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Proposed joint venture between Hilton Group Plc and British Sky Broadcasting Group Plc

No. ME/1402/01

Report under section 125(4) of the Fair Trading Act 1973 of the Director General's advice, dated 27 September 2001, to the Secretary of State for Trade and Industry under section 76 of the Act

The parties

Hilton Group plc ('Hilton') operates through two divisions: Hilton International, which is primarily concerned with the operation of 230 hotels in 62 countries, and Ladbrokes, which provides betting services through 2,500 betting shops and through other media. Hilton had a turnover of £3,951.5m in the year to 31 December 2000, with a gross profit of £334.4m.

Ladbrokes contributed £2,632m to the above turnover and accounted for £114.9m of the gross profit. Retail betting, with a turnover of £1,867.5m, was the largest element of this, but there were significant contributions from telephone betting, international gaming, casinos, eGaming and from Vernons pools (£31m turnover), the second largest football pools provider.

News Corporation owns 37.6% of British Sky Broadcasting Group plc ('BSkyB') through its subsidiary Sky Global Networks Inc. BSkyB is a diversified media company. It operates the UK's main satellite pay TV service and has 5.5 million subscribers (see note 1). It owns a range of television broadcasting activities, including basic and premium channels with the UK's leading film and sports channels. BSkyB channels are also available to other pay TV operators on wholesale terms.

BSkyB had a turnover of £1,847m in the year ending 30 June 2000 and made a loss of £271.5m. The unaudited turnover to 30 June 2001 was £2,306m, with a loss after tax of £539m.

BSkyB acquired Sports Internet Group during 2000. This included a business, Surrey Sports, which generated unaudited revenues of £78m in the latest financial year from telephone, online and interactive betting and gaming.

BSkyB also acquired 80.1% of British Interactive Broadcasting ('BIB') earlier this year. BIB offered interactive services such as home shopping, email and gaming to UK digital satellite customers through a separate TV channel known as Open. BSkyB offered undertakings to the Secretary of State associated with this transaction. The undertakings require BSkyB to provide distributors with the option to receive 'clean feed' broadcasts of premium channels which do not include interactive icons. BSkyB purchased the remaining BIB equity from BT on 9 May 2001 following acceptance of the undertakings and has since restructured its business to integrate BIB. It continues to offer interactive services through Open, many of which are provided by third parties.

The transaction

It is proposed to form a 50:50 joint venture (the 'JV') to develop a fixed odds betting business linked to Sky Sports channels on the digital satellite platform ('DSat') (see note 2) . BSkyB will transfer part of the Surrey Sports business to the JV. Hilton proposes to transfer its Vernons pools business to the JV. Hilton will pay BSkyB £30m on completion of the transaction, together with periodic payments relating to the success of the venture. It is proposed that the JV will have exclusive rights to betting associated with Sky Sports channels and the Sky Sports internet site for a period of five years and will operate under the Ladbrokes and Vernons brand names.

Jurisdiction

The transaction qualifies for investigation under the share of supply test in section 64(1)(a) and (3) of the Fair Trading Act in relation to the supply of interactive betting services through digital television within the UK. The ECMR does not apply.

Assessment

There are two broad areas for consideration: betting markets and the markets for sports channels and sports rights. These will be considered in turn.

Betting markets

Internet and telephone betting

The parties overlap in the provision of betting services via the Internet and telephone. The Internet has a large number of operators of betting services, most of whom are based offshore to avoid betting duty. There are several websites which allow punters to compare the odds available from the main betting sites, which encourages these players to set competitive odds. Internet betting is potentially a world-wide market, with relatively low cost barriers to entry. Reputational barriers to entry may be more significant, however, as customers need to have confidence that their winnings will be paid out. Telephone betting allows customers who have registered and opened an account to place bets from any location. All the major betting organisations, as well as other bookmakers, offer telephone betting.

Betting through interactive digital television (iDTV)

iDTV allows the viewer to place a bet directly through their TV once they have registered for an account. The registration process, which is also performed through the TV, involves transferring money into the account using a debit card. Such TV transactions are only possible with digital televisions, which are presently found almost exclusively in pay TV households (see note 3). Practically all pay TV households use only one provider of pay TV services. A further distinction can be drawn between bets placed on screen whilst simultaneously watching the event being bet upon ('in-vision' iDTV betting). Currently all iDTV betting services outside BSkyB's text service are not 'in-vision'. Other iDTV betting services are similar in layout to Internet sites and a customer would need to switch away from the service to view a broadcast.

