenues (which represent a small proportion (0.01% to 0.02%) of total display advertising) as these figures are not expected to be available for publication until June Table 3.3: TV Advertising Expenditure* million Current Prices 3,525 3,690 3,722 3,955 4,097 3, % change yr-on-yr Source: The Advertising Statistics Yearbook 2008; Advertising Association - Forecast of Advertising Expenditure to Q * includes agency commission Importance of TV advertising to advertisers 3.9 Television is a powerful and important medium for advertisers, both because it combines visual imagery, sound and movement and because television viewing is an extremely popular leisure activity 16. As noted above, TV advertising accounts for a substantial portion of all UK advertising (23%), and represents the single largest category of display advertising. In 2008, approximately 3.8 billion was spent on TV advertising in the UK During the course of the review, and in response to the OFT s consultation, media buyers and advertisers re-iterated the importance of TV advertising in achieving brand awareness, sales uplift and reaching large proportions of the public Television is a popular form of advertising among advertisers wishing to market goods and services to consumers for a number of reasons, including: near universal reach, which is important for manufacturers of Fast Moving Consumer Goods (FMCG) 17, such as detergent, toiletries, paper products; the ability to reach a large number of consumers rapidly, which is important for goods that have a limited duration (e.g. newspapers, promotions and sales); and 16 CC Report, paragraph FMCG is a term generally used to describe frequently purchased consumer goods which are relatively low cost. They are often common items used daily for which there is a high demand. FMCG products contrast with durable goods or major appliances such as kitchen appliances, which are generally replaced less than once a year. 14

18 TV Advertising the ability to multiply and prolong the effect of TV advertising by using creative techniques and complementary media (such as the internet) to engage public interest; and it allows for targeted mass marketing Along with its ability to market products both visually and audibly to a large audience, TV advertising provides advertisers with the ability to target particular demographics or audience types. The audience measurement systems, along with strategic advert placement by broadcasters, provide advertisers with the means to accurately target a desired demographic group of consumers 18. For example, if an advertiser is launching a new men s shaving product, it can ensure that the advert is broadcast at a time when adult males are more likely to be watching, and survey data will be available to measure how many individuals within the target audience have seen the advert. The targeting and measurement of TV audiences is discussed in further detail later in this section For these, and other reasons, the ability to advertise on TV is important to many businesses. Recent and future developments in the advertising sector 3.14 One of the key market developments since 2003 has been the growth of internet advertising. As demonstrated by Chart 3.1 above, internet advertising as a proportion of all advertising has risen rapidly from 3% in 2003 to 20% by 2008, and now attracts similar levels of revenue to that of TV advertising. Furthermore, it has been predicted that by 2010 expenditure on internet advertising will exceed TV advertising revenue in the UK However, it is important to note that this growth in internet advertising has predominantly been led by the growth in classified and search based internet advertising. Chart 3.2 provides a breakdown of the growth of different categories of online advertising between 2002 and This shows that the growth in classified internet advertising (comprising paid for search and other classified ) has been much more dramatic than display advertising on the internet. In 2008, internet display advertising accounted for approximately 20% of total internet advertising 20. While display advertising is currently the smallest component of internet advertising, there are signs that it is becoming more significant as a result of the growth of advertiser-funded online content (given consumers apparent reluctance to pay directly for this content 21 ). The extent to which internet advertising might be substitutable for TV advertising is discussed further in Section The presumption being that you can infer behavioural characteristics and purchasing preferences to a particular demographic group. However, the correlation between a particular demographic and actual target purchaser will vary by product. In some instances, even a narrow sub-demographic may not prove to be an entirely accurate proxy. 19 Advertising Association, Forecast of Advertising Expenditure to Q Advertising Association, Forecast of Advertising Expenditure to Q According to an IAB/PwC report, display advertising accounted for 637 million (19%) of total internet advertising spend. 21 Ofcom Communications Market Report 2008, page

19 TV Advertising Chart 3.2: Distribution and growth of internet advertising spend ( million) Advertising spend ( bn) Other classified Paid for search Display Source: The Advertising Statistics Yearbook 2008; Advertising Association and Internet Advertising Bureau (IAB)/PwC Note: All figures are nominal 3.16 The introduction of digital broadcasting has significantly increased the number and range of different channels available to TV viewers. In particular, the launch of Freeview in 2002 on the Digital Terrestrial Television (DTT) platform has provided a credible free-to-air alternative for those consumers who want multi-channel TV, but do not wish to pay for it. Digital penetration has lead to substantial increases in the uptake of multi-channel TV. By the end of 2008, 22.8 million UK households (88.9%) had digital television on their main set, with DTT representing the most widely-used platform (9.8 million or 38.4% of homes) 22. Ofcom has also announced proposals to reorganise the DTT multiplexes to accommodate a range of new services, including high-definition services 23. Chart 3.3 shows the increases in multi-channel TV penetration since Ofcom, The Communications Market: Digital Progress Report Q and 16

20 TV Advertising Chart 3.3: Take-up of multi-channel television on main sets 26.4% 32.6% 40.5% 44.3% 46.0% 54.2% 62.6% 71.8% 77.2% 86.5% 88.9% TV Households (m) Q Q Q Q Q % of homes Q Q Data from Q is based on consumer research Q Q Q Q Digital terrestrial only Analogue cable Digital cable Free-to-view digital satellite Analogue satellite Pay digital satellite Source: GfK research from Q onwards; previous quarters use platform operator data, research and Ofcom estimates Note: TV over ADSL take-up stood at around 0.3% by Q The up-take of multi-channel TV has lead to greater fragmentation of viewing, and thus advertising revenues. Chart 3.4 provides a breakdown of net advertising revenues (NAR) by sector between 2002 and This shows that commercial multi-channel operators have seen a growth in advertising revenues at the expense of the traditional commercial analogue channels (ITV1, Channel 4 and Five). However, the losses faced by the commercial analogue channels have been partly offset by gains made in relation to their portfolio of digital channels. Chart 3.4: Net advertising revenue by sector 100% 80% Commercial multichannels 60% 40% 20% 2,612 2,566 2,686 2,686 2,427 2,387 Commercial PSB portfolio channels Commercial analogue channels 0% Source: Ofcom/Broadcasters Over the longer term, the rapid growth in take-up of digital video recorders (DVRs), of which in 2008 were present in 23% of UK homes, is likely to have an impact on TV advertising. Given that 88% of DVR owners claim that they usually fast-forward 24 Figures for the calendar year 2008 will not be available until later in

21 TV Advertising during commercial breaks when watching recorded programmes, this could have a material effect on TV advertising revenues as DVR take-up increases 25. On the other hand, current research suggests that 87% of the viewing in DVR households is still live broadcast and DVR viewers continue to engage with ads even when they fastforward through them 26. Therefore, it appears that the effects of DVRs on TV advertising may not be as great as once feared Historically, advertising spend has broadly reflected the general performance of the economy. The recent economic downturn has therefore had a significant impact on 2008 advertising revenues and the trend is expected to continue in The second half of 2008 saw TV advertising revenues fall by 9% and the decline for the first half of 2009 is expected to be considerably steeper, with a forecasted decline of 10% across the whole of In line with this, ITV1 s NAR is predicted to decline by at least 12% in The Institute of Practitioners in Advertising s (IPA) latest Bellwether survey published in April 2009 found that overall advertising budget cuts in 2008 were the second steepest decline in the survey s nine year history, and spend was set to fall again in 2009, however, confidence in the market was beginning to recover. By the first quarter of 2009, the hardest hit budgets were considered to be main media advertising and all other (includes PR, events sponsorship and market research) 29. TV advertising supply chain 3.20 Diagram 3.1 provides an overview of the various players in the TV advertising supply chain. The role of each of these different players is also described briefly below. Diagram 3.1: the TV advertising supply chain Creative Agency (e.g. Saatchi & Saatchi) Advertiser Advertiser (e.g. Unilever, L Oreal) (e.g. Unilever, L Oreal) Media Media Buyer Agency: Planning / Media Buying Planning / Media Buying (e.g. MindShare, (e.g. MindShare, OMD, Starcom OMD, Starcom Broadcasting Sales TV Houses Sales House (e.g. ITV Sales, Sky, IDS) Channel Broadcasters Providers (e.g. ITV, Channel 4) (e.g. ITV, Channel 4) Viewers Proctor & Gamble Proctor & Gamble Media Auditor Media Auditor (e.g. Billets, Fairbrother, (e.g. Billets, Media Fairbrother, Audits) Media Audits ) BARB (Broadcasters' Audience Research Board) Trade Organisations: IPA, ISBA, Advertising Association Source: Ofcom & the CC s Report 25 Ofcom Communications Market Report 2008, p Advertising Association, Forecast of Advertising Expenditure to Q It currently predicted that this decline will level off in 2010 with a predicted increase of 1%, however, given the current economic climate any medium to long term prediction will be subject to error. 28 Deutsche Bank Forecast, 25 March 2009, ITV plc: Running flat out to stand still. There are a number of other forecasts suggesting a more significant decline in ITV s advertising revenues. For example, Citi Investment Research also forecast a decline of 18% in 2009 in advertising revenues for ITV1. []

22 TV Advertising Advertisers 3.21 The advertising process is initiated by an advertiser. The advertiser may launch or run a campaign for a variety of reasons: for example, the organisation may wish to raise a product s profile, launch a new product or increase brand awareness. Working together with the creative agency/media buyer, the advertiser decides which advertising medium it will use for a given campaign, and the length and scope of the campaign. Creative Agencies 3.22 Creative Agencies are employed by advertisers to provide consumer insight and to develop brand strategies. They are also responsible for designing the advertising campaign and the adverts. At times, some (or all) of the services provided by creative agencies may alternatively be provided by media buyers, specialist companies (e.g. communications planning companies), or in-house by the advertiser itself. Media Buyers 3.23 Media buyers (or media agencies) are employed by advertisers to act as a central point for negotiating the terms on which advertising is purchased from broadcasters. The majority of advertisers tend to use media buyers to buy TV airtime on their behalf rather than negotiate directly with broadcasters. Advertisers will often have a multiyear contract with their media buyer As well as negotiating terms with the sales houses, media buyers plan and implement individual campaigns on behalf of advertisers. They collaborate with broadcaster sales houses on a daily basis, implementing campaigns and where necessary agreeing where specific advertisements will be placed on the programme schedule. Media buyers deal with all sales houses and other media providers they do not limit their negotiations just to one sales house (or medium) for the delivery of all of its clients advertising needs. Broadcasting Sales Houses 3.25 Television advertising airtime is generally sold on behalf of broadcasters by broadcasting sales houses. Sales houses are responsible for managing the media buyer relationship, negotiating contracts and terms and conditions. The larger broadcasters have their own sales houses i.e., ITV, GMTV, Channel 4, Five, BSkyB, Interactive Digital Services (IDS) and Viacom Business Solutions (VBS). Smaller broadcasters often contract to sell some or all of their airtime through these sales houses 30. Broadcasters 3.26 The broadcaster broadcasts the adverts. Working with the broadcasting sales house, the broadcaster will determine their schedule, where to include advert breaks and the length and number of those advert breaks. The broadcasting sales house will then assist the broadcaster to determine where best to broadcast the adverts within this 30 Details of sales houses, and the channels they sell, can be found in Annex 2. 19

23 TV Advertising schedule. Broadcasters also face a number of rules on the amount and type of advertising they can air throughout the viewing day 31. Media auditors 3.27 Media auditors are employed by advertisers to assess the effectiveness of advertising campaigns, and the performance of the media buyer. They assess a number of areas including but not limited to: the price paid per impact; coverage; frequency; and other quality elements of the campaign. BARB 3.28 BARB (Broadcasters' Audience Research Board) is the primary provider of television audience measurement in the UK. It covers all channels broadcasting across all platforms - terrestrial, satellite and cable in both analogue and digital. 32 Targeting and measurement of TV audiences 3.29 Television audiences typically comprise a range of different demographic groups which can be differentiated according to three main characteristics i.e. age, sex, and socio-economic status. For example, a distinction can be made between broad categories such as Adults, Men, Children etc. The Adults demographic could then be further divided into (say) ABC1 Adults or Adult males, etc. Different demographic groupings are not necessarily mutually exclusive e.g. the Men demographic is a subset of Adult Men and also a subset of Adults Advertisers obviously want to target those demographic groups that are most likely to purchase their goods or services. For example, a manufacturer of soap powder will be most interested in targeting the person in the household that makes purchasing decisions. It will seek to reach the Housewives demographic group, comprising those most likely to make decisions about which brand of soap powder should be purchased 33. Some advertisers may be interested in ensuring that a range of different demographics see their advert, but will buy against their key demographic. For example, a chocolate manufacturer may buy Women as they represent a higher proportion of their customer base, but will also be interested in selling its product to other demographics such as Men. On the other hand, an advertiser may be interested in targeting a smaller, niche set of customers (e.g. pet owners) and may be able to vary the demographic (or group of demographics) they choose to buy against The audiences for most TV programmes will cross all demographic groups though the composition of the demographics may well vary considerably. A broadcaster can therefore sell the advertising airtime around its programmes against different 31 For example, the number of advertising minutes in an hour, advertising food during children s programming, etc. For more information see: ; and 32 BARB is jointly owned by ITV, BBC, Channel 4, Five, BSkyB, and the IPA. More detail is available on BARB s website at 33 BARB defines a Housewife as The member of the household who is solely or mainly responsible for the household duties. A housewife may be male or female. There is only one housewife per household. 34 As noted earlier, for some advertisers/products buying against a particular demographic may be more efficient than for other advertisers/products. The more niche a product or target market, the more difficult it may become to efficiently target customers. 20

24 TV Advertising demographics. As a result, within the same advertising break in a peak-time programme on ITV1, there may be adverts for a range of different products (e.g., a car, a shampoo product, a brand of beer and confectionery products) aimed at different demographics (although the advert will be viewed by a variety of different people when aired). Advertisers will be interested in ensuring that their advertising is targeted appropriately and that both (i) the number of people viewing the advert who are unlikely to be interested in the product is minimised; and (ii) the appropriate number of people within the selected demographic view the advert an optimum number of times 35. Equally, broadcasters will want to ensure that products are not advertised in airtime which could be used to target another demographic more efficiently. Therefore, broadcasters and advertisers both have an interest in ensuring that advertising is placed as efficiently as possible The demographic profile of television audiences for particular programmes is measured by BARB. BARB statistics are based on television viewing by a panel of over 5,000 households, selected to be fully representative of all television households across the whole of the UK. This enables broadcasters and advertisers to identify what proportion of a particular demographic group is watching a programme. Experience of audience viewing habits enables broadcasters to predict what type of audience a programme will appeal to, and how many from each demographic group are likely to see it The exposure of a particular demographic to an advertisement is measured in terms of commercial impacts (or impacts). Each occasion an advert is seen by a viewer counts as one impact. The effectiveness of advertising in reaching a target demographic group is measured in television ratings, or TVRs. For a particular campaign, one TVR equates to reaching 1% of the target group with one 30 second advert 36. Thus, an advert in a programme that reaches 25% of a particular demographic group delivers 25 TVRs. These commercial impacts or TVRs provide the currency in which broadcasters and advertisers deal i.e. broadcasters and advertisers contract with one another for the delivery of a given volume of TVRs from a particular demographic group Advertisers will have a number of objectives when planning a campaign. Often these are expressed in terms of coverage and frequency. Coverage, or reach, refers to the percentage of the target audience seeing the advert a minimum number of times. For example, if a campaign s Adult coverage is said to be 80 or 80% then the advert was seen by 38.5 million of the 48.1 million Adults in the UK TV viewing population. Frequency is a method of describing the extent to which an advert in a campaign has been seen by the same person more than once. For example, if viewers have seen an advert 4 or more times, this is referred to 4+. As a result, 4+ cover refers to the percentage of the target audience seeing the advert at least four times. The effective or optimal frequency will vary depending on the type of product being advertised and the objective of the campaign (e.g., product launch, brand building, promotion etc) Advertisers may also be interested in the positioning of their adverts, for instance, whether the advert is broadcast during peak or off-peak viewing hours, during a programme or between programmes, and position in a break period (e.g. first, 35 The optimum number of times an advert is viewed will vary by product and campaign. Some advertisers may wish to ensure that viewers do not see the advert an excessive number of times, as they may consider this detrimental to brand value. 36 While a 30 second advert is the general standard, adverts can often range in time length (for example 10 or 60 seconds). These will be converted into a 30 second equivalent TVR for the purposes of measurement. 21

25 TV Advertising second or last in break). They may also be interested in broadcasting their adverts during particular programmes, for example, event programmes such as the rugby or football World Cups, or programmes which have a perceived link to their product such as beauty products during a TV makeover programme. The buying and selling of TV airtime The TV advertising sales process 3.36 Below we discuss the process which underlies the negotiations between media buyers and the ITV sales house for sale of advertising airtime. While the CRR remedy effectively requires ITV to follow this negotiation process, this need not be the case for other sales houses. However, in general, most sales houses have tended to adopt a similar process to that of ITV. Negotiation of annual contracts 3.37 Contracts for the sale of television advertising airtime are typically negotiated between sales houses and media buyers on an annual basis. Historically, negotiations have taken place between the October to December (the deal season ) prior to the commencement of the new advertising year in January 37. Core terms are normally agreed by December, however, negotiations over other terms may continue throughout January and February At the negotiation stage, both the media buyers and sales houses will only have an indicative idea of the number of commercial impacts likely to be delivered on each channel and the amount of TV advertising which will be demanded by advertisers (i.e. how much advertisers will choose to spend on campaigns) in the coming year. It is due to this uncertainty that negotiations have traditionally tended to focus on a given SOB commitment, rather than a specific price for advertising (discussed further below). Types of deals 3.39 The main types of deals agreed during the deal season in order to satisfy the requirements of advertisers are: Agency Deal : an umbrella deal between sales houses and media buyers that encompasses their expected portfolio of advertisers: media buyers do not negotiate separate contracts for each of their clients. Most media buyers prefer these types of deals as they provide them with flexibility over the advertisers terms and conditions. Line-by-Line Deal : In these deals advertisers, or media buyers on advertisers behalf, agree their own specific terms. Some media buyers offer line-by-line deals to all of their clients. 37 Typically, the vast majority of negotiations take place in November and December. However, it should be noted that there are no significant barriers to negotiations being undertaken during an alternative period in the year, or indeed for contracts to cover period of greater or less than 1 year. []. Furthermore, we understand that by March 2009, several contracts for the 2009 deal season had yet to be signed, as the parties were still finalising some minor remaining issues relating to their terms and conditions (it did not appear that any of these issues were the result of a dispute between the parties). 22

