Carlton Communications Plc / Granada Plc: A report on the proposed merger.

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Summary

On 16 October 2002, Carlton Communications Plc (Carlton) and Granada plc (Granada) announced an agreed merger, which they believed would pave the way for a fully consolidated ITV and create a company that would be one of the leading commercial broadcasters in Europe. They said that the main objective of the merger was to remove the current dysfunctionality within ITV, and allow ITV to remain an effective player in the competition for viewers and advertisers, in a rapidly changing competitive environment. There were also significant cost savings to be realized by merging the two companies. The Communications Act 2003, which received royal assent on 17 July 2003, allows the merger to be completed.

On 11 March 2003 the Secretary of State for Trade and Industry referred the proposed merger between Carlton and Granada to the Competition Commission (CC). Following an extension, we were asked to report by 26 August 2003. Our terms of reference are set out in Appendix 1.1.

Television is a sector undergoing major change. Technological developments have led to a rapid increase in the channels available, and in the number of households able to receive them. This has had a major impact on ITV. In 2003, it is forecast to receive just over half of all television advertising revenue, down from 60 per cent in 1999. Its audience share has fallen from 55 per cent to around 40 per cent of viewers of commercial television over the same period, a decline that has mainly been to the benefit of the multi-channel broadcasters and Channel 5. Multi-channel penetration is likely to continue to grow as a result of the continuing progress of the satellite and cable companies, the successful launch of Freeview, and the Government’s announced intention to close down analogue transmissions by the end of the decade. Forecasts suggest that ITV’s share of advertising revenue may fall to around 45 per cent by 2007.

We looked at a number of areas of concern relating to the proposed merger: the independent production of television programmes, the availability of studio facilities in the North of England, the future competition for ITV licences, the impact on the other ITV regional licensees, and the sale of advertising airtime.

We did not expect the merger to operate against the public interest in the areas of programme production, the availability of studio facilities, or the future competition for ITV licences.

We considered two potential issues relating to the other ITV regional licensees: the ITV networking arrangements and the arrangements for the sale of their airtime. On networking arrangements, we concluded that, without additional safeguards currently under negotiation between Carlton and Granada, the other licensees and the Independent Television Commission (ITC), the proposed merger might be expected to operate against the public interest in this area. As for the sale of their advertising airtime, a merger that resulted in a single ITV sales house would remove from the other regional licensees the choice that they currently have to contract with either the Carlton or Granada sales house for this purpose. We concluded that, unless the other licensees could continue to sell their airtime through the merged entity’s sales house on terms similar to those that they currently enjoyed, the proposed merger would have an adverse effect on them, and so might be expected to operate against the public interest.

Our major focus was on the effect of the proposed merger on the sale of Carlton’s and Granada’s airtime. We concluded that the relevant economic market for this purpose was television advertising as a whole, and the relevant geographic market, the UK.

We concluded that the proposed merger would have an adverse effect on future competition for the sale of advertising airtime and so might be expected to operate against the public interest. We considered that London was the primary focus of competition within ITV, but believed that there was some competition between ITV regions outside London. Our view was that competition between Carlton and Granada limited what advertisers or media buyers could be charged by, in particular, limiting the advertising budget commitment that could be demanded for a given level of discount.

Competition between ITV and the other commercial channels had to be viewed in the context of a further decline in ITV since our last report on independent television companies in 2000. Despite this decline, we did not believe that other channels were yet sufficiently close substitutes to prevent an increase in the advertising budget commitment that ITV could demand for a given level of discount, following the removal of competition between Carlton and Granada. Whilst the analysis carried out by the parties, demonstrating equivalent levels of coverage with and without ITV, appeared to be technically correct, other considerations, such as the difficulty of purchasing enough slots to achieve the required coverage, and the likelihood of obtaining a lower sales uplift without ITV, would act as a barrier to switching for at least some advertisers. We were also told that ITV provided a number of ‘must have’ features, including the unique ability to attract big audiences for advertisers, a consistently high audience share in the evening peak, a very high proportion of prestigious programmes, and the ability to attract ‘light’ viewers. Some customers might also be deterred from marginal switching to other commercial channels as this might attract punitive reductions in discount they currently received from ITV. We did not accept that buyer power would prevent the merged entity from raising prices.

The adverse effects which we thought were likely to arise from this lessening of competition would centre on the enhanced market position of a merged Carlton/Granada. In terms of advertising sales, this might manifest itself in a number of ways, including in particular the parties’ ability, post-merger, to:

(a) insist on terms that were generally less attractive to advertisers or media buyers. This might include demanding a greater level of commitment, however expressed, of their television advertising budgets for a given level of discount off the station average price (SAP) or obliging advertisers or media buyers to accept worse terms and in particular reduced discounts;

(b) enhance the degree of price discrimination; and/or

(c) change the system under which television advertising airtime was sold to the advantage of the merged entity.

We expected that these adverse effects might allow the merged entity to achieve a higher level of revenue than if the merger had not gone ahead. This would be most likely to be to the detriment of advertisers and the other commercial broadcasters.

We saw benefits in the proposed merger in terms of broadcasting, programming and the competition for viewers, but, in the light of the adverse effects identified, we concluded that it could be expected to operate against the public interest in relation both to the other ITV regional licensees and to future competition for the sale of advertising airtime. We therefore went on to consider a number of possible remedies as alternatives to the outright prohibition of the merger.

