BBC and its paymasters: Cutting the Gordian knot

At the Telco 2.0 event last week there was much debate about whether online video (a fast growing phenomenon) would kill the ISP business, not only fixed, but mobile too. Our analysis of the real life effect of the BBC's iPlayer on ISPs in the UK was used to challenge the optimism around mobile broadband. Two senior execs from the mobile world agreed that the issue was an important one and, no, their companies, and the industry in general didn't have a solution...but needed one...pretty fast. They're lucky, they have some time on their hands, relative to the fixed world.

So, here is some more analysis to fuel the debate:

In our recent report on future broadband business models we have several case studies on how you need to match the distribution system to the content -- and how some people get it right (e.g. Sky), and others get it wrong (e.g. Joost).

The BBC is providing us with a fascinating experiment in the economics of distribution of digital goods. Who will pay for the postage and packing charges of all the content being delivered in future?

Decades-old business model

The BBC's business model is a relatively simple one. In 2006/7 it had around 25 million licence payers paying £131.50 per year (around £11/month) generating total revenues of £3.2bn. It then spent this on acquiring, packaging and distributing content to the UK homes. 25 million payers represents nearly every home in the UK, and the licence fee would be called a tax in most economics textbooks, especially since the BBC is state owned.

The BBC has certain ancillary activities which fall under the general umbrella of BBC Worldwide, which had 2006/7 revenues of £810m. The general model is that content can be repackaged and distributed overseas for a profit (2006/7 profits of £111m) and the proceeds reinvested in content for the greater good of all the Licence Payers. BBC Worldwide is a bit of a misnomer as some of the activities are actually UK-specific, and encompass selling additional repackaged content to willing licence payers.

A simple example is the weekly production of a commercial TV guide which operates in a highly competitive space and manages to generate sales of £56m. Another example is the distribution of DVDs related to TV tie-ins with top sellers such as Planet Earth (>600k units) and Dr Who (>1.9m units). BBC also repackages archive TV content within the 10 channels of the UKTV Group on UK PayTV channels, both cable and satellite, with 2006/7 Revenues of £91m.

Confusing to Licence Payer

The simple truth is that it is getting more and more confusing to the licence payer what is included within the licence fee, what is charged for and what can be accessed without a licence fee. And this is before the BBC's online activities are thrown into the melting pot.

The main BBC news website used to be ad-free and available for anyone to view worldwide. In 2006/7, bbc.co.uk had a weekly audience of 14.8m in the UK and an additional 13.5m overseas. However, in true web fashion now that the BBC has built an audience they now plan to start charging in the form of inserting adverts for overseas viewers.

The plan of action for the iPlayer, which allows viewing on a PC with a broadband connection, seems to be progressing in a slightly different direction. First, the BBC has built an audience for the iPlayer with the ad-free service covering a selection of content within a 7-day playback window. The service is only available in the UK. The next stage appears to be a ad-funded or pay-as-you-watch model in the UK, via the Kangeroo initiative, for content outside of the 7-day window, and will presumably include some or all of the vast BBC archives.

Beware the pirates

The big question is whether the Licence Payer will see Kangeroo as a legitimate extension of the BBC commercial activities, or something that should be included in the licence fee. The trouble for the BBC is that your average internet viewer is a lot more revolutionary than your average TV viewer. And they have been conditioned for accessing black market material whilst satisfying their thirst for music. The music industry provides a perfect blueprint for what happens when the black market proliferates and the supply chain is broken.

The BBC's next problem is that the very companies who they will want to provide assistance in policing and protecting their content, namely the ISPs, are the very ones that the BBC is currently ignoring. It is doubly ironic that these are people suffering the pain of the cost of distribution of iPlayer material alone.

It is worth contrasting how the BBC deals with online distribution compared to other methods of distribution of its product. In 2006/7 the BBC paid a total of £101.4m and £42.6m to distribute its TV and Radio signals over its main Free To Air, Satellite and Cable platforms.

Analogue and Digital "Free to Air" Distribution

The equivalent of the last mile distributor here is Macquarie Communications, the monopoly provider of TV and radio broadcast services. The BBC happily pays them, and although the actual figure is not divulged it will make up the bulk of the £144m bill. The figure is also probably increasing at the cost of upgrading Macquarie infrastructure to cover the cost of the switch to digital is factored in.

The signal reaches the Macquarie broadcast towers via a combination of the old Energis fibre network (now owned by C&W) and satellite transponders.

The parallels with ISP business are clear, with the licence payer paying the BBC for both core and last mile distribution, whilst paying their own home equipment (aerial, set-top box, TV and intra-home distribution). In return they get to watch, listen and record a set number of channels for personal consumption.