26 TV Advertising 3.40 In some instances, media buyers agency deals may also include an element of lineby-line deals for particular advertisers, and this will be negotiated under the overall umbrella of the agency deal. Negotiation of SOB and discounts 3.41 Given the uncertain future demand and supply of impacts, media buyers and sales houses do not negotiate on an absolute price to be paid per impact. Rather, when a media buyer commits to a campaign with a broadcaster it actually commits a level of expenditure with the broadcaster in the expectation that it will achieve a certain level of impacts for that expenditure. It is not until the end of the campaign that the actual price (referred to as Station Average Price or SAP 38 ) is calculated and the volume of impacts actually delivered at that price can be determined. Therefore, media buyers generally agree to commit a proportion of their SOB to a sales house in return for a discount from SAP 39 and quality of service terms, such as position in break, daypart guarantees, regional shares, programme guarantees and programme access. The size of discounts offered to media buyers and advertisers will depend on a number of factors, including: the size of the SOB committed by the media buyer or individual advertiser; advertisers (and thus media buyers ) demand for each target demographic and the ability of that sales house to optimise those demographics; the relative negotiating strength of media buyers and sales houses, which may include, whether the media buyer/advertiser is sensitive to the size of discount offered (price sensitivity), the history of the relationship between the media buyer and the sales house and the importance of the media buyers business to the sales house; and the terms required such as: non-pre-emption clauses which prevent the broadcaster from moving an advert from a pre-determined slot; the costs associated with late bookings and cancellations; the proportion of impacts to be delivered across different day-parts; and the positioning of advertisements in breaks, access to special event programming etc In general, sales houses have discretion to offer a smaller discount, or charge a premium, to those who they judge to be less price elastic, or are less skilled at negotiating Media buyers and sales houses may agree a range of different discounts, including: a single discount which applies to all demographics for the whole portfolio of advertisers; different discounts for each demographic for the whole portfolio of advertisers; 38 Note, SAP is the relevant calculation used by ITV, other sales houses generally use pricing mechanisms that are loosely based on the SAP mode, with sales house revenue and audience performance figures still forming the basis of the various pricing models to a lesser or greater extent. The calculation of SAP is discussed further at paragraph Discounts from SAP are essentially delivered in the form of volume increases in the number of impacts. For example, a discount of 15%, results in 15% more impacts being delivered, therefore if an advertisers buys 100 impacts, after the discount they receive 115 impacts. Annex 3 provides a worked example of how discounts from SAP are calculated. 23

27 TV Advertising a single discount which applies to all demographics for most of the portfolio of advertisers; individual discounts for specific advertisers across all demographics; and individual discounts for specific advertisers for each demographic A key aspect of the annual negotiations is that sales houses and media buyers tend to put considerable emphasis on a broadcaster s SOCI 40. That is, if broadcasters have been able to increase their SOCI over the previous year, then they would use that to try to get media buyers to commit a greater share of broadcast to them for the following year. Equally, media buyers will be more interested in committing expenditure to broadcasters that have increased their SOCI because that would tend to demonstrate an ability to attract audiences which are of interest to advertisers or are able to deliver a niche set of impacts. Calculation of discounts to individual advertisers 3.45 If a media buyer operates an agency deal, once the overall discounts are negotiated with the sales house, the media buyer will need to consider how these are distributed across its advertising clients 41. This distribution may be influenced by the contracts agreed between the media buyers and their advertisers and other factors such as: the size of the advertiser s contract with the media buyer, whether they are likely to commit a larger budget in the future (for example the media buyer may wish to retain the custom of a large client; the client may have a global or international business with potential for growth in the UK market); if the client is high profile and likely to bring more business to the media buyer in the future; whether the contract with the media buyer is up for renewal in the near future etc Media buyers cannot grant discounts to clients individually which, when calculated as a whole, are greater than the blanket discount offered by the sales house. For example, the media buyer may be offered a discount of 10% off the Houswives demographic it may then choose to offer 12% discount to a client that committed a larger than the average share of SOB and offer 8% discount to a client that committed a lower than average share of SOB. However, it is important that the aggregate discount offered to clients does not exceed 10%, otherwise, the media buyer will not be able to meet the terms that it has agreed with the sales house. Individual campaigns Media Plan 3.47 Prior to booking each individual campaign, the media buyers and their clients will agree the specific advertising objectives of that campaign. These objectives will generally include targets for cover and frequency in a given month or over the campaign. For example: an advertiser may estimate that a typical viewer will need to see the advertisement three times before responding and may structure its campaign accordingly. 40 As explained in paragraph 3.33 above, one commercial impact represents one viewer seeing an advert once. A channel's share of commercial impacts ( SOCI ) is simply the total number of commercial impacts delivered by that channel divided by the total number of all the commercial impacts delivered across all channels. 41 This is in contrast to a line by line deal whereby agencies agree specific terms with sales houses in relation to specific clients. 24

28 TV Advertising 3.48 The media buyer will also continually estimate the likely cost of the TVRs/impacts over the year. These estimates will take into account information from broadcasters about expected price and the likely demand for impacts among all other advertisers that month Once a media buyer has determined the precise needs and requirements of an advertiser, the media buyer will develop a detailed media plan to be approved by the advertiser. These plans set out the number of TVRs (impacts) that each channel must provide in order to meet the advertisers coverage and frequency objectives, and are based on estimated future costs of impacts across the channels. The resulting budget estimate for the campaign may lead advertisers to either increase, decrease or maintain their original budgets for the particular campaign so that they can ensure the delivery of the required number of impacts for the campaign or to amend coverage, frequency and impact delivery plans. Booking airtime 3.50 Once the media plans are agreed, media buyers book the campaign with the sales houses by the advance booking deadline (for the ITV sales house this will normally be 8 weeks in advance of the advertisement broadcast date) to avoid a late booking penalty The sales houses, for their part, use an airtime booking system to aggregate the demands and requirement of the advertisers and then optimise their airtime accordingly. Sales houses optimise their allocation of advertising airtime so that adverts are shown during programmes that they expect will be seen by the greatest possible number of people in that target audience, rather than from other target audiences. For example, a higher number of impacts for ABC1 Men can be achieved against programmes which are popular among this audience. Through optimisation sales houses can maximise the number of impacts traded and effectively achieve a higher number of impacts than would be the case if adverts were shown randomly throughout the day During the advertising year media buyers and advertisers may also separately negotiate a burst deal. This is a short term or one-off agreement between a single advertiser (usually negotiated by the media buyer on their behalf) and a sales house. A burst deal is typically used in regional advertising by some seasonal advertisers and for some retailers for one-off advertising campaigns. Ongoing reconciliation 3.53 Sales houses and media buyers must also ensure that the impacts traded throughout the year, via the individual campaigns, are consistent with the overall deal agreed during the deal season and that the overall discount agreed at that time has been delivered. If, in a particular month, the sales house fails to deliver the expected number of impacts, then it is considered to have overtraded (or underdelivered) and must give the media buyer extra impacts in a future month. In contrast, if more impacts were achieved for the advertiser than agreed, the sales house will have undersold (overdelivered), and will have to achieve fewer impacts for the advertiser in a future month Overtrading essentially means that individual advertisers are receiving less than their agreed share of impacts in that month. This means that the sales house owes a deal debt to advertisers/media buyers. If this is carried over into the following month, the sales house will face an increased difficulty in delivering on all its discount 25

29 TV Advertising commitments in that month. Sales houses therefore seek to ensure that this deal debt does not escalate. The pricing of advertising 3.55 As described, media buyers and sales houses do not set an absolute price per impact during the deal stage as neither party can be sure of the future demand and supply of impacts. Media buyers, therefore, do not know precisely how many impacts they will receive in return for their SOB commitment Although broadcasters will, in some cases, offer fixed price deals or sell specific spots, the most common pricing concept is the broadcaster s SAP. The SAP is an average price per impact across a channel (or sometimes a range of channels 42 ). There will be different prices for different demographic groups. A key feature of SAP is that it is calculated ex-post i.e. the SAP is determined by the level of advertising expenditure and the volume of impacts actually achieved by a broadcaster The SAP for ABC1 Men, for example, is calculated monthly as: SAP = Total Revenue committed to that station by all advertisers/media buyers for all audiences (ABC1 Men) Total ABC1 Men impacts delivered 3.58 SAP is an average price based on the total distribution of impacts. Rather than entitling media buyers to a given number of impacts, the SAP mechanism entitles media buyers to a share of the impacts actually delivered. In a simple world with one type of impact, the number of impacts delivered to a media buyer is determined both by the share of ITV1 revenue that the media buyer s spend accounts for and the total number of impacts actually delivered. For example, if a media buyer spends 10,000 and total ITV1 revenue for the month is 100,000, the media buyer receives 10% of total impacts delivered. Therefore, if the total number of impacts delivered is 1000, the media buyer receives 100 impacts; or if the number of impacts delivered is 900, the media buyer receives A discount from SAP equates to a bigger proportion of impacts than the proportion of spend (for example, a discount of 15%, results in 15% more impacts being delivered, therefore if an advertisers buys 100 impacts, after the discount they receive 115 impacts). However, given there are a fixed number of impacts, this must be offset by someone else getting a smaller share. Optimisation allows discount to be stretched i.e. everyone can get a discount, but there is still only a finite amount of discount available The sales houses are able to offer discounts from SAP due to the practice of airtime optimisation. If adverts were broadcast randomly throughout the day, without considering when these adverts were most likely to be seen by the target audience, then sales houses would not be in a position to offer a discount from SAP. However, by matching the adverts with an appropriate performance slot and appropriate target audience they are able to maximise the number of impacts and achieve a higher number of impacts for a particular demographic than would occur if the advert was broadcast randomly. It is, therefore, theoretically possible for all impacts to be sold at a discount. Annex 3 provides a worked example from the CC s Report of how discounts off SAP are achieved and calculated. 42 However, this is not the case under CRR where the price on ITV1 is calculated individually. 26

30 TV Advertising 3.61 There are two main reasons why the SAP achieved may be lower or higher than planned. First, programmes may achieve different ratings than expected e.g. if they achieved higher than expected ratings this would increase the number of impacts delivered and reduce SAP compared to forecast. Second, media buyers may incorrectly forecast the total expenditure committed by all buyers. For instance, total revenues committed to a particular demographic may be higher than anticipated, raising the SAP for that target audience. An increase in committed revenues raises the overall revenue of the sales house for the period relative to achieved impacts, thereby raising the SAP and actual price paid by each media buyer. Thus, the increase in expenditure effectively increases the price of TVRs In most instances, the price paid by an advertiser on an individual campaign will be determined by the media buyer rather than the broadcaster: it will be up to the media buyer to determine how to share the discount from SAP it receives across its different clients 43. The use of auditors is a way for advertisers to compare the price they have been charged with the market rate. However, the auditing of advertising campaigns tends to focus on the relative rather than the absolute level of price for the delivery of commercial impacts against particular demographic groups. Conclusion 3.63 Since the CRR remedy was put in place there has been virtually no change in the way in which ITV1 sells it advertising airtime. This is hardly surprising given a core tenet of the CRR remedy was to prevent ITV1 from changing its trading model. Similarly, other sales houses have continued to emulate the ITV1 model when selling airtime, and this is unlikely to change while the CRR remedy remains in place On the other hand, there have been a number of developments in the UK advertising sector since In terms of revenues, although TV advertising revenues have decreased slightly, internet advertising has grown significantly. The increase penetration of the multi-channels has lead to viewer fragmentation and a shift in advertising revenues away from the traditional commercial analogue channels to the commercial digital channels Looking forward, the recent economic downturn is also expected to impact on overall advertising spend, with a predicted decline in the TV advertising sector of 10% in The exception being where the media buyer has negotiated a line by line deal with the broadcaster on behalf of its client. In this case, the advertiser will have an individual price set for access to advertising on that channel(s). 44 Advertising Association, Forecast of Advertising Expenditure to Q

31 Market Definition Section 4 4 Analysis of Market Definition Introduction 4.1 In the CC s Report the relevant market for the purposes of the merger was defined as the market for television advertising in the UK 45. As part of the process of reviewing whether there have been changes in the extent of competition faced by ITV1, it is relevant to consider whether this definition of the economic product market is still appropriate. 4.2 In this section we review the relevant market definitions used in previous competition investigations to build up a picture of the factors that have previously been taken into account in determining the scope of the relevant economic market. This gives us a sense of how the definition of the relevant market in this sector has changed over time. We also briefly set out the purpose of market definition and our approach. 4.3 We then consider the definition of the relevant product market in terms of reviewing potential focal products which could provide a starting point for the market definition process. We move on to work through the definition of the relevant product market and the relevant geographic market, taking into account the responses to the OFT consultation. We also consider potential future market changes before setting out our conclusions. 4.4 A more detailed discussion of these various issues including the responses to the OFT consultation is set out at Annex 4. Previous definitions of the relevant market for TV advertising market 4.5 In terms of assessing TV advertising s product characteristics and intended use, the approach taken in previous competition investigations can be informative. 4.6 In 2000 in its report on the merger involving Carlton, Granada and United News and Media 46, the CC noted that advertisers, media buyers/analysts and also Granada appear to regard TV advertising as having distinctive features and advantages that distinguish it from other forms of advertising. In particular, the CC noted the following product characteristics as being important: TV on all channels and platforms is the only mass medium with daily availability in virtually all UK homes. It can build mass awareness more rapidly than any other media, with the potential (using ITV in particular) to offer 60 to 70 per cent awareness of a brand or a product within a weekend. TV (on all channels and platforms) offers the scope for combining colour, sound and moving images to create a high impact with potential customers (although cinema has always offered these features and the internet is increasingly able to do so). 45 Paragraph 5.35 CC Report. 46 Carlton Communications Plc and Granada Group Plc and United News and Media Plc: A report on the three proposed mergers Competition Commission

32 Market Definition TV, given the range of channels and programmes available, offers the advertiser the ability to target (and monitor in some detail) particular audiences and demographic/socio-economic groups (SEGs) whether these be all Adults or ABC1 Men, etc. 4.7 The CC did describe ITV1 as an identifiable segment within a wider market covering all commercial TV channels 47 referring to ITV1 s particular position in respect of (among other things) pricing and the difference between free-to-air and pay-tv channels. Nevertheless, it concluded that there was a single market for TV advertising on the basis that some advertisers were likely to regard combinations of other channels (e.g. Channel 4, Five and pay-tv channels) as offering comparable national coverage and reach. 4.8 The CC returned to this issue in 2003 in its investigation into the Carlton-Granada merger which gave rise to the CRR remedy. 4.9 The CC s Report considered that the factors identified in 2000 remained relevant considerations. The CC took as its starting point the position that the market was no wider than television advertising and considered whether the market should be defined more narrowly. However, the CC s Report concluded that any market power the parties might have in relation to selling advertising airtime could be suitably assessed within television advertising as a whole. This was on the basis of the views of the parties to the merger and third party stakeholders, as well as including consideration of other factors such as a comparison of the relative costs of press and TV advertising over time Most recently, at the end of 2007, the CC considered the appropriate market definition for advertising in its examination of the BSkyB/ITV merger 48. In its report the CC started from the position that the market could be drawn at least as widely as television advertising and went on to consider whether the market should now be drawn more widely to consider other forms of advertising, with internet advertising as the closest potential substitute However, the CC concluded that there was no evidence to suggest that internet advertising acted as a constraint on the price of TV advertising. It also went on to suggest that it did not consider that it was likely to form a constraint in the foreseeable future Taken together these three reports indicate that the starting point for any review of market definition should be the market for TV advertising in the UK. They also help to inform our understanding of what factors have historically been considered to be important for market definition. Ofcom s Approach to Market Definition 4.13 The purpose of market definition is to provide a context for the analysis of a firm s market position. Market definition is an important means of identifying the competitive constraints that individual firms face and that in turn can be used in the assessment of whether firms in the market, either individually or collectively, possess market power. It is important to make clear that market definition is not an end in itself: 47 Paragraph Acquisition by British Sky Broadcasting Group Plc of 17.9 per cent of the share of ITV Plc (December 2007). 49 Paragraphs of BSkyB/ITV report. 29

33 Market Definition rather it is an exercise which assists regulators and competition authorities in the assessment of the relative competitive positions of firms The market definition exercise is aimed at identifying all the relevant products that consumers consider substitutable by virtue of a product s characteristics, prices and intended use. Conceptually, we are seeking to establish the competitive pricing constraints on a product or service, i.e. which products or services are in the same market. In order to do that we need to consider the scope for demand- and supplyside substitution A useful tool for identifying the range of substitute products that might be considered to form a market is the hypothetical monopolist test (HMT). This is also commonly known as the SSNIP test (Small but Significant Non-transitory Increase in Price). Formally, the test considers whether it would be profitable for the hypothetical monopolist of a particular focal product to sustain a small but significant price increase (typically 5-10%) above the competitive level of pricing. If such a price increase was likely to be unprofitable, either because consumers could substitute to other products, or because other firms switch production to supply the same product, then these substitutes are considered to exercise a competitive pricing constraint on the focal product and should be regarded as forming part of the relevant product market. If that is the case, the definition of the relevant market is therefore extended to include these products and the experiment is repeated until a point is reached when a price rise is judged to become profitable. That is, the point at which all the demand- and supply-side substitutes which are capable of exercising an effective pricing constraint have been included in the relevant product market The most direct way to implement a SSNIP test is through direct customer and competitor surveys to elicit an understanding of how they would react to a SSNIP. In practice, it can be difficult to implement a SSNIP test systematically and a consideration of the HMT will generally be supplemented with other pieces of analysis: e.g., studying the product characteristics; evidence of how customers/competitors have reacted to previous price changes; considering expenditure data etc In Annex 4 we outline a number of practical issues in applying the standard tools of market definition to broadcasting markets. Many of these arise in defining markets in other industries but in combination they can make the definition of broadcasting markets particularly challenging Three important issues in this context are: the operation of the pricing mechanic (i.e. SAP); the fact that TV advertising is part of a two-sided market the other side of the market being the broadcaster offering programmes to attract audiences; and product differentiation As set out in Section 3, SAP is a pricing metric which is calculated on an ex post basis. It does not have a direct bearing on how much revenue advertisers might commit to a particular broadcaster in that advertisers and broadcasters do not negotiate for the delivery of a volume of commercial impacts against a fixed price. Rather, the focus of the annual negotiations is over the discount off SAP that a broadcaster will offer in return for an media buyer committing a share of its expenditure on TV advertising to that broadcaster. Any analysis of switching behaviour needs to take this into account in structuring a SSNIP test i.e. that the relevant pricing metrics are changes in discount off SAP and/or changes in the SOB committed to a broadcaster. 30

34 Market Definition 4.20 The fact that TV advertising is part of a two-sided market also means that in principle there is a need to take into account the inter-dependencies across the two sides of the market. In this instance, an increase in the price of advertising would potentially reduce the volume and frequency of advertisements, which may make channels more attractive to viewers. This interaction could increase the profitability of a SSNI P and suggest a somewhat narrower market than if we considered the advertising side of the market in isolation. However, this effect is not likely to be substantial and in practice we do not believe it would affect our results in any material way Finally, advertising airtime is not a homogeneous product. The pricing metrics which are examined in more detail in Annex 4 (and the sections dealing with the assessment of competition) indicate that pricing varies between different broadcasters for different demographics, which reflect the efficiency of different broadcasters in reaching different demographics. Negotiations between media buyers and broadcasters sales houses do not simply focus on price but also cover a broad range of non-price factors relating to the delivery of airtime and which will have a bearing on the perceived value of the airtime. These factors include the proportion of commercial impacts to be delivered across different day-parts (peak vs. off-peak); the actual positioning of advertisements in breaks; access to special event programming (such as the finals of Big Brother, the X-factor, sports events) etc The data on pricing suggest that those channels which are able to deliver mass coverage and reach quickly are able to command a premium over other, smaller channels. This in turn suggests that commercial impacts on some channels or around some programmes are more highly valued than on other channels. This implies that even without the CRR remedy in place we might expect channels which provide larger audiences to enjoy a premium. Similarly, channels which attract highly valued audiences, which at times may be harder to reach, (e.g Men) may also be expected to trade at a premium. Of course, the fact that one product may be of a higher quality and at a higher price point than others does not necessarily mean that it is in a separate economic market the question is rather whether those other products constrain the price of the higher quality product. Candidate Focal Products 4.23 The focal product is the starting point for the market definition analysis: it is the product or bundle of products which constitutes the smallest potential product market that is relevant to the analysis. In this section we give a brief overview of some potential relevant focal products As was set out in detail in Section 3, media buyers aggregate the demands of their clients for different socio-economic demographics into broadly speaking a consolidated, annual contract with the broadcaster. The annual negotiations between sales house and media buyer therefore involve the negotiation of SOB commitments and discounts simultaneously across a broad range of demographics rather than demographic by demographic for their portfolio of clients (often referred to as an umbrella deal). The negotiations do not determine the actual price paid for different demographics: prices are determined at a later date against individual campaigns during the course of the year One potential candidate focal product would be to start from the position in which TV advertising for each socio-economic demographic is treated as a potential product market in its own right. The market definition exercise could then explore the extent of demand- and supply-side substitution for each type of demographic. Other potential focal products would include different temporal product markets (i.e. looking 31