Surrey Sports presently offers an 'in-vision' betting service associated with the Sky Text service. When the viewer presses the 'text' key on the TV handset they are presented with a menu. One of the menu options is interactive betting. If this item is selected the customer enters their password and the set top box dials out to check the balance on the customer's account before allowing them to place a bet. The viewer is able to continue to watch the TV channel while placing a bet, but is not able to switch channels. The JV will employ a similar approach.

Ladbrokes offers betting services on a non-exclusive basis through cable and digital terrestrial television. Some of these services have different features, reflecting the technological capabilities of the platforms concerned. As a general point, however, betting services cannot be accessed while viewing channels.

The JV is to offer interactive 'in-vision' betting in which viewers can place bets on the events that they are watching, as well as other events. This is largely a new service, and with betting, market definition is not straightforward. There are four other forms of betting which could conceivably form part of the same market: licensed betting offices ('LBOs'); telephone betting; Internet betting; and 'non-in-vision' interactive betting services. LBO betting takes place outside the home and in venues which have limited appeal to some parts of the population. However, both telephone and Internet betting can take place in the home and need to be considered more carefully as potential substitutes to interactive 'in-vision' betting.

Demand-side substitution

I have considered whether other betting services, including the Internet, telephone betting and LBOs are likely to be demand-side substitutes to iDTV. The market could be viewed as a single broad market for betting, or an 'at home' market which would include iDTV, Internet and telephone betting, or a distinct market for 'in-vision' iDTV betting. The extent of demand-side substitution is difficult to assess, as the iDTV betting segment is relatively small and at a very early stage of development. There is little reliable information on consumer profiles or switching behaviour.

The available data indicate that the new betting media (including the Internet, mobile phones and iDTV) attract a younger and more affluent client base than LBOs. The new services are likely to be more successful in attracting bets on a wider range of events than LBOs, whose business is mainly associated with horse racing. Internet services and iDTV betting are available 24 hours per day, whereas LBOs and telephone betting are closed at certain times.

The JV proposes to offer 'in-vision' iDTV betting, whereby the viewer can place impulse bets which are directly related to the events unfolding on screen (e.g. live sporting events). This type of impulse betting service is not widely available elsewhere, although such bets are sometimes offered by telephone betting companies. It also differentiates the offering of the JV from that of Blue Square, a third party which offers a betting service through the Open channel. It appears that it would take a significant time for a sports viewer to change channels and access this service, during which they would be unable to view the live sporting action. It seems unlikely that many viewers would do so for this type of impulse bet. Likewise, households may not have Internet access in the same room as their main TV set, so that accessing the Internet might require the customer to stop watching the event. It is conceivable that viewers could place bets by telephone while watching an event, but they might not be aware of the odds offered before making their call, which could reduce the likelihood of making impulse bets by this method. It is also possible that SMS-based betting services and the interactive services available through WAP phones could be relevant in due course. Such betting services are not yet well established in the UK.

Supply-side substitution

Whilst betting companies can easily extend their basic services to other new media, the nature of iDTV betting services requires negotiations with both channel owners and pay TV operators and the development of software for each platform. These can be significant barriers to supply-side substitution. In addition, given the exclusive nature of the JV, no supply-side substitution into providing interactive DSat betting services on BSkyB Sports channels can occur. However, this is an innovative market and I would expect other betting companies to seek to find alternative routes to the market. At this early stage it is impossible to say how effective this will be.

Geographic markets

The iDTV betting service will be associated with channels which are broadcast across the UK. The broadcast, and the odds offered through the betting service, will not vary within the UK, so that the geographic market is considered to be the UK. The geographic markets for telephone and Internet betting are also likely to be at least as wide as the UK, but it is not necessary to reach a firm conclusion on this point.

Horizontal issues

Several points can be made about the overlaps which occur in betting markets:

On the widest possible market for all forms of betting service, the parties have an estimated share (see note 4) of less than 25%. This is almost wholly attributable to Ladbrokes, with an increment of less than 1% arising from Surrey Sports.
If a narrower view of either telephone or Internet betting is considered, then the parties' combined market share in each of telephone or Internet betting is less than 25%, with an increment of less than 3% in each case. Each of the market segments contains several other strong players. Such a share in a competitive market with low barriers to entry is unlikely to raise concerns. Furthermore, Surrey Sports is not one of the main 'betting brands', a combination of which may have raised more concern. It is therefore not necessary to reach a conclusion on the relevant market definition here, and the effect of the merger on these channels of betting will not be considered further.
In the market for iDTV betting, the parties will have a combined market share in excess of 25%, with an increment of 5-10%. Independent research reports have considered that 'in-vision' iDTV has the distinct advantage of the customer being able to simultaneously watch the event being bet upon, so that future growth is likely to be concentrated within this type of service. The JV would be well placed to capture the majority of this growth and its market share might further increase as a result of this transaction. However, there is a degree of uncertainty about current shares, reflecting the early stage of development of this sector.
On the narrowest possible market definition, that of interactive 'in-vision' betting services, the parties will initially have 100% of the market through the JV, although there is no increment arising from the merger. No other operator is currently able to offer 'in-vision' betting services combining both sports broadcasts and the ability to place bets whilst watching the broadcast. Research reports have suggested that this type of service may attract a different range of customers than LBOs. In particular, it is believed that customers will be younger, include a higher proportion of women, and more people who are willing to place impulse bets. The JV could have a substantial effect on the development of this service which is likely to grow rapidly, increasing the overall betting market.

Given that iDTV betting is a new and evolving market segment, market share figures are not reliable and it is more difficult to determine the likely effects of the JV than with a merger in a more mature market. Independent reports have estimated that the iDTV gambling market may be valued at £1.4 billion by 2004. BSkyB has (see note 5) set itself a target to raise its average revenue per subscriber unit from £313 in the year 2000/2001 to £400 by 2005. The iDTV market is regarded by many as a key growth area within gambling with the potential to attract a new profile of gamblers, compared to the declining or stagnant markets of LBOs and telephone betting.

All of the major betting enterprises (William Hill, Corals, Ladbrokes and the Tote) as well as new entrants (such as Blue Square) already offer, or intend to offer, iDTV betting services on a non-exclusive basis through rival pay TV platforms. They are, however, limited in the degree of competition they could offer to the JV on digital satellite, as the JV will be exclusive to the Sky Sports channels. Users are unlikely to switch from watching these to Open in order to place bets. There is therefore some concern that the exclusivity given to the JV, together with the strong ability and incentive of the parties to promote these services, may distort the development of competition in iDTV betting services.

First-mover advantage alone is not usually a reason for viewing a merger as potentially anti-competitive, since it can be a proper reward of risk or innovation. Investments to develop new services are generally to be encouraged, as they should benefit consumers, but there is a question whether the degree of protection afforded by the five-year period of exclusivity in the case at hand may be excessive and restrictive of competition.

Vertical issues

This JV links the provision of iDTV channels and services to the betting services provided on digital satellite television. The JV agreement contains exclusivity clauses relating to betting through BSkyB sports channels while simultaneously viewing the channel, and betting through BSkyB's Internet websites.

Possible foreclosure of the market for iDTV betting

The possibility of market foreclosure was the main cause of concern expressed by third parties. They considered that a five-year exclusivity period was likely to prevent significant competition on the DSat platform, where BSkyB is the principal operator. DSat is the most popular iDTV platform, with around 70% of iDTV households, affording advantages of scale and scope in developing services for this customer base. Exclusivity was thought likely to enable the JV partners to build on Surrey Sports' first mover advantage. Third parties also considered it unnecessary, as the JV would be profitable from an early stage. The parties, on the other hand, asserted that exclusivity was necessary to secure the promotional backing that would be required to make the JV successful.

In considering the scope for foreclosure, one question is the ease with which non-Sky channels could launch betting services on DSat, and the ability of cable and DTT platform operators to launch their own betting services linked to sports channels. The two main competing platforms to DSat are the digital terrestrial service offered by ITV Digital and digital cable (NTL and Telewest), but there appear to be technical issues which may limit their ability to provide 'in vision' services in the near future, so that competition from other platforms may be delayed. Recent press articles (see note 6) suggest that ITV Digital and Telewest have commenced negotiations with Global Interactive Gambling to provide interactive betting services via a TV Internet portal possibly in 2002. Their position is less favourable with respect to betting through sports channels. BSkyB has said that it would require a fee from any operator that wished to link a betting service to one of its channels (see note 7). Operators might therefore be limited, in the first instance, to linking a service with their own channels. ITV Digital has one premium sports channel, while NTL has a stake in a basic sports channel (British Eurosport). Telewest has no sports channel of its own.