Satellite distribution added to the mix

Here the BBC pays both core and last mile transmission fees to SES-Astra for delivery. Fees are in the range of £70k/MB/annum and with a "normal" DVB-S channel costing around £250k as a ballpark. The last time we looked the BBC had around 33 TV channels, 17 radio channels and some interactivity. The absolute maximum they must be paying is around £15m/p.a. which certainly looks a cheap option compared to the Free To Air (FTA) alternative.

The BBC also pays Sky for its Electronic Program Guide (EPG) listing and a contribution towards the platform cost, the big chunk of which is the subsidised set top box. We estimate that this adds another £10m/pa to the costs. All these charges relate to the FTA channels, however the UKTV channels are licensed to Sky and earn a carriage fee. This carriage fee is normally the subject of intense negotiation and is usually evaluated around the contribution to the overall desirability of the various PayTV packages.

Again, the parallel with the ISP business is clear -- transmission fees are paid by the BBC, and for monetised content the BBC earns a share of the revenue. However, the standard FTA channels are free after the BBC has paid Sky a contribution to its platform costs.

Cable distribution too

Here the BBC pays to distribute the content to the cable head end, and we believe Virgin Media rebroadcasts it free of charge to the BBC. However, unlike Sky you have to subscribe to another paid for service (e.g. Phone) to get the FTA channels.

Once more, the parallels with the ISP are clear: core distribution is paid for by the BBC, however the last mile charges are "free" to the BBC and Virgin Media covers these costs by the revenue earnt in the bundle.

The situation is further complicated by the joint ownership of the UKTV channels by the BBC and Virgin Media.

The new distribution network: going online

For online distribution, the BBC pays Akamai a fee for effectively carrying the content across London. BBC spent £8.6m on online distribution in 2006/7 which admittedly was before the iPlayer costs kicked in and not all of which will end up with Akamai. Akamai is more like a first mile distribution and the ISP pays for the middle and final mile distribution to the home, effectively out of their ISP fees.

For the ISP, the parallel is more like the Virgin Media relationship with two major caveats:

  • the cost for Virgin Media to distribute the FTA BBC content is fixed per month. The BBC channels occupy a relatively small amount of bandwidth on the end-to-end network. However, the cost for ISPs are variable -- the more popular the BBC content the more expensive for the ISP.
  • Virgin Media earns a share of the BBC revenues and asset value in the BBC paid for content through joint ownership of the UKTV channels. We don't expect the BBC will be offering the ISPs either equity or a revenue share in Kangeroo anytime soon.

An uneven playing field

The BBC does not apply consistent logic around paying all of its distribution partners. It is also clear that the line between what is included within the licence fee and what is excluded is fairly blurred. Furthermore, whenever the internet touches an industry, it usually works out to pretty painful for the incumbents.

We would strongly argue that the disaster scenario for the BBC is not paying out a few tens of millions to the ISP industry for distribution of its content. Rather, it is the uncontrolled distribution of its content in the black market.

The apocalyptic scenario for the BBC is the loss of a universal licence fee from every UK home. As the BBC starts charging for more and more in the digital world, the BBC bundle starts looking less and less attractive.

Pulling is more disruptive than pushing

Broadcast is a world of "video pushed at you whether you want it or not", whereas online downloading is a world of "video pulled by the user". The strange thing is that to exercise choice or personalise the service, either via a PVR or online, is not only a more compelling option but a more expensive option than taking a preset feed. The old powers of aggregation via channels and controlling supply in the peak hour are rapidly diminishing. BBC One content will get unbundled much in same way as CDs got unbundled by iTunes. Any investor can tell how painful that is for the newspapers and music industry, but isn't the BBC a public service and shouldn't be too worried about such monetary matters?

Network neutrality follies

There is concern about users facing tiered fees by ISPs. The network neutrality debate grossly over-simplifies the nature of both the problem and likely solution. Every packet delivered is of variable value for both the sender and the receiver. Phone networks have always polarised into 'calling party pays' and 'sending party pays'. The Internet, by avoiding having any charging mechanism baked in, potentially allows any kind of charging relationship between content host and consumer to be layered on top.

The outcome is likely to be messy, with a mixture of taxes (license fee), content provider payment, ISP revenue subsidy, and explicit end-user tiered charges (e.g. for HD video content). To minimise piracy and maximise ease of payment collection, the BBC should be courting the ISPs and helping to co-ordinate the development of their distribution platform and securing the end points. After all, it is the big ISP/media companies who are subsidising those set top boxes.

Or, as the US cable industry has taught us so many times, a hostile distribution channel can be fatal to your media business. There are few organisations in the UK with the political power to match the BBC. However an aggregation of licence payers have far more powers than the BBC and it would take a lot less than a 51% majority.

The internet provides a perfect reverse channel for both positive and negative feedback. The accumulation of negative feedback could ultimately break the Gordian knot between the UK licence payer and the BBC. The BBC has to think very carefully how to structure its business model in the digital era and more especially what is in and out of the Licence Payer bundle