35 Market Definition a market definition in terms of time of day, peak versus off-peak etc) and also looking at channels in this case ITV1 in their own right In the case of different demographics, further analysis indicates that in most cases there is a significant element of overlap between demographics and in a number of cases some demographics are sub-sets of others. For instance, the Housewives with Children and the ABC1 Housewives demographics are both subsets of the broader Housewives demographic as well as overlapping with each other. In addition the Housewives demographic is nearly a complete subset of the broader Women demographic. Further, as Housewives refers to the individual in the household responsible for household duties, rather than being gender specific, it will also include a proportion of men (overlapping with the Men demographic) Given the significant overlap between the different demographics, we think it is likely that if we were to start with TV advertising to a specific demographic as the focal product, we would find that the TV advertising to different demographics is linked by a strong chain of substitution on the demand-side. Thus although two demographics, A and B, may not be direct substitutes for one another, there is a sizeable overlap between demographic A and demographic C so that the two are close demand-side substitutes and there is also a sizeable overlap between demographic C and demographic B such that they are also close demand-side substitutes. In this way different demographics can be linked together. This would tend to suggest that if we started with narrow demographic advertising markets, we would move quickly to looking at a broader market definition Responses to the OFT consultation confirmed this assessment. ITV argued that advertisers often advertised the same brand against different demographics across the course of a year. In addition, advertisers indicated that as well as the particular demographic they were targeting, they were also aware of the fact that other demographic audiences would be exposed to the advert. This would mean that they might purchase impacts against a narrow demographic but that would be in the knowledge that they would also pick up impacts across other, related demographics at the same time. They suggested that this overspill issue was an important factor to them. Furthermore, the key audience being targeted by a particular campaign may not neatly fit into the demographic sold (e.g. pet owners) and there may be a number of demographics, or combination of demographics, against which advertising airtime might be purchased We have also considered temporal markets. It might be possible to make a distinction between different time periods e.g. peak versus day-time. However, in practical terms it appears difficult to make hard and fast distinctions between different time periods and it appears that there is likely to be a chain of substitution which joins together different day-parts. This would tend to suggest that if we started from a narrow time of day focal product, we would end up considering a wider market definition The OFT consultation did not raise this specific issue and none of the responses argued that it would be appropriate to define separate time of day markets. A number of responses did raise issues around the delivery of mass audiences which tend to be linked to the peak-time day-parts but we consider that it would be more appropriate to deal with these issues as part of the assessment of competition rather than to define separate economic product markets Finally, in terms of starting with channel specific markets, e.g. ITV1 as a market in its own right, survey results submitted by ITV on switching behaviour by advertisers and 32

36 Market Definition media buyers together with a critical loss analysis appear to indicate that if faced with an increase in the amount of expenditure they had to commit to ITV1, advertisers and media buyers would seek to switch away from ITV1 to other channels. While there are a number of weaknesses in the survey, the evidence gathered during the course of our investigation indicates that for some campaigns/advertisers ITV1 is sufficiently substitutable with other channels. The study and evidence gathered is discussed in more detail in the Competition Assessment in Annex We note that advertisers currently have a wide range of choice between different types of channels, including channels that rely mainly on subscription revenue. Many of these channels offer advertising airtime in and around their programming (e.g. Sky Sports). For the purposes of defining advertising markets, we do not consider that it is appropriate to make a distinction between channels with different business models. Media buyers/advertisers do not appear particularly interested in the business model of a channel when it comes to decisions about purchasing advertising airtime: rather they are generally focussed on the ability of the channel to deliver reach and coverage for different types of audiences From the above discussion of different candidate focal products, it appears that if we start with a narrow TV advertising focal product, overlaps with related TV advertising products imply a chain of substitution to a broader TV advertising product market. Given that the primary focus of the competition analysis in this review is on the market position of ITV, and ITV1 in particular, with respect to the purchasing of TV advertising by media buyers, we consider that the relevant focal product for our consideration of market definition is TV advertising in general i.e. as negotiated in the annual contracts negotiated between broadcasters sales houses and media buyer. That would also be in line with the findings of the 2003 and 2007 CC Reports We also considered the extent to which a broadcaster could discriminate between different types of advertisers. We consider that given the umbrella nature of the annual contracts the scope for price discrimination may be limited and so we have not considered it as part of the market definition process. We do, however, discuss this issue in more detail in Section 5. Market Definition 4.35 Taking TV advertising in general as our focal product, the relevant question is thus whether the relevant product market should be expanded to include other advertising media. The focus for the application of the HMT test is therefore on what advertisers and media buyers would do if a hypothetical monopolist of TV advertising tried to force them to increase the amount of total advertising expenditure devoted to TV A key development since the CC s Report in 2003 has been the rapid growth of internet advertising and we therefore consider whether internet advertising represents a close demand substitute for TV advertising Taking the product characteristics identified by the CC in the 2000 Report, the internet is, in theory, a medium that offer advertisers the scope for combining colour, sound and moving images, similar to TV advertising. However, the majority of advertising on the internet is actually classified advertising whereas TV advertising is a form of display advertising. In 2008, internet display advertising accounted for 20% (around 637m) of total internet advertising with the majority of internet advertising (58%) comprising paid-for search and the rest being more traditional classified 33

37 Market Definition advertising 50. The internet is therefore not a significant medium for display advertising and it is approximately less than a fifth the size of TV advertising Another important issue for advertisers is likely to be the fact that the internet does not yet offer the mass, broad demographic appeal of television. Whilst television is in virtually every home in the UK TV penetration is around 98% - internet penetration had reached around 67% of homes by the end of Those with an internet connection are increasingly more representative of the UK population as a whole, however, despite the internet no longer being the domain of young men it is still predominantly upmarket. ABC1 users comprise 59% of the internet population compared to 49% of the population as a whole. The number of C2 users has increased particularly quickly recently, though 52. As such, advertisers seeking to build mass awareness across a broad range of audiences quickly may not yet see the internet as a close substitute for television. Of course this could change as broadband penetration increases Another constraint on the extent of demand-side substitution with TV is that the systems in place to measure the success of advertisements on the internet have not yet been developed as comprehensively as those on TV. For instance, the BARB audience measurement system is able to provide detailed minute by minute data on the number and type of viewers who see particular TV advertisements, as well as more general information on viewing habits, use of time-shifting etc. This helps advertisers to plan campaigns and also to monitor and assess the effectiveness of their advertising campaign at reaching its target audience In contrast, measurement of the success of internet advertising in reaching target audiences has been more limited. Whilst advertisers can currently track the volume of click throughs and there is increased tracking technology, there is less certainty as to who is actually accessing the advert. That said, the fact that a person is researching a particular product does tend to indicate that they may be in the market to make a purchase which itself is an important signal to suppliers ZenithOptimedia has noted that the lack of standard reporting in the internet market continues to be a topic of much discussion. In addition ZenithOptimedia also report that brand advertisers in particular, used to offline accountability, have struggled to understand the value of on-line advertising without the ability to measure reach and frequency. 53 We would expect that over time the sophistication of audience measurement systems for internet advertising will improve We can also compare which firms are using TV and internet advertising. Tables 4.1 and 4.2 show the top 20 advertisers who use the internet and top 20 advertisers who use television advertising. It is noticeable that the list of internet advertisers is dominated by communications/technology companies (e.g. BSkyB, mobile operators, ebay, Dell) and financial service companies (Egg, HSBC, Virgin Money). In contrast the list of TV advertisers is dominated by firms supplying fast moving consumer goods e.g. Procter & Gamble (P&G), Kellogg, Scottish & Newcastle, Tesco, Marks & Spencer etc). Only BT and the CoI appear in the top 20 in both lists. A fuller list of internet and television advertisers is set out in Annex IAB/PwC. Alternative figures will also be available in the Advertising Association s Advertising Statistics Yearbook, due for release in June Ofcom s Technology Tracker, Q Page 161 The UK Media Yearbook ZenithOptimedia, May Page 182 The UK Media Yearbook ZenithOptimedia May

38 Market Definition 4.43 It is also noticeable that, not only are the amounts spent on internet advertising much smaller than the amounts spent on TV advertising, but also that the top internet advertiser accounts for less than 1% of total internet advertising whereas the top TV advertiser accounts for more than 3% of TV advertising expenditure in its own right. This perhaps suggests that a more diffuse range of firms are using the internet compared to TV. Table 4.1: Top 20 Internet Advertisers 2007 Advertiser Total Ad Spend 000 Percentage of total Personal Loan Express 28, % ebay 19, % British Sky Broadcasting 15, % Capital One 14, % Microsoft 14, % Orange 13, % Virgin Money 12, % O2 10, % Amazon 9, % COI Communications 8, % BT 7, % Norwich Union Direct 5, % American Greetings.com 5, % Bingos Net 4, % Eloanshop.com 4, % Experian 4, % Thomson Tour Operators 4, % Dell Computer Corporation 4, % Barclays Bank 3, % William Hill Bookmakers 3, % Source: The Advertising Statistics Yearbook, Advertising Association 2008 Table 4.2: Top 20 TV advertisers in 2007 Advertiser Total Ad Spend 000 Percentage of total Procter & Gamble 145, % Unilever 90, % Reckitt Benckiser 87, % Kelloggs 61, % COI Communications 54, % Nestlé 48, % L'Oréal Paris 42, % Tesco 39, % Marks & Spencer 36, % Vauxhall Motors 34, % DFS Furniture 34, % BT 33, % Ford Motor Company 30, % British Sky Broadcasting 27, % Direct Line Insurance 27, % Mattel 26, % Wm Morrisons Supermarkets 25, % Sainsbury's Supermarkets 25, % Argos 25, % GlaxoSmithKline 24, % Source: The Advertising Statistics Yearbook, Advertising Association

39 Market Definition 4.44 It has proven difficult to obtain reliable estimates of the relative cost of advertising on the internet compared to advertising on TV. However, discussions with broadcasters, advertisers and media buyers in the course of our research suggest that at present internet advertising is regarded more as a complement to TV advertising than as a close substitute and that decisions about expenditure in one medium or the other were not driven by relative price differences. For instance, one media buyer 54 argued that its clients regarded TV and internet as performing different marketing functions The analysis submitted by ITV on switching behaviour indicated that the main response to an attempt by ITV to increase the level of expenditure committed to ITV1, would be for media buyers and advertisers to switch to other channels. Only [] of responses indicated that they would switch to another media. Analysis by ITV suggests that this could have amounted to around [] of its 2007 revenues Input from stakeholders indicates that the internet is not regarded as a close demand-side substitute at this point in time. Responses to the OFT consultation also confirmed that stakeholders do not regard internet advertising as a close demandside substitute. Supply-side Substitution 4.47 We do not consider that there is currently much scope for supply-side substitution by other media at this point in time. As discussed above, the characteristics of most other advertising media are not well suited to offering the combination of sound and visual imagery together with the monitoring and evaluation systems that TV advertising provides We discuss further the issue of ease of entry into the TV advertising market in Section 5 as part of the assessment of the extent of competition in the relevant market. Definition of the relevant geographic market 4.49 ITV licences are regional in nature and the respective sales houses sell some advertising on a regional basis. Channel 4 and Five also have an ability to sell advertising airtime on a sub-national base using various macro-regions. However, virtually all other channels broadcast a single national service and sell airtime on a national basis For the purposes of this investigation, we took as our starting point the position adopted in previous competition investigations, namely that the relevant geographical market is national in scope A number of responses to the OFT s consultation argued that that there was a reasonably significant market for regional advertising and that this should be taken into account when defining the market. Advertisers/media buyers argued that the ability to advertise in specific TV regions could be important to advertisers wanting to test market products or for advertisers wanting to give more weight to one particular part of the country than another. In addition, some responses argued that the ability to roll out campaigns over time across the country was an important facility. 54 []. 36

40 Market Definition 4.52 We recognise that a regional dimension to advertising can be important to some advertisers. However, as referred to above, it is possible to secure a regional element to advertising using other channels: e.g. Channel 4 and Five offer regional macros, and it is possible to purchase regional TV advertising in Wales, Scotland and Northern Ireland independently of ITV Sales. In addition, data indicates that the overwhelming majority of TV advertising is sold on a national basis and so genuinely local TV advertising is not significant Taking these arguments into account, we did not consider that it was appropriate for the purposes of this analysis to define regional markets for TV advertising. However, we do accept that this regional facility is a factor which could be relevant to the assessment of market position and we therefore consider it further in the Competition Assessment In terms of whether the relevant geographical market could be broader than the UK, we do not consider that advertising on channels broadcasting to other countries would represent a realistic substitute for advertisers seeking to address UK-based audiences. We therefore assume that the relevant geographical market is national (UK) in scope. Conclusions 4.55 In 2003 the CC found that there was a single UK market for the supply of TV airtime for advertising. We have considered whether the appropriate market definition has changed since then and conclude that it has not Taking into account the scope for demand-side substitution and the discussion of the characteristics of TV as an advertising medium, we do not consider that internet display advertising is currently a close demand-side substitute for advertising on television In terms of the relevant geographical market, there is no suggestion that advertising on channels broadcasting to other countries would represent a realistic substitute for advertisers seeking to address UK-based audiences. We assume that for the purposes of our analysis the relevant geographical market is UK-wide We have therefore concluded that the relevant market for assessing whether there has been a relevant change of circumstances since the 2003 merger is the market for TV advertising in the UK and that this is separate from advertising on other media such as the internet, radio, etc However, we acknowledge that this market may evolve and that over time internet display advertising could come to exercise a more significant competitive constraint on TV advertising. In terms of characteristics internet display advertising is probably the closest substitute for TV advertising and it is likely that as measurement systems become more sophisticated and as the penetration of internet increases, then internet advertising has the potential to become more credible alternative to TV advertising. Equally, over time other media may also emerge as new sources of competition to TV advertising, e.g. mobile advertising. 55 [] 37

41 Competition Assessment Section 5 5 Competition Assessment Introduction 5.1 The previous section outlined Ofcom s approach to market definition and presented our view that the relevant market in this case is TV advertising in the UK. This section summarises Ofcom s analysis of competition in the UK TV advertising market. The full analysis is presented in Annex 5 of this document. 5.2 As noted in Section 2, in reaching a decision as to whether the merger operated against the public interest, the CC did not explicitly quantify the merger effects. Instead, conclusions on the adverse effects to the public interest were based on a qualitative assessment of the market dynamics. As a result, the purpose of our analysis is not to establish whether or not ITV has market power. Rather, it is to assess whether, by reason of a change in circumstances, there has been a reduction in the enhanced market position created by the merger. In undertaking our analysis, we have therefore considered a wide range of indicators and factors, including: measures of market share; price measures; changes in profitability; barriers to entry and barriers to expansion; buyer power; and measures of substitutability. 5.3 It is important to be aware that some indicators will have been influenced by the CRR remedy itself because the remedy was aimed at constraining ITV1 s ability to price discriminate and offer less attractive terms to advertisers/media buyers. 5.4 As discussed in Section 2 the analysis includes an assessment of the overall position of the ITV sales house and the individual position of ITV1 (as this is the focus of the CRR remedy). ITV did not believe that ITV digital channels were relevant when considering whether the CRR remedy should be kept in place 56. However, since the ITV digital channels and ITV1 are under common ownership and sold by the same sales house, and the ITV digital channels would not exert any competitive constraint on ITV1, Ofcom believes that it is still important to take them into account. 5.5 The following analysis examines how the competitive landscape has changed since the 2003 merger and in particular whether the market position of ITV1, and ITV, has changed such that the adverse effects to the public interest identified by the CC no longer remain. 56 ITV pointed out that in 2003, despite ITV2 already being broadcast and sold by both sales houses, the CC had suggested that ITV2 should not be covered by CRR. ITV also noted that the ITV digital channels were substitutable and that, given their SOCI, if the price of ITV1 rose only a small amount of money lost from ITV1 would be diverted to these channels, as opposed to other broadcasters, such as Channel 4 and Five.