With regard to potential competition on DSat, I have been advised that OFTEL's access control regulation will ensure that channel operators have access to all of the tools they need on fair, reasonable and non-discriminatory terms. The ITC has told me that it does not, in principle, see any reason why other commercial channels should not launch betting services associated with their own channels on DSat (although ITV1 is not yet available on this platform).

Markets for sports channels and sports rights

Product markets

The markets for sports channels and rights have been previously considered by the Monopolies and Mergers Commission in their investigation of the proposed merger between BSkyB and Manchester United plc (the MMC report) as well as by the European Commission (see note 8). In all cases Pay TV was considered to be a separate market from free-to-air TV. In particular the MMC report found a separate market for premium sports TV channels, in which BSkyB has market power. Premium sports TV channels are those which require additional payments above the basic subscriber fees for access to the pay TV platform. Appropriate market definition can change, especially within innovative industries. However, no convincing new evidence has been presented which suggests the adoption of a wider market definition in this case. Consequently, the perspective taken here is that there are distinct markets for the acquisition of sports rights, premium sports channels, and Pay TV.

Geographic markets

The geographic market is considered to be national. Sports rights are normally sold on a national basis, having a different value within each nation. Sports programmes and channels are broadcast nationally, though Ireland will sometimes receive the same version as the United Kingdom.

Vertical issues

The JV will establish a vertical link between the leading provider of digital pay TV and premium sports channels (BSkyB) and a leading betting company (Ladbrokes). A vertical link with betting already exists due to BSkyB's existing Surrey Sports business. Nevertheless, a link between Ladbrokes (which is a leading gambling brand) and BSkyB is of potentially far greater scale and significance than the existing link. Ladbrokes will bring significant management expertise in betting and will have every incentive to promote the service to new customers such that the JV is likely to grow much faster than if Surrey Sports were to continue alone.

Important considerations here are the additional advantages that may accrue to BSkyB above those already present. The growth in betting revenue, aided by the barriers to new entry into the 'in-vision' betting market, will give BSkyB the ability to afford to bid a higher amount for premium sports rights. This could affect competition for premium sports rights and, in turn, for pay TV subscribers.

Barriers to entry

BSkyB has established a strong reputation as a sports broadcaster, and has, over the years, bid for almost all of the available sports right (see note 9), either on its own or in combination with other broadcasters. As such it already has advantages over many of its competitors. It has a large number of subscribers which give it credibility in bidding ¾ many rights holders want their events to be seen by large audiences ¾ as well as the opportunity to obtain more revenue from its channels than other pay TV broadcasters. It also has the opportunity to offer revenue sharing deals with rights holders, by which rights holders could receive additional sums relating to the success of their events. Such deals could conceivably include a share of betting revenues.

A pay TV competitor wishing to launch a new premium sports channel would need to outbid other broadcasters and acquire a portfolio of rights sufficient to offer a credible channel. Since these rights are available at different times, and contracts may last from 3-5 years, it can take some time, and entail a significant investment, to assemble a portfolio. Given the uncertainty of demand for a new sports channel, such an investment entails a significant commercial risk both for the broadcaster and, potentially, for those rights holders with whom the company deals (see note 10).

ITV Digital has recently launched a new premium sports channel. This is a new development, albeit ONdigital started the process of acquiring rights in 1998, and it has yet to be seen how the channel will fare in the market. This channel has relatively few premium sports rights in comparison to BSkyB and ITV Digital will need to continue to acquire sports rights in order to maintain this channel.

BSkyB is not to be criticised for obtaining these advantages insofar as they reflect risks and investments undertaken in setting up their pay TV services. However, the JV, with its five-year period of exclusivity, could have consequences for competitive entry in the market for sports rights and, indirectly, in the provision of pay TV more generally.

effect of the JV

In examining this proposal, it is necessary to distinguish carefully between the effect of the JV and BSkyB's existing market position. In this respect, it is open to question whether the period of the exclusivity of the JV is necessary to provide the interactive 'in-vision' betting services. The parties have stated that exclusivity is required to ensure that the benefits from promotional activities fully accrue to the JV.