As for the other ITV licensees and the ITV network, we concluded that, as a condition of the proposed merger going ahead, Carlton and Granada should undertake to agree to a package of safeguards proposed by the ITC, and should accept any relevant changes to licence conditions that followed from them. On airtime sales arrangements, assuming that the merger resulted in a single Carlton/Granada sales house, we concluded that Carlton and Granada should give an undertaking that the other ITV licensees should have the option to carry forward, for the duration of the companies’ respective licences, the terms currently in effect between each of them and Carlton’s and Granada’s sales houses, which had been independently agreed in competitive tenders.

We consulted widely on four potential remedies relating to advertising sales:

(a) prohibition of share deals;

(b) commoditization of airtime;

(c) divestment of one or both of Carlton’s and Granada’s sales houses; and

(d) contract rights renewal (CRR).

We did not believe that either the prohibition of share deals or the commoditization of airtime would be effective remedies. We also concluded that keeping one internal sales house and selling off the other, including the proposal to outsource LWT sales, would not be effecttive.

We considered both the divestment of two sales houses, and the CRR remedy, in some detail.

The two sales houses would be run as independent entities, with their own back-office functions. Airtime would be divided along current lines. They would receive an annual fee from ITV to cover their basic running costs and an incentive scheme would be designed to motivate each house to compete. There would need to be quality of service guarantees. We would expect this remedy to be in place for a minimum of three years.

We saw both advantages and disadvantages with this remedy. It had the virtue of preserving the pre-merger market structure in terms of airtime sales, rather than relying on other types of intervention to mitigate the adverse effects. We also believed that it would be possible to devise incentives to encourage the two sales houses to compete and to maintain an adequate level of performance. Our greatest concern, however, was ensuring that the merged entity, which would be the ultimate owner of the airtime being sold, would not be able to exert excessive influence or a degree of control over the independent sales houses. We also had some concerns about divorcing the broadcasting company from its principal source of income.

The CRR remedy is designed to give all existing customers the fallback option of renewing the terms of their 2003 contracts without change for the duration of the remedy, with the exception that where a contract specified a share of broadcast, this share would vary in direct proportion to ITV’s share of commercial impacts, subject to a cap at the initial share. The protection could be rolled forward such that a subsequent year’s contract became the base set of contractual terms, subject to mutual agreement. Customers would not be precluded from negotiating different deals if they wished.

Advertisers would be able to switch between media buyers and benefit from the protection of the ‘new’ media buyer’s base contract, subject to safeguards to protect Carlton/Granada against the risk of overtrading; new advertisers would be protected by a media buyer’s base contract; lapsed advertisers would have the right of renewal of the terms of their most recent contract in force since 2000; and rights would not expire if advertisers chose to move away from ITV for a period of time during the remedy. The remedy would cover all airtime sales referred to in the 2003 contracts, including sales on behalf of the other ITV regional licensees as well as, in some cases, ITV2 and ITV News.

To ensure the successful implementation of this remedy, Carlton and Granada should fund an independent adjudicator (or a small panel), selected by the ITC. The adjudicator would deal in the first instance with issues of contract fairness, enforcement or interpretation, as well as with any issues associated with potential overtrading. His or her decisions would be binding on the parties. Additional undertakings would be needed to prevent material changes to the current airtime sales system for the duration of the remedy. We would expect this remedy to be in place for a minimum of three years.

Four of us believed that the strength of this remedy was that it addressed, in a direct way, our concerns about the merged entity’s increased market power, in particular with regard to being able to extract a higher advertising budget commitment for a given level of discount, to increase any existing price discrimination against more vulnerable customers, and to change the current mechanism for airtime sales in ways that could disadvantage ITV’s customers and the other commercial channels. Such an arrangement seemed to us to be particularly well suited to dealing with competitive concerns that may reduce over time with the increasing penetration of digital and multi-channel television and in an already highly regulated industry.

The four of us considered both the CRR remedy and the divestment of the two sales houses to be potentially effective remedies, but concluded that the CRR remedy would place a lesser burden on the parties and was thus the more appropriate.

One of us, Mrs Brown, dissented from this view and considered that the divestment of the two sales houses was the only effective remedy to address the adverse effects on advertising sales.

We all concluded that as effective remedies had been identified, the prohibition of the merger would be disproportionate.

So, in sum, on the position of the other ITV regional licensees we concluded that:

(a) without additional safeguards on ITV networking arrangements, the proposed merger might be expected to operate against the public interest; and

(b) on the sale of their national advertising airtime, unless the other licensees could continue to sell through the merged entity’s sales house on terms similar to those that they currently enjoyed, a merger that resulted in a single Carlton/Granada sales house might be expected to operate against the public interest.

(c) As for its effect on future competition for the sale of advertising airtime, we concluded that the proposed merger might be expected to operate against the public interest.

As for remedies, we concluded that:

— On (a), Carlton and Granada should agree to a package of safeguards proposed by the ITC, and should accept any relevant changes to licence conditions that followed from them.

— On (b), if the merger resulted in a single Carlton/Granada sales house, Carlton and Granada should give an undertaking that the other ITV licensees should have the option to carry forward, for the duration of the companies’ respective licences, the terms currently in effect between each of them and Carlton’s and Granada’s sales houses.

— On (c), four of us considered both the CRR remedy and the divestment of the two sales houses to be potentially effective, but that, as it would place a lesser burden on the parties, the CRR remedy was the more appropriate.

Although it lay beyond the CC’s terms of reference on the present occasion, we all believed that the Office of Fair Trading or the ITC/Office of Communications should look at other features relating to the sale of airtime that have caused us disquiet and consider undertaking a review of the wider market, with a view to ascertaining whether the nature of the deals struck, the trading mechanisms, and the overall market structure substantially lessen competition in the sale of airtime on commercial television, and how the system might be changed to enable it to operate more effectively and competitively.

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