42 Competition Assessment Measures of market share 5.6 Market shares can provide an indication of the relative strengths of different players in a market. Differences in market share by value compared to volume may reflect the fact that TV advertising is a differentiated product and some impacts may be more highly valued than others. Hence we have examined market shares both on the basis of volume (SOCI) and value (NAR). 5.7 Chart 5.1 shows SOCI for the Adult demographic for the major sales houses for 2003 to ITV1 s Adult SOCI is also included for context. Chart 5.1: Adult SOCI by sales house [] 5.8 ITV s Adult SOCI has fallen from [] in 2003 to [] in The fall in SOCI for ITV1 was more significant, decreasing from [] to [], although ITV1 still remains the single largest commercial channel 57. The slower rate of decline in ITV s SOCI, reflects the offsetting growth of the digital family of channels. Even so the gap between ITV and Channel 4 (its nearest rival) has narrowed since This evidence is consistent with a decline in ITV s market position. 5.9 Forecasts suggest that ITV1 s Adult SOCI will continue to decrease over the next few years, whilst the forecasts for the SOCI for ITV are reasonably flat. These are both consistent with continued fragmentation of viewing Whilst we would normally view market shares measured by value as a more useful measure, as it takes into account the differentiated nature of advertising, in this instance, market shares measured in terms of NAR may be a less reliable indicator of market position as NAR will have been influenced in part by the CRR remedy 58. Bearing this in mind, it is still useful to consider what has happened to this indicator Chart 5.2 provides an overview of the distribution of NAR by sales house since the CRR remedy came into effect 59. It demonstrates that both ITV and ITV1 s NAR have declined over time. At the same time the share of NAR of Channel 4 rose slightly over the period, so that overall the gap between the ITV and its nearest rival decreased between 2004 and The market position of the other sales houses has been broadly stable over this period. Current forecasts suggest that both ITV and ITV1 s share of NAR will continue to decline over the foreseeable future 60. Chart 5.2: Revenue shares by sales house [] 5.12 Whilst we must be careful how we interpret changes in shares of NAR given the impact of the CRR remedy, overall, the changes in market shares are consistent with the view that ITV s market position has declined since The change in market position of ITV and ITV1 for other demographics is broadly similar i.e. a decline in the market position of both ITV1 and ITV sales. There has been a more significant decline in ITV s delivery of the Men demographic, although ITV remains the market leader. 58 The CRR ratchet allows media buyers to withdraw revenue from ITV1 in proportion to the fall in ITV1 s SOCI so part of ITV s decline in share of NAR can be attributed to the CRR remedy itself. 59 Shares of NAR for 2008 are estimates in that not all licensed channels have submitted final returns for 2008 to Ofcom. 60 These forecasts are discussed in more detail in Annex 5. 39

43 Competition Assessment 5.13 As part of our analysis we also examined the changes in ITV1 s position in relation to both the top 15 channels (by SOCI) and share of SOCI by time of day. These are discussed in greater detail in Annex 5, however, in general these indicators showed that ITV1 s position has declined since Most stakeholders, aside from ITV, believed that ITV had maintained its relative position in the market place. They noted that whilst ITV1 s SOCI and share of NAR had fallen, the market shares of ITV s digital channels had increased significantly over the period We have observed that both ITV1 and the ITV have seen falls in SOCI and NAR whilst the gaps between them and their nearest rivals have narrowed. Furthermore, these falls in SOCI and NAR have only been partially offset by the growth in the ITV digital channels. These changes may reflect viewer fragmentation as digital television penetration has significantly increased over the period along with corresponding growth in the number of channels Whilst market shares of ITV and ITV1 remain significant, the downward trend in both SOCI and NAR, particularly for ITV1 (from which ITV was considered to derive its strong market position), indicates that the enhanced market position created by the merger has declined. Pricing Measures 5.17 TV advertising is a differentiated product market, and as a result, prices for individual channels will vary and certain products may be able to command a premium in the market based upon the particular mix of characteristics/attributes that they offer As in the case of market share data, the presence of the CRR remedy itself makes it difficult to draw conclusions from the pricing measures. However, these indicators may still offer some insights into the workings of the market place, as long as we are careful in their interpretation The pricing metric often quoted when discussing outcomes in TV advertising is the power ratio 61. A power ratio over 100 suggest that a relatively greater weight of revenues is attracted to the channel than its SOCI would imply, all things being equal. This measure provides an estimate of the overall premium paid by media buyers for a particular impact and may reflect other qualitative factors not fully captured by SOCI Chart 5.3 shows Adult power ratios for a number of channels over the period 2003 to It indicates that ITV1 s power ratio rose slightly between 2003 and 2006 but fell back to just above 2003 levels in Therefore overall the power ratio for ITV1 was flat. The chart also shows that the power ratios for Channel 4, Five and ITV s digital channels (excluding CITV) have all increased over the period. Chart 5.3: Adult Power Ratios [] 61 The power ratio for an audience is defined as Share of Broadcast (SOB)/ SOCI for a particular demographic x The denominator in the calculation of shares of NAR in 2008, i.e. total market NAR, is an initial estimate.. 40

44 Competition Assessment 5.21 A number of stakeholders argued that ITV1 s relatively high power ratio is a sign of market power. However, whilst this may be one explanation, there may be other reasons for the high power ratios. As noted, TV advertising is a differentiated product market. Hence, we would not expect to see uniform prices or indeed prices tending towards a particular industry average. For instance, if advertisers value mass audience attributes and these are not readily available, then channels that are able to deliver mass audiences are likely to command a greater share of revenue than their SOCI might imply reflecting this higher valuation and the scarcity of supply. We see this is the case for ITV1 and Channel 4. It is therefore possible that certain products will command a premium in the market which reflects the value of the mix of characteristics/ attributes that they offer. However, such differences in prices are not inconsistent with a competitive market and lower quality products may still be able to constrain the price of their more expensive competitors ITV argued that the power ratios did not fully reflect its market position as it has had to offer better terms and conditions to keep levels of SOB at or above the CRR remedy levels Ofcom is wary about drawing any particular conclusions from this metric on its own, both as the operation of the CRR remedy will have influenced it and because a relatively high power ratio may reflect differences in quality, and therefore may not necessarily equate to market strength. Change in profitability since The publicly available data on profitability is limited. In so far as it goes, it does not suggest that ITV has been earning excessive profits. Further, ITV s profitability has been declining over the last few years, which is consistent with large falls in its share price 63. Indeed, the share performance suggests that the market believes outlook for ITV has worsened and that future profits will be lower than previously earned. Barriers to entry and expansion 5.25 The extent to which other sales houses are able to compete with ITV for advertising revenues will also be influenced by the potential barriers to entry and expansion faced both by these competing sales houses, and the channels they represent Ofcom considers that there may be barriers to entry and expansion for new sales houses. Whilst there are probably few sunk costs (most of the resources required being offices and staff), the most attractive channels are already represented by their parent channel s sales house and it is unclear whether a completely new sales house could attract a sufficient number of smaller channels to make entry profitable. However, Ofcom considers that there are enough sizable sales houses currently within the market place for any barriers to entry or expansion to be unlikely to impact on current or future levels of competition Whilst there are likely to be significant barriers to entry for channels wishing to provide premium content, Ofcom consider that entry barriers for free to air/basic TV channels are likely to be lower than they were in There has been a substantial increase in the number of free-to-air and basic commercial channels since 2003 and libraries of content are available for purchase from other UK broadcasters, foreign companies (e.g. the US) and independent producers. Though the same level of 63 (in the three months to 27 th May 2009, ITV s share price varied between p compared to around 1.50 shortly after the merger was completed) 41

45 Competition Assessment growth in channels is not expected to continue, we doubt that this will limit competition in the TV advertising market in the future Ofcom considers that there may be some barriers to expansion for TV channels. Some free to air/basic channels owned by the PSB families have been particularly successful at growing market share, as have other channels such as Dave, and there are some recent examples of these channels developing some mass audience programming 64. On the other hand, it is likely that expansion into mass audience programming on a sustained basis remains difficult since it requires a significant increase in programming budget. In addition, the ability to cross promote, EPG position, availability of channels across all platforms and use of an established brand to grow viewers are likely to be important factors Some stakeholders believed that it would be very difficult for another channel to be able to develop mass audience programming capable of challenging ITV1 s market position due to the costs involved, the strength of ITV s brand and ITV s superior ability at generating large audiences to view new content It is unclear whether barriers to expansion are as significant a factor today as they were in Whilst ITV1 retains a strong position in mass audience programming, there have been some examples of larger audiences being achieved on non-itv1 channels. Furthermore, to the extent that media buyers and advertisers are already able to substitute away from ITV to alternative broadcasters (discussed later), low barriers to entry may not be an essential factor in constraining ITV s behaviour. Buyer power 5.31 If buyers, in this case media buyers and some individual advertisers, are able to assert some bargaining power ITV may be limited in its ability to raise prices were the CRR remedy to be removed Since 2003 there has been some consolidation of buyers. With many media buyers now owned by larger groups or negotiating on a group basis. Table 5.1 shows the top negotiating points for 2003 and 2007 on a group basis 65. It shows that the share of TV advertising spend accounted for by the six top groups has risen from 69.1% to 83.1% over the period. Table 5.1: Changes in concentration of media buyers [] 5.33 ITV has also provided data to show that in 2008 the proportion of ITV1 s revenues accounted for by []; [] and [] resulting in the top three media buyer groups accounting for [] of ITV1 s revenues in total. This compares to 2003 where the top three media buying groups accounted for [] of ITV1 revenues. Overall, the increase in concentration 66 and the creation of some sizable buyers would be consistent with an increase in countervailing buyer power Some other stakeholders suggested that larger buyers had less buyer power than smaller buyers on the basis that large media buyers are less able to credibly threaten to remove large amounts of TV advertising from ITV, as they have more clients who 64 For example, Dave s revival of Red Dwarf and Sky s Hogfather. 65 Buyer shares for 2007 are calculated as if the Vivaki sales arrangement had already taken place. 66 The HHI for the top 6 agencies in 2003 was 813. It rose to 1533 (including Vivaki) in

46 Competition Assessment will insist on advertising on the ITV channels 67. []. Even if a media buyers had a large proportion of clients with a greater demand for ITV, [] they would only need to convince a small proportion of their clients to switch (or a large proportion of clients to switch a small amount) to exert buyer power Hence, purely on the basis of concentration on the buyer side we might expect buyer power to have increased since However, the ability for media buyers to credibly threaten to substitute away from ITV1 may depend on other factors. This is covered in the next section on substitutability. Substitutability 5.36 In 2003, the CC found that it was relatively difficult for media buyers and advertisers to substitute spend away from ITV1 given its unique ability to deliver fast mass audiences and light viewers, and the superior quality of ITV impacts. In this subsection we consider how the substitutability of ITV1 s impacts has changed since This is relevant to building a picture of how ITV1 s overall market position has changed and whether the enhanced market position arising from the merger has been eroded If it is possible for advertisers or media buyers to move (or credibly threaten to move) advertising spend from ITV to alternative non-itv channels without compromising their campaign objectives it may be possible for them to limit ITV s ability to raise prices on ITV1. Moreover, where a sufficient amount of revenue can be moved away from ITV, such that an attempt to increase prices on ITV1 would be rendered unprofitable, the CRR remedy may no longer be required. That is, competition from other broadcasters alone may be sufficient to constrain ITV1 prices Advertisers and media buyers have gone to considerable lengths during the course of the review to explain that ITV1 still provides a unique service, particularly in terms of its delivery of fast, mass audiences. As a result some campaigns or parts of campaigns are reliant on ITV1 and would find it impossible to move away from ITV1 as they would be unable to meet their campaign objectives (both in terms of price and quality) However, the evidence also suggests that some advertising is not reliant on ITV1 and for which it is possible to achieve campaign objectives without using ITV1 or the ITV family of channels. Figure 5.1 illustrates these different components of a media buyer or advertisers spend on ITV1 - Y represents that spend which is substitutable and could move away from ITV1; and X represents spend which cannot switch away from ITV1. We are therefore interested in assessing whether the size of Y is sufficient to undermine a potential price rise by ITV1. 67 This appeared to relate to a number of factors including the difficulty of co-ordinating across a wider range of advertisers and the desire to maintain existing discounts on ITV1 (which may fall if the volume of spend is reduced). 43

47 Competition Assessment Figure 5.1: Diagrammatic representation of an media buyer/advertisers total spend Substitutable spend Y X Y Core which requires ITV1 Y 5.40 Media buyers and advertisers have explained that there are two elements to campaign objectives. Firstly, objectives can be defined in terms of quantitative campaign goals, e.g. achieving particular reach and frequency levels within a certain period, and/or for reach and frequency to be delivered to a certain pattern over the timescale of a campaign (its shape). Secondly, media buyers and advertisers have stressed that qualitative factors are also important, in that some impacts (supplied at different times of day or from different broadcasters for instance) may be perceived as better quality impacts by advertisers and so may represent higher value to them Our analysis has therefore examined whether media buyers and advertisers are able to run campaigns excluding ITV without compromising these campaign objectives, i.e. we assess whether Y exists and if so, how large it might be. Where impacts are assessed on the basis that they are homogeneous 68 the evidence provided suggests that the ability of campaigns and advertisers to switch away from ITV1 has increased since the CRR remedy has been in place. Once the analysis is expanded to include quality aspects of impacts and campaign objectives, the ability to switch away from ITV1 does appear to reduce for some advertising campaigns (that is, the size of Y may be smaller than implied by the previous analysis). However, we consider that even when these factors are taken into account, there still exists a group of advertisers and campaigns able to move a proportion of their spend away from ITV1 without compromising overall campaign objectives and this group is likely to have increased since We have also considered whether, even if individual campaign goals could be achieved without ITV1, advertisers and media buyers face barriers that would prevent this spend being moved to other broadcasters. While some of the barriers identified by media buyers and advertisers may be plausible, little or no evidence was provided to support these concerns, or establish how significant they might be Finally, we considered whether it was possible to estimate the amount of switching that is available to switch (or can credibly threaten to switch) away from ITV1. While there was limited evidence to estimate the actual size of this group, overall it would appear that it may only be necessary for a small proportion of spend to switch away from ITV1 to render any attempt to increase prices unprofitable. Substitutability on the basis of homogeneous impacts 5.44 During the course of the review ITV provided a number of pieces of analysis, covering both theoretical and actual campaign parameters, which it claimed 68 That is, all impacts are of equal value and campaigns are purely measured on a quantitative basis where reach and frequency are the primary focus. 44

48 Competition Assessment demonstrated that ITV 69 was fully substitutable with other channels. With the possible exception of the Housewives demographic, ITV s analysis showed that it was possible to achieve the same levels of 1+ and 4+ cover whether or not ITV1 and the ITV digital channels were included in the campaign. In particular, the analysis indicated that levels of 4+ cover were generally better if ITV was excluded from a campaign, suggesting that it may be advantageous for those advertisers seeking to maximise 4+ cover to remove ITV from their campaign mix The evidence supplied by ITV therefore supports the proposition that for some campaigns it is possible to substitute away from ITV without compromising cover or frequency campaign objectives. The analysis also indicated that the ability to substitute away from ITV has increased since A number of media buyers and advertisers also submitted their own analysis on the ability to replicate campaigns without ITV. These examples included a range of different campaign sizes, budgets and other parameters. In general, their analysis suggested that, for the campaigns selected, excluding ITV1 from the campaign would result in lower 1+ cover, but for higher levels of frequency (3+ and 4+) cover was broadly similar when ITV1 was excluded In response to concerns that ITV s substitutability analysis only considered the ability to replicate an individual campaign, it submitted further analysis examining outcomes if both [] and [] worth of campaigns were moved off ITV1 to other channels. This analysis took into account any subsequent increase in the price of non-itv channels. The results for moving [] worth of campaigns were broadly similar to the analysis of a single campaign (discussed above). In respect of moving the larger sum of [], as might be expected, substitutability declined by a few percentage points relative to the original analysis Most comments on this analysis focussed on the impact this would have on the prices of the other channels and not whether this would affect their ability to achieve campaign goals within the original campaign budget. The analysis provided by media buyers and advertisers suggests that if high levels of revenues shifted away from ITV, there would be slightly larger falls in substitutability than suggested by ITV s analysis However, it is important to note that the level of revenue considered [] represents around [] of ITV1 NAR in It may be that a smaller proportion of revenue need switch in order to discipline ITV s behaviour. As discussed later, ITV argued that it would be constrained by much lower levels of switching Many media buyers and advertisers expressed significant concerns about their ability to obtain fast, mass cover if ITV1 was excluded from a campaign plan. They submitted that ITV1 remains essential due to its ability to deliver mass audience programming and therefore rapid 1+ cover. They consider that the ability to build cover rapidly, particularly in the first few weeks of a campaign, is essential to their campaign objectives and that ITV1 is uniquely placed in this regard as it is the only channel capable of consistently delivering audiences large enough to achieve fast mass cover While ITV1 s position in the provision of mass audience programming has, to a degree, declined since 2003, it still retains a strong position in respect of the top ITV s analysis investigated two scenarios - whether ITV1 could be removed from a campaign plan and whether all ITV channels could be removed from a campaign plan. 45

49 Competition Assessment commercial programmes and programming which is watched by large audiences. Furthermore, the examples of campaigns provided by media buyers and advertisers to demonstrate that ITV1 was not substitutable tended to be those campaigns which you might expect to be reliant on achieving fast mass cover It may be the case that advertisers could still achieve high levels of 1+ cover in a short time period by purchasing impacts from a combination of non-itv channels. In an attempt to illustrate this point, ITV provided analysis examining a range of weekly weights (ranging from 100 TVRs up to 250 TVRs). The results suggested that smaller campaigns were more likely to be able to replicate cover levels without ITV1. For the largest campaign type (250 TVRs) cover was lower for several, but not all, demographics. ITV also provided a weekly breakdown of its earlier analysis of a 400 TVR campaign over four weeks, which suggested that weekly 1+ cover was actually higher in the first week if ITV was excluded One potential weakness of ITV s analysis of fast mass cover is that, the definition of a fast, mass campaign used is restrictive (i.e. it requires all impacts to be delivered in one week). ITV s analysis may therefore understate the impact of removing ITV1 from the campaign plan. On the other hand, even the analysis provided by media buyers and advertisers suggests that for some campaigns, particularly those with low weekly weights, it is possible to remove ITV from the campaign plan without compromising cover Overall, we consider that it is likely to be easier to obtain fast, mass cover if ITV1 is included within a campaign plan, given ITV1 s strength in the provision of mass audience programming. As a result some advertisers may continue to be reliant on ITV1 if they absolutely require fast, mass cover. However, even if some campaigns are reliant on ITV1 media buyers may still be able to constrain ITV s behaviour in the market place by threatening to move revenues which do not require ITV1. Differences in quality and its impact on substitutability 5.55 During the investigation, advertisers and media buyers explained that they consider a variety of factors other than desired cover, frequency and campaign shape, when planning campaigns. These factors can be broadly described as quality effects and imply that in reality impacts are heterogeneous (i.e. impacts on different channels and at different times of day have different values to advertisers/media buyers) Stakeholders, not including ITV, raised a number of different quality aspects which they considered made impacts on ITV1 superior and non-substitutable for impacts on other channels, including: Advertising on ITV1 results in greater sales uplift. A number of stakeholders referred to the TVworks study examined by the CC in 2003, however, limited new evidence was submitted on this point. [] provided some analysis indicating that ITV1 may be associated with higher sales uplift, but the strength of this effect was unclear Overspill effect. Some stakeholders submitted that, while only one demographic was generally purchased, advertisers were also interested in maximising the number of impacts across a wider audience. Due to its strength in mass audience programming ITV1 was seen as particularly desirable. [] provided some evidence which showed a decrease in cover for these wider demographics when ITV1 was excluded from a campaign. However, we also observed that overspill demographics were not included 46

50 Competition Assessment in campaign objectives, so it is difficult to understand its value to advertisers ITV1 leads to greater advertising recall and engagement. The evidence provided suggested that advertising recall and engagement may be higher when an advert is screened in Event TV programmes i.e. programmes with a high rate of shared viewing. There was no established link to ITV1 programming per se. However, shared viewing appears to be linked to programmes with mass audiences. As noted earlier, ITV1 accounts for a significant proportion of mass audience programmes ITV1 attracts a higher proportion of light viewers. ITV1 s proportion of light viewers has clearly declined since Furthermore, several stakeholders noted that the provision of light viewers was now less important for advertisers the large number of specialist channels now enable them to target specific niche audiences in a more focussed manner. Some media buyers have suggested that they are now more interested in accessing the heaviest viewers as they may be more responsive to advertising Excluding ITV1 from a campaign results in higher levels of excessive frequency. Stakeholders argued that this would give rise to concerns about boring or annoying the viewer. Removing ITV1 from a campaign does appear to increase the average number of times a viewer may see an advert, however, it is not clear how significant this effect is. Furthermore, no attempt has been made to quantify the cost of wastage ITV1 has a particular strength in regional advertising. Regional advertising represents a relatively small proportion of total ITV advertising and there has been little change in such advertising since Given the small proportion of customers concerned, this factor appears unlikely to significantly decrease media buyers ability to negotiate with ITV or move advertising spend to other channels. Moreover, it was not a feature of ITV1 that was particularly enhanced as a result of the merger Ofcom considers that following the OFT consultation there is more clarity about media buyers and advertisers perceptions of the quality of TV advertising. However, in many cases, it is difficult to find up to date quantitative evidence as to the scale of ITV1 s superiority and whether this has changed since the CRR remedy has been in place. Whilst this does not mean the issues raised are not real, it makes it difficult to assess the strength of the concerns and their impact on the ability to substitute. Many of these quality aspects may be linked to the provision of mass audience programmes and is difficult to disentangle these effects. However, some quality aspects such as light viewers and regional advertising do not seem as important as they were when the CRR remedy was put in place On the other hand, many advertisers seem to place value on quality, reflected in the extent to which particular quality features are identified in contracts with ITV. This may explain ITV1 s price premium, but it also remains consistent with the proposition that a proportion of advertising spend is substitutable. Barriers to switching 5.59 Some media buyers and advertisers have agreed that advertising spend associated with some campaigns may be capable of being switched away from ITV and still achieve campaign objectives. However, they argue that there are barriers to 47