This exclusivity may afford the JV certain advantages which would not occur if BSkyB either continued with Surrey Sports or allowed several betting companies to offer these services. In particular:

If the JV does not face effective competition from other forms of betting then the exclusivity may allow greater revenue to be generated per subscriber than otherwise would be the case. This will provide BSkyB with revenue directly linked to sports rights and will increase its ability to purchase such sports rights. It can be argued that the current exclusivity with Surrey Sports would also allow this. However, it appears that brand names are particularly important in betting markets. I also note that the JV commits BSkyB to exclusivity when it currently has the flexibility to make non-exclusive arrangements with several betting companies (see note 11). Independent research has estimated that betting revenues could add 10% to the value of sports rights over the next few years.
Wider contentions have been made that the parties might use their equity interests in other media concerns to procure benefits in content which the JV would then be able to exploit through betting rights. I have not sought to substantiate these suggestions. However, the JV will align the incentives of Ladbrokes and BSkyB such that Ladbrokes will profit from BSkyB gaining further exclusive live sports coverage and from increased subscriber numbers. It further aligns both parties' interest in the BSkyB sports channels acquiring those rights most suitable for betting. Given Ladbrokes' existing links with sports contents providers such as the Bookmakers Afternoon Greyhound Service and potential competitors such as the Satellite Information Services Ltd, this could potentially provide BSkyB with informational advantages. I have noted third party representations that cross-promotional activities will also have an important impact. The parties clearly have significant resources to apply to such activities, but alternative promotional options are available to their competitors.
The JV could therefore potentially enhance asymmetries in competition to acquire premium sports rights, an area in which BSkyB already appears to have substantial advantages. Related considerations led to the prohibition of the proposed merger between BSkyB and Manchester United. However, I also recognise that substantive differences exist between these transactions. In particular, Manchester United had a financial interest in some sports rights in question. The JV itself is a response by BSkyB to the emergence of a new commercial opportunity, to which it is responding by bringing in expertise to help develop its services.

(see note 12) This raises questions, however, about the rationale for the exclusivity clause. Arguably it would appear less risky to license several betting companies to develop these services on Sky Sports Channels. BSkyB has also argued that interactive betting services can and are being replicated by other broadcasters who can use the additional revenue in the same way as BSkyB. In particular they have pointed to ITV Digital's potential to develop these services on their ITV1, ITV2 and ITV Sports channels, as could rivals such as Channel 4, which has a good reputation in broadcasting horse racing. These developments seem likely to occur over time, but there are reasons to believe that ITV Digital is unable to launch such services in the short term. ITV Digital has far fewer subscribers than BSkyB and consequently ITV Digital would be unable to generate such revenues in the same volume as BSkyB. The JV potentially exacerbates this asymmetrical situation.

Third party views

This proposed JV has raised considerable concern from broadcasters, rights holders and betting companies. Their concerns primarily related to the exclusive nature of the deal and the linkages between premium sports rights and betting. The betting companies were concerned that they would be effectively excluded from the largest digital TV platform market whilst broadcasters and rights owners were concerned that it would reinforce BSkyB's market power in acquisition of sports rights. Concerns expressed by competitors should be considered with a degree of caution, but these issues have all been considered above.

Undertakings in lieu of reference

This case raises a number of issues in developing markets which are not clear-cut, and it is not readily possible to assess the benefits which could arise from innovation. In these circumstances it has not been possible to identify particular undertakings which would fully address the competition issues raised.

Conclusion

The joint venture will result in modest increases in market share in the areas of Internet and telephone betting. I do not consider these areas to raise significant competition concerns.

The other services which the JV will offer, 'in-vision' iDTV betting services, are largely new. The advent of these services widens consumer choice and may attract a range of new customers to betting services. The development and take up of such services is likely to add to competition in the betting market generally. Moreover, innovators deserve rewards.

There are, however, two possible causes of concern about the development of competition. First, the JV's exclusivity provisions, which the parties claim are integral to the venture, may result in a less competitive evolution of interactive betting services than would otherwise be the case. Whether or not competitive disciplines from elsewhere in the market for betting would remove this potential adverse effect is hard at this stage to judge.

Second, it is important to consider possible effects on competition in vertically related markets, bearing in mind BSkyB's existing position in relation to pay TV distribution and especially premium sports content. There is in particular the question of whether BSkyB's mutually exclusive JV relationship with Ladbrokes has the potential to distort future competition for sports rights. This general question arose in relation to Premier League football rights in 1998 when BSkyB proposed to purchase Manchester United plc. The MMC found that proposed merger to be against the public interest, though the present case differs in significant respects.

This proposed joint venture presents a dilemma. In some respects it may enhance innovation and competition in the wider betting market. But its exclusivity provisions pose possible risks to the development of competition in interactive betting (which is forecast to be a large market within the next few years) and in the acquisition of sports rights. These risks require a more thorough examination, which the Competition Commission is best placed to undertake.

I therefore recommend that you should refer this transaction to the Competition Commission.