51 Competition Assessment switching which would prevent them from exercising potential buyer power and moving any money away from ITV1 in practice A number of stakeholders suggested that switching spend away from ITV1 would result in reduced discounts or quality of service which will offset any potential savings made from switching to cheaper channels 70. In addition, they considered that ITV could punish those seeking to move revenues away by targeting advertisers reliant on ITV1. This may be achieved by reducing access to key programmes and enforcing late booking penalties, and may be a particular problem during the negotiation period when ITV would be aware of which advertisers or campaigns are particularly dependent on ITV1 e.g. because they need mass audiences quickly in the lead up to Christmas It may be feasible that ITV could target particularly vulnerable advertisers during the negotiation period. We have not been presented with evidence to show that ITV does create these barriers to switching, but that does not mean the barriers don t exist. However, the extent to which ITV can effectively impose these barriers is likely to differ over time and by media buyer/advertiser. For example, we might expect the potential barrier to be less significant to larger media buyers who may be more important to ITV. In addition, we note that ITV presented evidence to suggest that despite this potential barrier, media buyers and advertisers have successfully switched money away from ITV1. It may also be possible for a media buyer to avoid these problems by negotiating at a different point in the year Media buyers have suggested they are restricted by advertisers in their ability to move revenues away from ITV. Similarly, advertisers have claimed that they in turn face restrictions from retailers, who may insist that ITV1 be part of a campaign plan. For example, it was claimed that the major supermarkets require some advertisers to ensure their products appear on ITV1 in order to achieve prime placements in their stores. However, whilst this argument appears plausible, we have not received any supporting evidence from stakeholders Several stakeholders noted that media buyers have an incentive to invest heavily in ITV1 to achieve a good discount relative to their competitors 71. However, we note that when media buyers and advertisers were asked about the role of auditors they acknowledged that auditors provide advertisers with a range of information which is not limited to comparing the discount achieved with ITV Media buyers have said that there are also practical limits to purchasing slots since broadcasters limit the weight of advertising of any particular advert. These limits may reflect conventions which limit the type or number of similar products being advertised in a single break and government regulations which restrict where some adverts can be placed However, growth of the multichannels and digital penetration since 2003 would suggest that many more slots and impacts are available in the market place and should counteract these problems. In addition, no media buyers have presented any evidence to suggest the impact is significant and ITV argues that these restrictions have been taken into account in its modelling. 70 On the other hand, evidence provided by ITV suggests that only a small proportion of spend needs to switch away to make a price increase unprofitable. 71 A number of media buyers told us that one of the measures that advertisers often tend to use to assess the performance of a media buyer is the price charged for ITV1 compared to it the media buyers competitors. 48

52 Competition Assessment 5.66 Overall, even if some of the barriers cited do exist, we do not consider that they are sufficient to prevent any switching taking place, particularly since examples of switching have been observed 72 (and we have no reason to believe that these examples could not be replicated more widely). The key issue is whether a sufficient proportion of spend can be switched away from ITV1 to impose a competitive price constraint on ITV1. Proportion of spend able to switch away from ITV As discussed above, while in general the ability to move away from ITV1 has improved since 2003, some advertisers may still be reliant on ITV1 and are therefore unable to switch away due to the need for fast mass cover or high quality impacts. However, there is also likely to be some advertising expenditure which does not rely on ITV1 airtime to deliver campaign objectives. We therefore attempted to identify what proportion of spend is available to switch away Media buyers and advertisers provided little firm evidence as to the proportion of advertising revenue which could switch away from ITV1. They suggested that the ability to build up cover quickly is particularly important to certain categories of advertising campaign or advertiser, including newspapers, FMCG, and time dependent campaigns, i.e. those advertising particular promotions, product launches etc. However, we note that it is not easy to precisely define dependent groups as different advertisers, products and campaigns are likely to require fast coverage at particular stages in the product cycle and at different times of year A number of media buyers and advertisers suggested these campaigns comprised the majority of TV spend. However, it has been difficult to obtain clear evidence as to the size of this group and whether advertisers delivering these dependent campaigns require fast, mass cover for the entire campaign 73 or indeed all their campaigns In order to test whether sufficient switching could take place to constrain ITV1, ITV engaged an independent research company, [], to carry out an on-line survey of advertisers and media buyers to find out how they would respond to 5% and 10% price increases. The study concluded that although 74% of respondents stated that ITV1 was essential to their media mix (with 94% of these respondents citing access to large audiences as the reason), when faced with a 5% increase in the cost of purchasing ITV1, 69% of advertisers/media buyers said they would switch some or all of their spend away from ITV A number of stakeholders were very critical of the [] survey particularly since the survey asked buyers what they would like to do if prices rose. They also raised concerns that [] did not approach the appropriate people when undertaking its survey and that the survey gave no consideration to the nature of the negotiation process or the practical ability to switch revenues to other broadcasters Ofcom accepts that surveys based on stated preference tend to overstate responsiveness when faced with actual price rises. Despite this, the results do appear to indicate that some advertisers and media buyers are willing to switch advertising spend away from ITV1 following a price increase. This is consistent with our view that not all advertisers, or campaigns, require ITV1 and switching of at least a proportion of advertising spend is feasible. 72 These examples are discussed in Annex For example, high weekly weights of advertising may only be needed during the first few weeks of a campaign. 49

53 Competition Assessment 5.73 ITV also used the estimates of switching behaviour derived from the survey to calculate the reduction in revenue that would result from a 5% increase in SOB commitment. It found that such an increase would result in a significant reduction in revenue (even taking account of the higher prices paid by advertisers/media buyers that do not switch) and that, in fact only a relatively small amount of revenue would need to switch away from ITV1 for a 5% price rise to be unprofitable for ITV1. We consider that the results of this analysis are broadly in line with the expectations of a sector characterised by high price cost margins As noted above, there was limited evidence on which campaigns and advertisers are reliant on ITV1 for access to fast mass cover. It is likely that this group will change over time, depending on the campaign type and product being sold. Similarly, it has not been possible to determine the proportion of ITV1 s current revenues which would be able to switch in the event of a price increase. However, ITV s analysis suggests that the amount of spend would not need to be very large to make a relatively modest price rise on ITV1 unprofitable. Potential for ITV to price discriminate 5.75 In the previous sub-section we concluded that it should be possible for media buyers to constrain ITV s ability to raise prices on ITV1 if they could credibly threaten to move sufficient revenues away from ITV1. We also suggested that the amount that needs to switch to impose a price constraint may not be particularly large. However, this potential constraint on ITV s pricing may be undermined if ITV could identify the advertisers who are reliant upon ITV1 and raise prices to this group of advertisers who are likely to be more price insensitive than others There are two stages during which ITV could identify and target advertisers which are reliant on ITV1. The first is during the deal season when media buyers negotiate SOB deals with sales houses. The second is during the advertising year when media buyers book actual campaigns with the sales houses We consider that the ability of ITV to identify and effectively price discriminate against those campaign types which require rapid mass coverage during the deal season is limited. The types of advertising which require rapid coverage do not strictly correspond to specific demographic or product groups, so it would be difficult for ITV to reduce discounts for particular demographic groups without loss of business. In addition, advertisers are spread across different media buyers, so it would be difficult for ITV to identify an individual media buyer as being particularly dependent on ITV1, particularly given advertisers move between media buyers, so reliance will change over time Even if ITV could identify dependent advertisers it is not clear that ITV could set different terms to non-dependent advertisers, particularly given that most terms are negotiated under umbrella deals. Umbrella deals bundle together the demands of a number of advertisers into a single contract, combining the demands of reliant advertisers with the demands of other advertisers. As a result, it will be difficult for ITV to identify the different groups and set differential terms One remaining concern we have is that ITV could potentially target advertisers who are reliant on fast, mass cover by increasing peak time prices in excess of what might be justified by any perceived quality attributes. Although, again, there would be some risk involved in this strategy, if a portion of the peak time spend is sensitive to price rises (e.g. if some peak-time impacts purchased are not required for fast, mass 50

54 Competition Assessment cover) it is likely to be less risky than increasing prices on ITV1 generally, given the importance of peak time impacts for delivering fast mass audiences With respect to price discrimination during the advertising year, while ITV may be better able to identify campaigns reliant on fast mass cover, the presence of an annual contract (with pre-agreed terms and conditions) will, to a large extent, limit ITV s ability to target these advertisers. It is also not clear that ITV has the necessary incentive to target these advertisers, given there is no financial benefit in doing so (as prices are already agreed). Further, if ITV1 did manage to undertake such actions, then this should impact on negotiations by media buyers in the next deal season i.e. media buyers and sales houses are in a repeated game. Conclusion 5.81 We have examined a number of indicators of competition - market shares, pricing metrics, profitability, barriers to entry and expansion, buyer power and substitutability. Whilst some are difficult to interpret (given the influence of the CRR remedy itself) other indicators such as buyer power, SOCI and substitutability indicate a decline in ITV s strength. Overall we conclude that ITV s market position has weakened since Examination of the evidence on substitutability in particular suggests that while ITV1 retains some unique features (primarily associated with access to mass audience programming) which may leave a subset of advertisers or specific campaigns reliant on ITV1, there is also a group of advertisers/campaigns for which ITV1 is substitutable. This group therefore should be able to switch away from ITV1 to other broadcasters channels without compromising their campaign objectives (either in terms of price or quality). However, we are still unclear about the size of the group able to switch away from ITV1. During the course of the review, very little evidence was provided which would enable us to quantify precisely how much spend is represented by this group Although this group is likely to fluctuate over time as reliance (and therefore nonreliance) on ITV1 will vary with the nature of the campaign and/or product being sold, the data on the changes in substitutability suggest that the feasibility of switching has increased over time and therefore the group able to switch should also have increased as well. Furthermore, evidence provided by ITV suggests that only a small amount of revenue need switch before a price increase would become unprofitable for ITV. On this basis, we consider that the evidence supports the overall view that sufficient switching could occur such that ITV would be constrained in its ability to raise prices Concerns have also been raised about the ability for media buyers and advertisers to switch away any spend (even if its substitutable spend) due to barriers to switching, although, evidence on these barriers to switching remains limited and anecdotal Finally, while price discrimination seems unlikely under the current trading mechanism, the possibility exists that, absent the CRR remedy, ITV may be able to change the way that it trades its advertising airtime such that price discrimination becomes feasible. In this case we have concerns that ITV may be able to target and set excessive prices for impacts which are necessary to deliver fast mass cover, e.g. peak time impacts. 51

55 Impact of the CRR remedy Section 6 6 Impact of the CRR remedy Introduction 6.1 In this section we provide an analysis of the potential distortions arising from the CRR remedy, taking into account stakeholder responses about the effectiveness of the remedy. 6.2 Behavioural remedies may be associated with some level of distortion compared with a competitive market outcome, and so the existence of distortions per se would not justify relaxation or removal of regulation. However, it is possible that distortions may have a detrimental effect on the operation of the market such that the remedy does more harm than good to end consumers. As a result, we consider what distortions exist and whether their likely impact is sufficient to support a case for the amendment or release of undertakings. 6.3 ITV and others have identified a number of aspects of the CRR remedy which have an impact on ITV s incentives and the negotiation process. These are considered under the following broad themes: Contract negotiations and switching; ITV s incentives to innovate SOCI maximisation; and Contract rigidities. 6.4 We consider these in turn, starting with an overview of stakeholders views about the effectiveness of the remedy. Effectiveness of the CRR remedy 6.5 The vast majority of stakeholders, including advertisers and media buyers, consider that the CRR remedy works well and has been successful in dealing with the concerns identified in the CC s Report. It is generally recognised that the CRR remedy prevents ITV from raising the price for ITV1 advertising airtime and ensures access to airtime even when negotiations could be problematic. However, concerns have been raised by some stakeholders that the CRR remedy had not entirely prevented ITV from leveraging its market position in relation to the ITV family of digital channels. 6.6 Since 2003, the CRR Adjudicator has acted on [] formal disputes, with over [] of disputes being found in favour of the complainant 74. In the same period, the CRR Adjudicator has also dealt with around [] requests for informal guidance. Nonetheless, some stakeholders still consider that there are limits on the willingness of advertisers and media buyers to take cases to the CRR Adjudicator. The primary 74 As at April 2009, [] formal disputes have been lodged with the CRR Adjudicator, of these [] were found in favour of ITV, [] in favour of the complainant, and [] were withdrawn during the dispute process after settlement was reached independently. 2008/09 was the first year, since CRR was put in place, where no disputes were received by the CRR Adjudicator. 52

56 Impact of the CRR remedy reasons given for these concerns was the potential for the referral process to be daunting and protracted and the fear of the risk of reprisals from ITV. Contract negotiations and switching 6.7 There are some concerns about the way in which the CRR remedy might limit the extent to which negotiation and switching takes place in the sector. In response to the Issues Statement, a number of media buyers observed that the CRR remedy has influenced the way in which contracts, and the surrounding negotiations, are now conducted with broadcasters. In particular, media buyers stated that the existence of the CRR remedy has created a new currency for negotiation, with each sales house outside ITV focusing their sales efforts on winning a proportion of the amount of money which is expected to move out of ITV1 in line with the ratchet mechanism. Even for the ITV digital channels, media buyers told us that the starting point for negotiation was usually the proportion of spend coming out of ITV1 and how much of this would be placed with ITV s digital channels. 6.8 If media buyers incentives to switch are dampened by the existence of the remedy, then there may be no chance that the remedy will become obsolete as media buyers and ITV move away from CRR-protected contracts. As a result the CRR remedy will remain critical to media buyers for the foreseeable future. 6.9 Some media buyers also considered that the CRR remedy has increased the complexity of contract negotiations, with agreements becoming increasingly legalistic where every aspect of the deal is covered. While these more formalised agreements may have the advantage of certainty, it was also considered by some media buyers and advertisers that they reduce flexibility. Media buyers have also commented that the CRR remedy has changed the timing and nature of negotiations, shifting from a start date during the summer to as late as mid-november as broadcasters wait to see what revenue can be released from ITV1. Some media buyers and advertisers further noted that concentrating negotiations into the latest part of the year placed increased pressure on media buyers to reach a deal with ITV1 and therefore placed them in a more vulnerable negotiating position. However, it is worth noting that [] stagger their contract negotiations throughout the year, so it may be possible for media buyers to do so as well to relieve this pressure. Moreover it would be possible to sign contracts which last a number of years With the expansion of digital television, and the number of channels offered by broadcasters, contract negotiations have increasingly focussed around families of channels, rather individual channels. Some media buyers consider that ITV is able to leverage its position across its family of channels to maintain SOB in ITV1. For example, it has been argued that 75 : ITV had offered not to take back the value of impacts over-delivered on the ITV Digital channels in one year in exchange for an media buyer taking less than the maximum (as dictated by the CRR remedy) out of ITV1 in the following year. 75 The examples given where generally raised in responses to the OFT s Issues Statement in January This was not particularly reflected in stakeholders response to the OFT consultation, as these submissions tended to focus on the allegations of conditional selling (prohibited under the airtime sales rules), rather than other ways in which ITV might leverage its position. 53

57 Impact of the CRR remedy On the other hand, it was also suggested that ITV may have an incentive to undertrade 76 ITV2 to secure a stronger negotiating position in relation to the CRR ratchet. However, we note that [] commented that there were very few instances where any sales point has been undertraded. No evidence of undertrading was provided by stakeholders. ITV had included the CRR remedy considerations (i.e. how much spend the media buyer would take out of ITV1) in negotiations over sponsorship deals. However, no evidence of this behaviour was provided It is worth noting that the Airtime Sales Rules 77 prohibit the conditional selling of all channels. Although buyers can purchase a bundle of channels if they choose, ITV (or other broadcasters) are not allowed to require media buyers and advertisers to purchase a particular bundle of channels A number of media buyers have acknowledged that the existence of the CRR remedy has frozen the market at a point in time. One media buyer has noted that the CRR remedy essentially enshrines the status quo from 2003 for as long as it is in operation, potentially perpetuating an outdated trading model. It argues that in order to be protected by the CRR remedy, buyers must keep the structure of their trading the same as it was in their last contract. To depart from that structure (i.e. to change their channel profile, target audiences, trading parameters etc), according to media buyers, necessitates complete renegotiation a potentially protracted process. Another media buyer commented that the underlying principle to the ITV1 CRR contract is to preserve what you have and that the CRR remedy was, in that respect, a retrospective mechanism which does not take into account any change in demand for particular audiences. As a result the CRR option may represent the path of least resistance for the advertisers and media buyers. However, we note that there are some examples where ITV1 and a media buyer have renegotiated their protected contract to take into account a change in the media buyer s client base 78. Ofcom s views 6.13 Ofcom s view is that the arguments put forward by media buyers, as to why they have no bargaining power, could reflect the impact of the CRR remedy on commercial incentives to negotiate with ITV for advertising on ITV1. Although it is credible that media buyers possess countervailing buyer power, as suggested by the level of buyer-side concentration presented in Section 5, media buyers do not appear willing to exert their negotiating power. At present, while the current pattern of relationships and trading is maintained, media buyers and advertisers may have limited incentives to move significant levels of spend away from the contracts protected by the CRR remedy and so do not currently exert countervailing buyer power on ITV. Therefore, the CRR remedy may potentially be restricting the development of competition. 76 As discussed in paragraph 3.53, undertrading arises where the sales house is effectively undersold and more impacts were achieved for than agreed or expected, as a result the media buyer will have to receive fewer impacts in a future month. This build up of owed impacts, can be used as a bargaining tool for future negotiations. 77 The Airtime Sales Rules (2003) state that Conditional selling of all channels will continue to be prohibited under ex ante rules. However, bundling of channels will be permitted to the extent this does not breach Chapter II of the Competition Act For example, following the introduction of regulations on the food advertising in children s programming, ITV and media buyers successfully accommodated the necessary changes within their protected contracts. 54

58 Impact of the CRR remedy 6.14 The concern that has been expressed is that in order for advertisers to move greater levels of revenue from ITV1 than allowed by the ratchet mechanism, they would have to completely renegotiate contract terms with ITV1, thereby forgoing the right to apply the terms and conditions set out in their protected contract 79. Media buyers and advertisers may be concerned about losing the deal they obtained in 2003, to the extent that this protected contract represents a better deal in terms of discounts and other concessions 80. While any new contract must be offered under fair and reasonable terms, it is possible that the terms offered may be worse than would be achieved if the 2003 contract was rolled over In particular, if the media buyer is looking to remove a significant proportion of SOB from ITV1, this may result in lower discounts (but still remain within the definition of fair and reasonable). From the perspective of the media buyer this may be offset by better terms achieved on that SOB which has been removed from ITV1. On the other hand, if there is uncertainty about the deal achievable elsewhere, or about the terms ITV would offer if more money was moved away, then media buyers may be reluctant to forfeit their current level of protection under the CRR remedy. As a result, switching is likely to be constrained and the amount of negotiation with ITV1 is likely to be dampened as a result of the CRR remedy, i.e. limited to just that portion of revenue that media buyers can remove via the ratchet mechanism. We also note comments from stakeholders that the nature and timing of negotiations may have been influenced by the operation of the CRR remedy As a result, while changes in terms and conditions have been negotiated within protected contracts, few media buyers have moved away from their original CRR protected contract completely. Therefore, media buyers and advertisers may face a bias against exerting their countervailing buyer power and moving away from the CRR remedy and as a result it is unlikely that non-crr protected contracts will evolve whilst the CRR remedy exists. Hence, the CRR remedy is unlikely to be bypassed or fall into disuse without some form of intervention or change. The CRR remedy s impact on other broadcasters 6.17 ITV has submitted that, given the automated nature of the ratchet mechanism, other broadcasters benefit the more ITV1 s SOCI can be reduced. As a result, these broadcasters may be overly incentivised to launch new free-to-air channels that assist in reducing ITV1 SOCI. We have observed that while a number of new channels have launched in the last few years, this has begun to decline more recently so we would not expect this to have a significant effect on ITV s SOCI in the future. 79 Under CRR regulation in any year an advertiser or media buyer can: Reduce SOB in line with the ratchet and performance of SOCI, whilst maintaining the remainder of their contract terms; Take a holiday from CRR and move all SOB away from ITV1. Upon returning from this holiday, a media buyer/advertiser can either seek to negotiate a new contract (on fair and reasonable terms), or return to their previous protected contract; or Decide to negotiate a new contract under fair and reasonable terms. The media buyer/advertiser has the option of agreeing with ITV that this negotiated contract becomes their new protected contract. Alternatively, if the negotiated contract is not protected, then ITV continues to be obliged to offer the media buyer/advertiser its protected contract terms each year. 80 For instance, if the (absolute) volume of spend that a media buyer was contributing in 2003 has declined (e.g., it lost a large client), it may be expected to face a lower discount more commensurate with this lower level of spend (and therefore its relative importance to ITV1 s revenues) 55

59 Impact of the CRR remedy 6.18 Media buyers also commented that the CRR remedy provides broadcasters with the incentive to follow ITV s example, targeting larger audiences and developing new channels to maximise the number of impacts. However, since advertisers value large volumes of impacts, it seems likely that this incentive would exist even in the absence of the CRR remedy so Ofcom does not believe that this is a significant problem. The CRR remedy s impact on ITV s incentives to innovate 6.19 ITV has suggested that the way the CRR remedy is currently defined has discouraged investment in the way it delivers ITV1 content. Specifically, ITV claims it has no incentive to launch an ITV1HD (high definition) or an ITV1+1 service The CRR remedy only applies to Regional Channel 3 Services 81 and since ITV1HD and ITV1+1 services on DTT would require separate licences (which differ from Channel 3 licences) then these services, and the impacts achieved on them, would not be covered by the CRR remedy Where the content, including advertisements, shown on the different linear versions of ITV are identical, we would expect these new services to cannibalise impacts on ITV1. Under the CRR remedy this reduction in ITV1 s SOCI would lead to a corresponding fall in SOB as media buyers and advertisers withdraw revenue under the ARM. Therefore, ITV would face significant difficulties monetising the impacts delivered by an ITV1HD or ITV1+1 service, and could actually see an overall decline in its revenues as a result of launching these new services In assessing ITV s incentives to develop new services, we have also found that the CRR remedy does not strictly apply to the satellite and cable broadcasts of ITV1, since the ITV licensees operate these satellite and cable services under TLCS licences 82, rather that under the Digital Replacement Licences (DRLs) Since the CRR remedy came into effect it has always been treated as applying to all ITV1 services, including those delivered over cable and satellite platforms. Ofcom believes this is consistent with the CC s intention. Hence Ofcom believes it is appropriate to amend the undertakings to link them to the linear content provided by ITV1, regardless of the platform or method of delivery. As a result, it would be necessary to define any service which is a simulcast or identical time delayed version of the original ITV1 service (i.e. the version broadcast on analogue terrestrial TV and DTT) as falling within the scope of the CRR remedy A number of stakeholders commented on this proposition. Some broadcasters were opposed, noting that their own shares of SOCI and hence revenue will decline as a result of changes to the definition. In addition, one media buyer suggested that impacts delivered over time shifted or HD channel will be of a lower value. However, the vast majority of media buyers and advertisers, who actually buy the impacts, seemed supportive of the proposals to change the definition. 81 As defined by section 14(6) of the Broadcasting Act Only the regional licences held for the analogue terrestrial TV and digital terrestrial TV broadcasts of ITV1 fall within this definition. 82 A standard Television Licensable Content Service (TLCS) licence provides for satellite or cable transmission in analogue or digital form. 83 Licensing arrangements for the PSBs are discussed in more detail in Annex In practice if the ITV1 HD service is based on only one ITV1 region then we would propose that only impacts for that region would be counted for the purposes of calculations for the CRR remedy, consistent with the current treatment of ITV1 satellite and cable services. 56

60 Impact of the CRR remedy SOCI maximisation 6.25 ITV has raised concerns that the CRR remedy provides an incentive for it to maximise the share of commercial impacts on ITV1, in a way that is inconsistent with the demands (and interests) of viewers and advertisers. ITV considers that there are a number of components to the way in which the CRR remedy leads to inappropriate SOCI maximisation: Absolute volume issues; Changes to ITV s revenue maximisation function; Brand building issues; and Risk Aversion. Absolute volume issues: Daytime versus peak investment 6.26 ITV claims that the CRR remedy simply rewards the delivery of impacts in terms of absolute scale indiscriminately. As a result, ITV has the incentive to invest where it is most likely to get a higher volume of impacts that will translate into a larger increase in SOCI. ITV argues that since the implementation of the CRR remedy, pound for pound, it had a greater incentive at the margin to invest in daytime programming rather than peak time programming (or indeed programming elsewhere), to maximise the number of commercial impacts it achieves. This incentive, ITV says, has arisen for two main reasons: Peak time programming is relatively more expensive to produce than daytime programming and thus requires a higher level of investment to achieve incremental viewers. Peak time is generally a more competitive time in terms of programming making it harder to attract incremental viewers Since 2003, ITV has argued that its investment in daytime programming has increased by [] while, at the same time, ITV s investment in programming outside daytime has fallen by []. In terms of ITV s delivery of SOCI, while ITV1 s total volume of impacts increased marginally between 2006 and 2007, this was primarily driven by growing impacts in daytime, with impacts in peak time falling ITV has submitted that, while advertisers value scale and the delivery of higher numbers of impacts rather than lower numbers of impacts, advertisers also want those impacts to be delivered where they (generally) have greatest demand i.e. in peak. Therefore, the fact that the CRR remedy has encouraged ITV to increase expenditure on daytime programming demonstrates that ITV s investment incentives are inconsistent with the demands of its advertisers who are looking to achieve impacts in peak time to deliver an audience profile that matches their target audience. ITV stated that prior to the CRR remedy this was not the case, with ITV seeking to maximise its return by undertaking investment where advertisers were most likely to reward that investment. 85 ITV carried out a similar exercise for all of its traded audiences. For each traded audience where ITV1 s volume of impacts has increased, ITV submitted this had been due to an increase in the volume of daytime impacts at the expense of peak time impacts. 57

61 Impact of the CRR remedy Changes to ITV s revenue maximisation function 6.29 ITV considers that pre-crr while it naturally sought to maximise its ratings and share of commercial impacts, this was not the sole determinant of ITV1 s commercial position under the annual deal round. Rather, negotiations considered a broader range of factors, with most advertisers focussed on the extent to which ITV could deliver the largest number of impacts that would deliver higher reach and frequency within the subset of demographics relevant to that particular advertiser ITV has submitted that since the adoption of the CRR remedy, for the majority of advertisers, the SOCI performance of ITV1 became the sole determinant of the level of their SOB commitment to ITV1. The ratchet mechanism, according to ITV, effectively ignores the delivery of reach/frequency and the targeting of specific demographics and therefore does not factor in these additional relationships that have an associated value for advertisers Consequently, ITV considers that this has led to a shift in its commissioning and scheduling incentives. Prior to the CRR remedy ITV may have chosen to commission and/or schedule a programme even if it was not SOCI maximising if it would be valued highly by viewers and advertisers. For example, ITV may have chosen to invest in programming attracting new viewers to ITV1 and so extending reach, or programming targeted at a demographic valued by certain advertisers, but potentially not delivered effectively elsewhere in the ITV1 schedule. ITV argued that under the CRR remedy it has no incentive to invest in such programming, despite the fact that it is in the best interests of advertisers (and viewers). This view was echoed by some media buyers, who suggested that the CRR remedy encourages ITV to focus on delivering high audience share, thus potentially discouraging innovation and experimentation in programming. On the other hand, there is evidence that ITV has invested in niche programming, for example the recent Lost in Austen series on ITV1 earned critical acclaim, although in terms of number of viewers it performed below normal for that particular evening slot 86. Risk aversion 6.32 The CRR remedy gives advertisers the right to translate automatically a fall in ITV1 s SOCI into a reduced SOB commitment to ITV1 the following year. Under the CRR remedy, ITV considers that it no longer has the opportunity to sell the benefits of its future schedule and new programming, as it may have done in the past. Instead, it is now incentivised purely to deliver with as much certainty as possible large volumes of impacts. ITV argues that even if advertisers were to believe that this loss of SOCI was an aberration and would not be repeated in the following year, a loss of SOCI still automatically translates into a guaranteed loss of SOB ITV submitted that this provides it with a strong incentive to be risk averse when commissioning and scheduling programmes, with a tendency towards a narrower, less ambitious schedule, with more returning series and extended runs. ITV suggested a number of ways this might influence its programming, including: A limited incentive to be innovative in regards to big event entertainment programming as this type of programming has the highest opportunity cost associated with failure; 86 The Guardian, Pride before advertising fall, 6 October

62 Impact of the CRR remedy An increase in the frequency of broadcast of programming with guaranteed high ratings (such as soaps) despite the fact that this has in some cases been detrimental to the programming brand itself; and Reduction in the amount of time that ITV1 can devote to testing new programming. ITV states that pre-crr ITV was able to allow a programme time to bed in, however, this is no longer feasible as the CRR remedy provides the incentive to remove a programme if it does not deliver volume. Brand building issues 6.34 ITV stated that, prior to the CRR remedy, it frequently broadcast and commissioned programming that was costly, but of particularly high quality (e.g. period dramas) or event status programming, which was designed to deliver a positive association (or halo effect ) over and above its ratings performance. This kind of investment was viewed - by both ITV and its customers - as important for brand building purposes, despite the fact that it may not deliver particularly high audiences However, as noted above, ITV considered that the CRR remedy has significantly increased the opportunity cost of such programming as broadcasting this kind of brand building programming when other programming is available is not consistent with a SOCI maximising (and therefore revenue maximising) strategy. As a result, ITV argues that this type of programming is now less likely to be commissioned and broadcast than pre-crr ITV also pointed to the example of Coronation Street, where it had significantly increased in the number of episodes per week of these soaps being shown in order to maximise SOCI. However, ITV considered that this increase in the number of broadcasts has in fact damaged the programme brand, and has reduced advertiser interest in having their impacts delivered in these, previously coveted, programmes. The long term effects 6.37 ITV submitted that focussing on delivering the maximum number of impacts, at the expense of reach, targeted demographics and brand maintenance, damages the ITV product as less and less new viewers are attracted to the channel. Over the medium term, ITV argued that pursuing a SOCI maximisation strategy will leave it unable to deliver what advertisers actually demand: access to a large number of diverse unique viewers within their relevant target audience. ITV considered that the long-term success of ITV1 is dependent on delivering the maximum amount of impacts but through a diverse range of quality programming including in peak time. However, it also noted that departing from a SOCI maximisation strategy will result in ITV automatically losing more SOB at the end of the year. This, ITV submitted, financially penalises it for delivering what is in the best interests of ITV, viewers and advertisers ITV further submitted that the CRR remedy and the way it incentivises SOCI maximisation on ITV1 has an impact on the long term growth and development of ITV s overall family of channels. In particular, there is a reduced incentive to invest in the family of ITV channels as this ultimately leads to a reduction in ITV1 SOCI, both through the cannibalisation of ITV1 impacts and, where a new channel is established, by an increase in total volume of impacts available. 59

63 Impact of the CRR remedy Ofcom s view and evidence from other stakeholders 6.39 The evidence on the significance of this distortion is mixed. Some media buyers have raised concerns that while the CRR remedy encourages ITV to produce programmes and schedules that will deliver high audience levels, it may also discourage innovation and experimentation. However, several others consider that linking investment into ITV1 to programme performance was a necessary and entirely acceptable approach given the features of the broadcast sector Very few media buyers raised concerns about the effect of the CRR remedy on the quality of ITV s programming since 2003 or an increased incentive for ITV to invest in off-peak programming, although they noted, in response to the consultation, that they place significant value on the quality of ITV1 s programming and the ITV1 brand One media buyer noted that the CRR remedy should be an incentive for ITV to produce top calibre entertainment that maintained their high share of impacts, thereby minimising the effect of the CRR remedy. Another media buyer observed that as ITV is incentivised by the CRR remedy to deliver maximum audience at all times, it had moved children s programming to weekends and, similarly in peak, the Sunday soap segment was moved to weekdays. They noted that this time was filled with Dancing on Ice and resulted in significant increases in audience levels Despite the concerns raised by ITV, ITV1 still achieves significantly greater reach than the other commercial broadcasters, and commands a price premium as a result (as reflected in its []). ITV1 also continues to account for a significant proportion of all peak time impacts ([]). This indicates that the value of ITV1 to advertisers remains strong, and that any changes in ITV s investment and programming incentives as a result of the CRR remedy may have had a limited impact While there are some qualitative aspects of ITV s (and other broadcasters ) offer that may not be fully measured by SOCI, it is clear that advertisers investment decisions are still primarily driven by the level of impacts a channel generates. This demand for impacts would be expected to influence heavily the investment incentives of all broadcasters, regardless of whether the CRR remedy existed or not. It is therefore difficult to distinguish the extent to which the CRR remedy may or may not enhance ITV s investment incentives over and above the existing market incentives. ITV has not provided any evidence to demonstrate that impact of the CRR remedy on its incentive to SOCI maximise is significantly greater than would be the case without CRR In addition, ITV has not provided any evidence to substantiate its claims that it is risk averse and its scheduling would be different in a world without the CRR remedy. In particular: ITV still continues to invest in significant event programming (for example, X Factor, Britain s got Talent, the Rugby World Cup and the UEFA Champions League); ITV did not provide any substantive evidence to demonstrate its assertion that the duration for programmes to bed down on ITV1 has changed significantly, nor that it is any different to that of other channels, following the introduction of the CRR remedy; ITV submit that customers want programming that delivers the brand, but have not provided any market research or other evidence supporting this point. In 60

64 Impact of the CRR remedy addition, it is not clear that ITV has ceased engaging in this type of programming, e.g. ITV1 still provides period drama Furthermore, the incentives described by ITV would appear to be at their strongest where a short term view is taken. Over the longer term, even in the presence of the CRR remedy, ITV should have an overriding incentive to improve reach through programming and invest in brand building as this is key to increasing and retaining viewers, and therefore impacts On balance, while it appears that the CRR remedy may provide some additional incentive for ITV to maximise SOCI, there is limited evidence to demonstrate that any distortions created by the CRR remedy in this regard are significant. Many of the incentives identified by ITV simply reflect existing commercial pressures. In particular the trade-off between short term revenue gains from maximising SOCI and long term gains from investing in a schedule and developing a brand, is faced by all broadcasters on an ongoing basis. As a result we do not believe that the CRR remedy imposes any significant adverse effects in this respect. Contract rigidities 6.47 The CRR remedy obliges ITV1 to fulfil the terms of historic contracts, some of which were negotiated as far back as ITV considers that this constrains ITV1 from reacting to changes in demand, which might better deliver what advertisers need, and over time this has led to the situation where ITV is unable to manage, optimise and monetise its inventory appropriately in light of demand changes ITV has pointed to a number of changes in the market which it believes have contributed to the impact of the rigidities created by the CRR remedy being far greater than was anticipated at the time of the merger: The CRR remedy was not expected to have endured for such an extended period of time and was not intended to be a long term remedy. The level and speed of change in the broadcast market. In particular, the successful launch of Freeview has fundamentally altered both the absolute supply of impacts as well as the ability to bring those impacts to market. In addition, digital switchover and the resultant change in viewer take-up of digital services was not fully considered at the time of the CC s Report. The associated changes in advertiser behaviour resulting from increased digital penetration. ITV states that there has been a shift in advertiser demand to younger, more upmarket audiences as a result of an increased ability to target particular demographics in larger numbers more accurately. ITV had anticipated a greater amount of negotiations occurring year on year which would allow adjustments to its inventory to better meet demand. ITV argued that since the CRR remedy had been put in place many media buyers had not sought to renegotiate their contracts at all, or had made only minor changes ITV identified two key areas in which contract rigidities affect ITV s business: the generation of deal debt; and the inability to manage, optimise and monetise its inventory. 61

65 Impact of the CRR remedy Deal debt 6.50 Deal debt arises when a large amount of money is booked against a particular audience and ITV is unable to deliver enough of that audience to meet its contractual commitments. ITV submitted that, pre-crr, it would have estimated how it anticipated its schedule performing over the coming year. It would then negotiate with advertisers to allocate that inventory, based on the impacts that it estimated it could deliver according to likely advertiser demand. In effect, annually the negotiations would ensure an appropriate recalibration of the supply of impacts with the demand for impacts In summer 2008 ITV provided evidence to demonstrate that since the CRR remedy was introduced there have been significant changes in overall advertiser demand for ITV1 for different demographics, often varying year on year. In particular, between 2002 and 2007 demand (in terms of revenue booked against demographics) for ITV1 changed substantially for 4 of its 6 major traded audiences: The revenue booked against Housewives with children increased by [] The revenue booked against Adults increased by [] The revenue booked against Adults fell by [] The revenue booked against ABC1 Men fell by [] 6.52 ITV also noted that, while these overall shifts are large, they also mask significant shifts year on year. As can be seen from the data provided, from 2004 to 2005 the revenue booked against Adults fell by [], yet the following year rose again by []. Indeed, even for those audiences where the overall change in revenue booked across the period appears to have been relatively stable (Housewives [] ABC1 Adults []) changes year on year have been significant: in 2005 revenues booked against ABC1 Adults increased by [], yet in 2006 they fell by [], increasing again by [] in For Housewives: revenues booked fell by [] in 2005, rose by [] in 2006 and fell again by [] in Several media buyers also indicated that they have seen changes in the profile of their own demand, however, it is not clear whether this is a reflection of changes in their client profile, or wider industry demand Over the same period many contracts were only marginally amended through negotiations 87. Therefore, significant amounts of deal debt were generated due to changes in demand with ITV having limited opportunities to negotiate changes to contracts, given the protection afforded to media buyers via the CRR protected contacts. ITV stated that, at the time that the CRR remedy was introduced, neither ITV or the regulatory authorities, foresaw the extensive ability of media buyers with agency deals to manage demand changes under their umbrella share deal without any need to discuss those changes with ITV 88. As a result, many media buyers and large advertisers have been able to accommodate changes in their pattern of spend on ITV1 without needing to make major changes to their contracts. ITV argued that 87 ITV submitted that on average across the CRR period, [] contracts were not renegotiated each year, with over [] of contracts still unchanged since pre-merger (2002 and 2003). 88 ITV submitted that these difficulties have been exacerbated by the rapid consolidation of agencies over the same time period. As agencies have become larger, they now have a greater scope to manage changes of demand between advertisers within their portfolio without any need to change the core underlying terms. 62

66 Impact of the CRR remedy this has left ITV contractually obliged to supply an increasing inventory for certain demographics, despite the fact that it is not necessarily able to do so During 2005 and 2006 deal debt became a significant issue for ITV. ITV indicated that during this period it had made attempts to rectify the problem. However, it argued that for the most part media buyers were unwilling to resolve the debt issue due to the fact that holding deal debt is a useful tool for media buyers since it effectively operates as additional discount and is therefore useful to media buyers in attracting new advertising clients. In 2007, ITV s deal debt issues eased significantly due to a number of scheduling events which led to a particularly optimal schedule. In particular, the European Championships, Rugby World Cup and Formula 1 all had significantly larger audiences than was anticipated at the time of scheduling. However we note that whilst this is not currently a problem for ITV, it could cause ITV difficulties in the future []. 89 Inability to manage, optimise and monetise its inventory 6.56 ITV argued that the CRR remedy inhibits its ability to optimise its inventory in light of demand changes as it must still continue to deliver against contractual commitments made in 2002/2003. ITV stated that as this inventory is effectively locked up in protected contracts it continues to be obliged to meet these protected contractual commitments, despite significant shifts in demand for particular demographics In addition, ITV considers the more significant problem is the uncertainty that the CRR remedy has introduced in relation to any negotiations that do take place each year. ITV considered that it is unable to optimise its inventory under the CRR remedy even if all contracts were renegotiated. When a new contract is negotiated, new/renegotiated contracts do not have to become a media buyer/advertiser s new protected contract going forward. During the course of negotiation, and after the new contract is agreed, a media buyer/advertiser therefore still retains the ability to fall back to its historic protected contract. ITV submitted that at any point in time across all its negotiations ITV must be in a position to deliver both the terms of any newly negotiated deal and meet the possibility that any or all of these negotiations may result in the advertiser/media buyer falling back on taking its CRR offer. According to ITV, trading under newly negotiated contracts, whilst a historic protected contract from a preceding year continues to exist, accounts for approximately [] ITV argued that in practice, this means that even if 100% of contracts were being negotiated annually ITV would still never be able to fully optimise its inventory since it can never use its entire inventory during the negotiations, while the option of falling back to a protected contract exists. Ofcom s view and evidence from other stakeholders 6.59 There is limited evidence available to demonstrate whether or not there has been a consistent and significant industry wide shift in demand for particular demographics. Views amongst individual media buyers varied. ITV provided data to demonstrate that revenue booked against certain demographics has changed substantially for 4 of its 6 major traded audiences. However, it is not clear whether these shifts reflect a wider industry trend or changes in ITV s ability to deliver those impacts, relative to other broadcasters. For example, a fall in revenue for a particular demographic 89 [] 63

67 Impact of the CRR remedy group might actually reflect a decrease in ITV s performance in terms of delivering those impacts, rather than a shift in demand One media buyer observed that trading demographics fluctuate yearly depending on client communication objectives, but as a general rule advertisers appear to be increasingly looking to trade against more specific target audiences in order to maximise their target efficiencies. They considered that since 2003, there had been a significant increase in the volume of spend against audiences such as Adults, Men and a decline in the number of campaigns which are traded against an All Adults audience. However we note that we cannot draw any firm conclusions from this since we have been presented with mixed evidence; for example, in March 2008 [] presented data which suggests that demand for different demographic groups has not changed dramatically Some media buyers also noted that where their individual demands had changed, renegotiations have been protracted, due to the inflexibility of the CRR remedy to accommodate such changes. However, this may also be a function of media buyers reluctance to negotiate outside of the CRR remedy Given the structure and incentives of the CRR remedy we would expect that the CRR remedy has had an impact on ITV s negotiating flexibility to a certain extent this was the point of the remedy. However, there is limited evidence to show that the CRR remedy s impact is more significant than intended in this regard. In the past, contracts have been successfully renegotiated to reflect changes in trading conditions, for example, the new regulations on HFSS 90 advertising in children s programs. ITV indicated that approximately [] of contracts were not renegotiated each year, however, this also means that around [] are renegotiated in some form. Although, as discussed earlier, there may still be a reduced incentive for media buyers to renegotiate completely new contracts for ITV1 airtime While ITV s deal debt has recently reduced in due to improved viewing figures (and may therefore, in part, be a function of the generally volatility in viewing), we note that this problem could emerge again in the future. Conclusions 6.64 This section has identified a number of possible distortions arising from the CRR remedy. We have outlined stakeholder views and presented Ofcom s view on all of the issues raised Some of the concerns raised by ITV may have some validity, particularly in relation to the uncertainty surrounding its ability to optimise and negotiate contracts. However, they have provided limited evidence to demonstrate that any distortions created by the CRR remedy are significant More concerning, are potential distortions that impact on the wider market. Although it is credible that media buyers possess countervailing buyer power, as suggested by the level of buyer-side concentration, media buyers do not appear willing to exert their negotiating power. Ofcom believes that the CRR remedy has affected the way in which contracts are negotiated and may have reduced incentives to move away from existing protected contracts (for instance, by moving more money out of ITV1 than is 90 HFSS refers to High in Fat, Salt or Sugar products. Scheduling rules prohibit HFSS advertisements appearing: in and around children s programmes; or in and around programmes for which the child audience is disproportionately high 64

68 Impact of the CRR remedy provided for under the ratchet). Therefore, it may be the case that the CRR remedy itself is affecting media buyers willingness, or ability, to exert countervailing buyer power. This is concerning because, if material, the CRR remedy may represent a potential barrier to switching and its existence means that we would expect reliance on the CRR remedy to persist over time, rather than becoming increasingly obsolete as media buyers and advertisers negotiate away from the CRR protection We also note ITV concerns regarding deal debt and the possibility that this issue may arise again in the future Furthermore, we consider that the CRR remedy has adverse investment incentives for ITV and particularly on ITV s incentives to launch an ITV1HD or an ITV+1 service. 65

69 Issues outside the scope of the CRR review Section 7 7 Issues outside the scope of the CRR review Introduction 7.1 During the course of the CRR review, a number of stakeholders raised potential competition issues that do not fall within the legal scope of the CRR review. We indicated at the beginning of the review that should such issues be raised, the OFT or Ofcom would consider whether it would be appropriate to use alternative legal powers to address the concerns. This section reviews the comments made and presents Ofcom s view on the appropriateness of commencing a market investigation at this point. Calls for a Market Investigation Reference (MIR) 7.2 During the review and following publication of the OFT s consultation there have been a number of calls from stakeholders to suspend the CRR review and for Ofcom to undertake a market investigation with a view to making a reference to the CC, although a number of stakeholders have provided no basis for their request. Specifically, the issues raised include: The ITV digital channels and conditional selling - ITV s ability to leverage its position across its portfolio of channels in the sale of airtime; Channel 4 s position in the sale of TV advertising airtime in terms of its negotiating strength and its price premium; Concerns with some aspects of the underlying trading mechanism, including agency deals, SOB arrangements and the SAP mechanism; and ITV s dealings with the non-consolidated licensees i.e. stv, UTV and Channel. The ITV digital family and conditional selling 7.3 Several advertisers and media buyers have noted the increasing importance of the ITV digital channels 91. Most have linked this to the growth in these channels audience share and price premia, with some observing that the channels had benefited from factors such as cross promotion from ITV Some media buyers and broadcasters felt that although the CRR remedy had worked in terms of curtailing ITV1 s conduct in isolation, it had not prevented the ITV Sales House from leveraging a disproportionate level of investment into its portfolio of 91 Advertisers include []. Other stakeholders making similar comments in response to the OFT s consultation include []. Some media buyers and broadcasters made similar comments during the course of the review but did not particularly raise the need for a market investigation in response to the OFT consultation. 66

70 Issues outside the scope of the CRR review channels. Consequently, a number of stakeholders have suggested that the scope of the CRR remedy should be extended to include ITV s digital channels Linked to this, a number of stakeholders have also raised concerns about conditional selling by ITV, and the potential to leverage its market position on ITV1 into the sale of the ITV digital channels. Overall, stakeholders consider ITV s digital channels to be substitutable with other channels, and therefore in competition with all other broadcasters for the potential additional budget released by the CRR ratchet mechanisms. However, concerns have been expressed that the ITV is able to leverage its strength on ITV1 to retain a greater share of the money released by the ratchet mechanism with its digital channels than is warranted by their share of audience. It was submitted that this was the reason why the ITV digital channels have a higher price premium than comparable digital channels. For instance, [] has argued that the presence of high quality programmes does not explain why ITV s digital channels have been able to grow their share of NAR much faster than their share of audience, noting a contrast to other comparable digital channels 93. [] told us that between 2003 and 2007, ITV s digital channels increased their share of audience by [], and share of NAR []. As a result, [] estimated the power ratio of those channels had increased []. 7.6 Some stakeholders have suggested that Channel 4 bundles its family of channels in order to attract 50% of monies potentially released by the CRR formula. One stakeholder has claimed that it is not feasible to approach Channel 4 to negotiate an exclusive Channel 4 only deal (i.e. without the wider Channel 4 bundle of channels) On the substance of issues raised, Ofcom believes that any concerns about the market position of ITV1 are best addressed through the ongoing CRR review. We do not think the wider market position of ITV s digital family is a competition concern in its own right since stakeholders have stated that the digital family is substitutable and the low market shares of ITV 2, 3 and 4 are consistent with this. Any complaints about conditional selling can be addressed by the Airtime Sales Rules, which prohibit conditional selling Ofcom has the option to enforce these rules should evidence of a breach be forthcoming. However, no stakeholders have provided any evidence of conditional selling. Furthermore, while the issue has been raised with the CRR Adjudicator, no media buyers or advertisers have approached Ofcom (formally or informally), and we have not received any complaints regarding conditional selling. In addition, Ofcom has a duty to keep the Airtime Sales Rules under review and if there is a wider concern around conditional selling Ofcom could seek to address this through such a review. 92 In particular, [] recommends that ITV s digital channels be sold by GMTV at arms length, to remove entirely the potential for conditional selling. 93 In addition [] have suggested that the speed at which ITV had been able to turn the audience growth in its digital channels swiftly into revenue, compared to the more gradual year-on-year relationship for the rest of the market (with the exception of Channel 4), was prima facie evidence of conditional selling. 94 In this respect, [] if Channel 4 was able to exploit market power during the CRR period with a share of NAR of only around [], that arguably suggested that ITV would also have been be able to exercise considerable market power if CRR had been removed (i.e. also in respect of ITV1, whereas at the moment ITV s strong bargaining position had been largely limited to its digital channels)

71 Issues outside the scope of the CRR review Channel 4 s market position 7.9 During the course of the review some media buyers and advertisers called for the scope of the review to be extended to consider the market position of other broadcasters, notably Channel It was argued that Channel 4 had particularly benefited as a result of the CRR remedy and that Channel 4, alongside ITV, holds market power or is dominant. That said, no stakeholders cited this as a reason to launch a market investigation in response to the OFT consultation During the course of the review several advertisers and media buyers suggested that the CRR remedy has a knock-on effect on negotiations because of the transparency the ARM brings to the market. The fact that the impact of the ARM can be readily anticipated means that the other sales houses have a good idea of how much money could be released from ITV1 and focus negotiations on this. Some stakeholders have argued that Channel 4 and ITV s digital channels have been the main beneficiaries 97 of this effect As a result several broadcasters and media buyers believe that Channel 4 is able to negotiate aggressively on the basis of the revenues released from ITV1 each year. In addition, although the CRR remedy has, to some extent, constrained ITV1 s ability to exploit its market position, Channel 4 s ability to command a premium in the market has been improved relative to ITV 98 because of the CRR remedy [] suggested that this distortion results from a number of unusual features peculiar to the TV advertising market (i.e. beyond the scope of the CRR review). In particular, they noted that the ubiquitous SOB mechanism effectively makes the annual deal season a zero-sum game (at least in relation to major players), whereby a media buyer could only commit an additional 1% of its advertising spending to one sales house by taking it away from another Moreover, some media buyers have noted that there are substitutes to Channel 4 and that many advertisers have an attachment to the channel which does not reflect its real ability to deliver impacts. We have not been presented with evidence that Channel 4 is in a position of market power. [] Trading mechanism 7.14 During the course of the review some stakeholders suggested there may be problems with the underlying trading model but very few documented their concerns or evidence in response to the consultation. Where the trading model was highlighted as a cause for concern, it was suggested that a market investigation should be launched to consider a wider set of issues such as trading, media buyer remuneration; auditors role and pricing mechanisms, although there was not widespread agreement about the nature of problems identified or possible solutions Only a small number of stakeholders also referred to a lack of transparency and potential inefficiencies associated with the trading model in response to the consultation, notably [] and []. For example [] noted that the special features of the advertising market warrant an investigation; poor transparency of pricing as a 96 Including []. 97 This view is shared by []. 98 [] reported that since 2003, Channel 4 achieved remarkable results, in particular: (i) by increasing its Channel 4 premium []; and (ii) as its digital channels increased their share of audience by [] and their share of NAR by []. 68

72 Issues outside the scope of the CRR review result of SOB and umbrella deals dampen incentives for advertisers and media buyers to move away from ITV and inhibits dynamism Ofcom believes that the trading mechanism does display some odd features which may, in particular lead to poor transparency of prices. However, we also note that the trading model has evolved over time and is widely used and understood by stakeholders. We believe we would need to have a clear idea about the nature of the problem, the detriment to consumers and a clear sense that it would be possible to address the problems identified in order to commence a market investigation (either focussed on the trading mechanism or the sector more widely). [] 7.17 [] 7.18 [] Ofcom s view 7.19 There are a number of reasons why a market investigation/mir may not be appropriate at this point in time: Concerns about the wider market position of ITV, and complaints about conditional selling in particular, may be addressed by the Airtime Sales Rules. The presence of the CRR remedy itself has a major effect on the operation of the market and it is not clear which issues arise as a result of the CRR remedy or as a result of underlying market issues. For example we have noted that Channel 4 and Five s market position may have been influenced by the operation of the CRR ratchet. In addition the willingness of media buyers to exert countervailing buyer power may be limited due to the operation of the CRR remedy. The same issues have not been consistently raised and no strong evidence of consumer detriment has been presented (i.e. we have no clear understanding of the problem or likely remedy). The TV broadcasting sector is currently facing a period of potential upheaval. There has been a severe reduction in advertising expenditure given the current economic climate and this is expected to continue for at least this calendar year. In addition, the ongoing Digital Britain review increases uncertainty about the TV sector and TV advertising. Conducting a market investigation/mir in this environment would present a number of difficulties and might be considered premature Should Ofcom receive any reasoned requests from stakeholders for a MIR to consider other competition concerns these will be given due consideration. Ofcom would expect such requests to address the factors identified in the OFT s guidance on market investigation references (with particular reference to the competitive/consumer harm and possible remedies) which would form an essential 69

73 Issues outside the scope of the CRR review part of any assessment 99. Any decision to open an investigation would also be based on administrative priorities Ofcom will closely monitor any stakeholder concerns and market developments, particularly in the light of any changes resulting from the CRR review and in light of other changes in market structure. We recognise that it may be necessary to commence a market investigation of the TV advertising sector in due course. Indeed, the possibility of re-regulation associated with such a market investigation provides an important safeguard if the CRR remedy is eased or removed, though we also recognise that this threat is not always sufficient to discipline behaviour in a market. 99 Market investigation References - Guidance about making reference under Part 4 of the Enterprise Act (OFT 511, March 2006) 70

74 Recommendations Section 8 8 Recommendations Introduction 8.1 This section presents Ofcom s conclusions about whether there has been a relevant change of circumstances such that it is appropriate to remove or vary the CRR remedy. It provides a brief overview of the analysis we have conducted, drawing together our key findings on the changes in ITV s market position since 2003 and whether market developments have had any impact on the ability of media buyers and broadcasters to constrain pricing on ITV1. We also consider the implications of possible distortions created by the CRR remedy. 8.2 As noted in paragraph 2.21, the CC did not attempt to explicitly quantify the merger effects in Conclusions on the adverse effects associated with the merger were based on a number of factors which suggested that advertisers and media buyers could not switch away from ITV1. As a result we have considered a wide range of indicators in order to assess whether the market position of ITV1 and/or ITV has changed sufficiently such that the adverse effects to the public interest identified by the CC no longer remain. 8.3 The analysis indicates that the assessment is finely balanced and an element of judgement is required in reaching a recommendation about the extent to which the merger effects still exist and the ongoing need to retain CRR protection. 8.4 Given the decline in ITV s market position since the merger in 2003, Ofcom does not believe that retaining the undertakings in their current form is appropriate. Specifically, Ofcom believes there is a strong case for easing the burden of CRR regulation on ITV1 where market forces can provide a credible constraint on ITV s pricing. However, sufficient concerns may remain such that the CC should consider implementing safeguards (or alternatives to the CRR remedy) that continue to protect advertisers dependent on ITV1 for the quick delivery of mass audiences. 8.5 In addition, we note the need for ongoing monitoring of the advertising sector to understand the impact of amending the CRR remedy, recognising that it may be necessary to commence a market investigation into the advertising sector sometime in the future. Indeed, the possibility of re-regulation associated with such a market investigation provides an important safeguard if the CRR remedy is eased or removed, though we also recognise that this threat is not always sufficient to discipline behaviour in a market. Substitutability 8.6 A key feature of our analysis has been assessing the complex question of whether media buyers and advertisers have sufficient bargaining strength to constrain pricing on ITV1. The concern following the merger was that because media buyers and advertisers relied on ITV1 impacts to meet campaign objectives, they would be relatively insensitive to price changes and ITV would be able to profitably increase prices on ITV1. In particular, the CC found that it was relatively difficult for media buyers and advertisers to substitute spend away from ITV1 given its unique features, including the ability to deliver fast mass audiences and light viewers, and the superior quality of ITV impacts. As a result, much of our review has concentrated on assessing how the substitutability of ITV1 s impacts has changed since

75 Recommendations 8.7 If it is now possible for advertisers or media buyers to move advertising spend from ITV to alternative non-itv channels without compromising their campaign objectives it may be possible for them to limit ITV s ability to raise prices on ITV1. Moreover, where a sufficient amount of revenue can be moved away from ITV, such that an attempt to increase prices on ITV1 would be rendered unprofitable, the CRR remedy may no longer be required. That is, competition from other broadcasters alone may be sufficient to constrain ITV1 prices. 8.8 As noted in Section 5, in practice, media buyers and advertisers do not have to actually switch spend to constrain ITV s behaviour. Rather, they only need to be able to credibly threaten to switch sufficient revenue away from ITV. Furthermore, only a proportion of spend sufficient to leave ITV worse off than before its attempt to raise prices needs to be switched. 8.9 The evidence suggests that there is a proportion of advertising which is not reliant on ITV1 and for which it is possible to achieve campaign objectives without using ITV1 or the ITV family of channels. Moreover, this group is likely to have grown since However it seems that some campaigns or parts of campaigns remain reliant on ITV1 and would find it difficult to move away from ITV1 without compromising their campaign objectives, particularly if these relate to the delivery of fast, mass audiences. If the expenditure associated with the former group can be switched, a media buyer or advertiser may be able to impose a pricing constraint on ITV despite their ongoing need to use some ITV1 airtime to deliver some of their impacts or campaigns We have, therefore focussed on assessing whether that spend which is substitutable could move away from ITV1 if ITV raised prices We have also considered whether, even if individual campaign goals could be achieved without ITV1, advertisers and media buyers face barriers that would prevent this spend being moved from ITV to other broadcasters. While some of the barriers identified may be plausible, little or no evidence was provided to support their existence, or establish how significant the barriers might be Finally, we considered whether it was possible to estimate the amount of advertising that is available to switch (or can be credibly threaten to switch) away from ITV1. While there was limited evidence to estimate the actual size of this group, overall it appears that it may only be necessary for a small proportion of spend to switch away from ITV1 to render any attempt to increase prices unprofitable. ITV s market position 8.13 We have examined a number of indicators of competition - market shares, pricing metrics, profitability, barriers to entry and expansion, buyer power and substitutability. Overall they support the proposition that ITV s market position has weakened since Whilst some indicators are difficult to interpret (given the influence of the CRR remedy itself) other indicators such as buyer power, SOCI and substitutability indicate that ITV s market position may have decreased. The table below summarises in general terms - the direction of change in the major indicators of ITV s market power since

76 Recommendations Category Indicator of market strength Change in merger effect since 2003 Market shares SOCI - declined since 2003 Pricing Barriers to entry/expansion Countervailing buyer power Substitutability Shares of NAR - declined since difficult to interpret the decline given the interdependence with the CRR remedy. Difficult to assess the change, as influenced by the CRR remedy Barriers - no significant change for sales houses since 2003; - decline in barriers to expansion for channels since wouldn t expect significant impact on development of competition Buyer concentration - concentration increased since Homogenous impacts: ability to achieve coverage/frequency without ITV - more campaign types are now able to switch away from ITV than in 2003.? Speed of delivery of mass audience - Decline in size of audiences delivered since Little change in ITV s relative strength, other than for younger demographic groups. Better quality impacts on ITV1 Greater sales uplift on ITV1 than other channels o Strength of impact if any unclear. o Little evidence about change since Overspill effect on ITV1 o Unclear about value to media buyers/advertisers. o No evidence about change since Ad recall and engagement o ITV1 s strength in mass audience programming has declined since o However, strength of effect not clear. o No evidence about change since 2003.?? 73

77 Recommendations - Light viewers o proportion of light viewer impacts delivered by ITV1 has reduced - Wastage and excessive frequency o Strength of impact if any unclear. o No evidence about change since Regional impacts Barriers to switching - unclear how substantial these are or whether they have changed since no evidence that any are absolute barriers to switching? =? Size of group able to switch away from ITV1 has increased since The analysis undertaken shows that substitutability appears to have improved since In addition there are market indicators which support the conclusion that ITV1 s market position is declining. As a result, we are confident that ITV s strength has fallen. Hence, there is a strong case to suggest that there have been sufficient changes in ITV market position which means that the status quo is no longer appropriate. Price discrimination 8.16 We have concluded that ITV1 is still particularly good at delivering mass audiences over a short period of time because it consistently broadcasts programmes which appeal to large audiences. Its strength in delivery of mass audience programmes relative to other broadcasters has diminished only slightly since 2003.This is particularly important to some groups of advertisers or campaigns which need to build up a mass audience quickly such that they may not be able to move away from ITV and use other channels to meet their campaign objectives If ITV can identify and set higher prices for this dependent group the ability of media buyers and advertisers to constrain potential price rises on ITV1 pricing may be undermined. If this is the case, it may be necessary to retain some form of safeguard to protect this group of customers (as this adverse aspect of the merger may still remain) However, we note that it is not easy to define groups with this requirement as different advertisers, products and campaigns are likely to require fast coverage at particular stages in the product cycle and at different times of year. In addition, even if ITV could identify dependent advertisers it is not clear that ITV could set different terms to those offered to non-dependent advertisers since most terms are negotiated under umbrella deals If ITV could target advertisers who are reliant on fast, mass cover by increasing peak time prices, we would have concerns about undue price discrimination against this group. This may be a risky strategy for ITV if a portion of peak time spend is sensitive 74

78 Recommendations to price rises. However it is likely to be less risky than increasing all prices on ITV1, given the importance of peak time impacts for delivering fast mass audiences 100. Distortions arising from the CRR remedy 8.20 As noted in Section 6, we have considered a number of possible distortions arising from the CRR remedy. ITV has stressed that it faces perverse programme investment incentives and that the remedy limits its ability to optimise its advertising inventory given the ability of advertisers to simply roll over their existing contracts. Whilst Ofcom has some sympathy with ITV s position, it is not clear that these effects would disappear absent the CRR remedy (although it may be that the CRR remedy reinforces the effects) Of greater concern to Ofcom is the problem that the CRR remedy may limit incentives for media buyers to exert countervailing buyer power in negotiations with ITV1 and move away from CRR-protected contracts. This is of particular concern because, if material, while the CRR remedy exists the reliance on the remedy will not decline In addition we concluded that the CRR remedy has adverse investment incentives for ITV. Specifically, because of the way the undertakings are defined ITV has reduced incentive to launch an ITV1HD or an ITV1+1 service (and strictly does not cover the delivery of ITV1 on cable and satellite channels). Recommendation 8.23 Given the distortion to ITV s incentives to invest in high definition and time shifted variants of ITV1 Ofcom believes the undertakings should be redefined to link them to the linear content provided by ITV1, regardless of the platform or method of delivery Evidence on substitutability suggests that while ITV1 retains unique features (primarily associated with access to mass audience programming) which may result in some advertisers or campaigns being reliant on ITV1, there is a group of advertisers/campaigns which can move away from ITV1. Furthermore, the feasibility of switching away from ITV1 to other channels should have increased since We consider that the spend associated with these advertisers/campaigns may be sufficiently large such that any attempt by ITV1 to raise prices would be rendered unprofitable given that the amount of revenue which would have to switch away from ITV1 to make a modest price rise unprofitable is expected to be relatively small On this basis, there is a strong case for concluding that the CRR remedy is no longer necessary or appropriate However, there is still uncertainty about amount of revenue which could switch away from ITV, partly because there may be some barriers which limit the amount of spend that media buyers could switch following a price rise on ITV1. In addition, since ITV1 is still more efficient at delivering mass audiences quickly there may be concern about removing the CRR remedy if ITV can identify and set higher prices for dependent advertisers requiring this feature. Therefore, some concerns do remain 100 While the majority of fast mass audiences tend to occur during peak times, not all peak time programming will attract large audiences. Therefore, peak time is not a perfect proxy for fast mass audiences, and may be used by some advertisers/campaigns which do not require fast mass audiences. 75

79 Recommendations that ITV may be able to change the way that it trades advertising airtime such that price discrimination becomes feasible In particular, ITV could potentially target advertisers who are reliant on fast, mass cover by increasing peak time prices. Although there would be some risk involved in this strategy 101, it is likely that demand for these impacts will be less price sensitive than demand for ITV1 impacts generally given the importance of peak time impacts for delivering fast mass audiences Ofcom believes that there is a strong case for easing the burden of CRR regulation on ITV1 where market forces can provide a credible constraint on ITV s pricing. However, concerns remain such that the CC may wish to consider implementing safeguards (or alternatives to the CRR remedy) that continue to protect advertisers dependent on ITV1 for the quick delivery of mass audiences, but only if it is clear that competitive forces will not provide sufficient protection Given the distortion to ITV s incentives to invest in high definition and time shifted variants of ITV1 Ofcom believes the undertakings should be redefined to link them to all linear channels which contain the same content as ITV1, regardless of the platform or method of delivery 8.30 In addition, Ofcom believes that there is a need for ongoing monitoring of the advertising sector to understand the impact of amending the CRR remedy, recognising that it may be necessary to commence a market investigation sometime in the future. 101 For example some switching may occur in response to a price rise since some peak time impacts may not have been explicitly purchased for fast, mass cover. 76

80 Background information on TV Broadcasting and Regulation Annex 1 1 Background Information on TV Broadcasting and Regulation Introduction A1.1 This section contains background and contextual information on the following areas: An explanation of the broadcasting supply chain and key market developments in the broadcasting sector; explanation of Channel 3 and the ITV Network; an overview of ITV plc; overview of the licensing arrangements for PSB and non-psb channels; and overview of regulations relevant to advertising. Broadcasting Supply chain A1.2 The supply chain for the UK broadcasting industry may be considered to consist of four layers as illustrated by Diagram A1.1 below. Diagram A1.1: The broadcasting supply chain Content and production Wholesale channel provision Wholesale platform service provision Wholesale platform service providers (e.g. BSkyB) Wholesale platform services Content rights holders (e.g. FAPL, Endemol, Fremantle, ITV, Hollywood Film Studios) Content rights Wholesale channel providers (e.g. BSkyB, BBC, ITV) Channels Retail service providers (e.g. Setanta, Top Up TV, BSkyB, Virgin Media, Tiscali) Commercial impacts Advertisers Retail service provision Retail platform access services Retail content services Retail platform customer base A1.3 In reality, a number of operators in the broadcasting industry are vertically integrated and operate at multiple layers of the supply chain. For example, ITV is a content rights holder, wholesale channel provider and retail content service provider while BSkyB is a vertically integrated wholesale channel provider, wholesale 77

81 Background information on TV Broadcasting and Regulation platform service provider and retail (platform access and content) service provider (as well as being a minor content rights holder). Content and production A1.4 The content and production layer includes the companies or organisations which produce programmes/films, perform other creative services, and hold intellectual property rights for programme content / films. For example, the Football Association Premier League (FAPL), Paramount, Endemol, and Freemantle. These content rights are then sold to wholesale channel providers. Wholesale channel provision A1.5 Wholesale channel providers arrange different types of content into a complete schedule of programmes (including advertisements) and determine the business model for the channel to be transmitted to viewers (i.e. providing the channels to retail service providers or, where they are also active in retail service provision, purchasing wholesale platform services). Wholesale channel providers also sell advertising impacts to companies wishing to advertise their products or services to the end consumer. A1.6 There are two main types of TV channel provided by wholesale channel providers: free-to-air, and pay-tv. Free-to-air channels are available to viewers without subscription 102. Pay-TV channels are encrypted channels which are available to viewers upon payment of a monthly subscription fee. A1.7 In addition to providing a complete schedule of content, wholesale TV channel providers may also make their content available to viewers by providing it to retail video on demand (VoD) service providers or by streaming programmes on their websites. Wholesale platform service provision A1.8 This layer involves companies which operate wholesale TV broadcasting platforms and companies which provide technical capacity and transmission related services to retail service providers for TV channels and other content to be distributed to viewers/subscribers over those platforms. A1.9 In the UK there may be considered to be two analogue platforms which are being phased out (analogue terrestrial TV and to a limited extent analogue cable TV) and four digital multichannel TV platforms: DTT; Digital cable; Digital satellite (sometimes referred to as DSAT); and Digital Subscriber Line TV (DSL) / Internet Protocol TV (IPTV) (sometimes referred to as broadband TV). 102 In some limited cases, such channels may be encrypted and it will normally be necessary for the viewer to make a one-off payment for a viewing card. 78

82 Background information on TV Broadcasting and Regulation A1.10 Platform providers typically transact with both retailers and wholesale channel providers, with the transaction depending on the type of channel: Retailers will generally purchase both a suite of pay channels and the platform services that enable them to broadcast those channels and recover subscriptions from customers; Free-to-air channels, by contrast, purchase platform services directly from platform providers, since for those channels, there is no direct transactional relationship with end consumers. Retail service provision A1.11 Retail service providers such as Sky, Virgin Media, Top Up TV and BT Vision buy channels from wholesale channel providers, and may assemble combinations of channels into retail bundles to be sold to end consumers. Viewers procure television reception equipment to access analogue and digital TV channels and services. A1.12 Subject to some restrictions on geographical availability, viewers will normally have a choice between different digital TV platforms, as well as with the type of TV services available on those platforms. Thus, viewers may decide just to procure reception equipment to access free-to-air content on a particular platform (i.e. a retail platform access service), and/or may also decide to pay subscription and/or pay-per-view fees to access additional content (i.e. a retail content service). A1.13 Each of the three main digital platforms offers a free-to-view service. Freeview is available via terrestrial TV, while satellite now offers two main non-subscription options including: freesat from ITV/BBC and Freesat from Sky. Cable customers can also receive a free TV service as part of a combined package, but still have to pay a monthly line rental charge for access to this service. Consumers can subscribe to additional channels if they choose via Top Up TV on DTT, Sky on DSAT, and Virgin Media and other providers for cable TV. A1.14 Digital television penetration has increased substantially in recent years and now exceeds 88% of households. Increased take-up on the Freeview platform was the main driver behind the growth of digital television, with a total of with 9.8 million (38%) UK homes using DTT on their main sets by the end of A1.15 Intense competition for viewers in multichannel homes and the migration of analogue homes to digital, has resulted in a decline in the total audience share of the five main PSB channels has fallen from [] 104. This growth in multichannel households is likely to continue over the coming years as the process of digital switchover takes place and analogue television transmissions cease. Channel 3 and the ITV network A1.16 Channel 3 is the statutory name for a free-to-air, commercially funded national television broadcast channel. Channel 3 is made up of fifteen regional licensed areas, plus a national breakfast-time service. 103 Ofcom, The Communications Market: Digital Progress Report Q Source: BARB. PSB digital channels not included. 79

83 Background information on TV Broadcasting and Regulation A1.17 The regional Channel 3 service is commonly known and referred to as ITV1 105, and the national breakfast-time service is commonly known and referred to as GMTV. A1.18 The current arrangements for Channel 3 were established by section 14 of the Broadcasting Act A1.19 Eleven of the regional licences are held by companies owned and controlled by ITV plc. ITV plc also holds the controlling interest in GMTV the company which holds the national breakfast time licence. The two companies which hold two regional licences in Scotland (central Scotland and the North of Scotland) are owned and controlled by Scottish Media Group plc (SMG plc). The regional licence for Northern Ireland is held by Ulster Television plc. The regional licence for the Channel Islands is held by Channel Television Limited. A1.20 A key public policy objective for Channel 3 is to provide competition to other national broadcasters. In accordance with section 292 of the Communications Act 2003, the Channel 3 licensees are required to have in place a set of arrangements that enables them to work together to produce a national television service that is capable of competing effectively with other television programme services in the UK. This set of arrangements is known as the ITV Networking Arrangements (the NWA ). The legislation does not dictate the structure or content of the arrangements but they must be approved by Ofcom and are subject to an annual review by the regulator. A1.21 ITV Network Ltd ( ITV Network ) is a key organisation in the administration of the NWA. ITV Network is a company limited by guarantee, with a membership composed of the fifteen licensees. The board of ITV Network is known as the Network Council and was set up to agree the ITV strategy and budget. A separate management structure known as the ITV Network Centre ( NWC ) was created as a result of the initial NWA as the body to execute the instructions of the Network Council (to run the ITV network on behalf of all the licensees). A1.22 The current Channel 3 licences are normally referred to as the digital replacement licences (DRLs) and require the Channel 3 service to be broadcast via digital terrestrial TV and a corresponding analogue service to be provided until digital switchover. There are currently no obligations for the Channel 3 service to be broadcast on other platforms. However, the Channel 3 licensees choose to broadcast simulcast versions of the Channel 3 services on satellite, cable and IPTV platforms. The satellite and cable broadcasts of the Channel 3 services are operated under 16 separate TLCS licences (15 for the ITV1 services and 1 for the GMTV service). Table A1.1: Channel 3 Digital Replacement Licence Holders (regional and national franchises) Region/Service Anglia ITV: East of England Border ITV: Borders and the Isle of Man Licence holder ITV Broadcasting Ltd (formerly Anglia Television Limited) a wholly owned subsidiary of ITV plc) ITV Broadcasting Ltd (formerly ITV Border Limited) a wholly owned subsidiary of ITV plc 105 Channel 3 is branded as STV in Central and Northern Scotland and as UTV in Northern Ireland. 80

84 Background information on TV Broadcasting and Regulation London: London Weekday Central ITV: East, West and South Midlands Channel Television: Channel Islands Grampian Television: North of Scotland Granada ITV: North-West England Wales and West ITV (A.K.A. HTV): Wales and West of England LWT: London Weekend Meridian ITV: South and South-East England Scottish Television (A.K.A. STV): Central Scotland Tyne Tees ITV: North-East England Ulster Television (A.K.A. UTV):Northern Ireland Westcountry ITV: South-West England Yorkshire ITV: Yorkshire GMTV: National Breakfast-time (UK) ITV Broadcasting Ltd (formerly ITV Carlton Broadcasting Limited) a wholly owned subsidiary of ITV plc ITV Broadcasting Ltd (formerly ITV Central Limited) a wholly owned subsidiary of ITV plc Channel Television Limited STV North Limited (owned by SMG plc) ITV Broadcasting Ltd (formerly Granada Television Limited) a wholly owned subsidiary of ITV plc ITV Broadcasting Ltd (formerly ITV Wales and West Limited and HTV Group Limited) a wholly owned subsidiary of ITV plc) ITV Broadcasting Ltd (formerly London Weekend Television Limited) a wholly owned subsidiary of ITV plc ITV Broadcasting Ltd (formerly ITV Meridian Limited) a wholly owned subsidiary of ITV plc STV Central Limited (owned by SMG plc) ITV Broadcasting Ltd (formerly Tyne Tees Television Limited) a wholly owned subsidiary of ITV plc Ulster Television plc ITV Broadcasting Ltd (formerly West Country Television Limited) a wholly owned subsidiary of ITV plc ITV Broadcasting Ltd (formerly Yorkshire Television Limited) a wholly owned subsidiary of ITV plc GMTV Limited a subsidiary (75% interest) of ITV plc Source: ITV plc Annual reports Ofcom Licensing webpage ( 81

85 Background information on TV Broadcasting and Regulation Diagram A1.2: Map of Channel 3 Regions Table A1.2: TLCS licences held for ITV1 Channel/Service Channel Television ITV1 (STV North) ITV1 (STV Central) UTV ITV1 (Meridian) ITV1 (Granada) ITV1 (Tyne Tees) ITV1 (Yorkshire) ITV1 (London) ITV1 (Anglia) ITV1 (Border) ITV1 (Border Scotland) ITV1 (HTV Wales) ITV1 (HTV West) ITV1 Carlton (London Licensee Channel Television Limited STV North Limited STV Central Limited Ulster Television plc ITV Meridian Limited Granada Television Limited Tyne Tees Television Limited Yorkshire Television Limited LWT (Holdings) Limited ITV Broadcasting Limited ITV Border Limited ITV Border Limited ITV Wales and West Group Limited ITV Wales and West Group Limited Carlton Broadcasting Limited 82