Like others, I spent a fair bit of time on February 23 reacting to the decision by the Commerce Commission to deny clearance to the plans of Sky and Vodafone to merge their businesses in New Zealand. It had been a long-running process under the Commerce Act, and our instincts suggested that clearance was becoming a line call.
In the end, the Commission went against the clearance, and seeing their detailed reasons for the decision in the coming weeks is going to make for interesting reading. On the day, Commission Chair Mark Berry made it clear that the key issue was the tying up of high-value premium sports broadcasting rights.
So why did we at InternetNZ care about this?
There were three main fears we had about the impact of a merger. We never said “no merger please, ComCom!” – but we did ask the Commission and the players to think about issues that often live under the heading ‘network neutrality’. It’s an uncomfortable term in New Zealand, but I won’t spend your time or mine trying to define it. Instead, let’s talk specifics.
One fear was that the merger would tilt the playing field of the market for broadband access. Vodafone tied up with Sky would have the ability and incentive to create “bundles” – think broadband access + Sky content + voice (landline and/or mobile) – that other providers wouldn’t be able to match.
They could do this because they would have the ability to supply themselves with content on terms they didn’t offer to other Internet Service Providers (ISPs) other than at high wholesale prices. This could have made Vodafone broadband bundles more desirable in ways other ISPs couldn’t match (premium sport to the fore). We believe in fair open competition in markets for Internet services, and this would push things in a less competitive direction.
A second and related fear was that the merger would reduce the likelihood of the new entity offering reasonably priced wholesale offers for other ISPs to use in offering access to Sky content. If Sky up and Vodafone were tied together, it seemed that it would be even less likely that a compelling wholesale offer would be forthcoming. There has been little take-up of wholesale content from Sky by ISPs so far, other than by Vodafone. That would be even less likely post-merger.
ISPs report that the prices are currently too high to take most if not all Sky wholesale services. With the merger, Sky would have a very real incentive to work with the rest of the merged business, rather than to try and sell its content on reasonable terms. It would have strong incentives not to drop the those high wholesale prices for content, as that would take away the main benefit of the merger.
Expert economists in this area, some of whom provided evidence to the Commission on behalf of parties opposing the merger, were clear that if the merger did not go ahead, Sky would need to, and have incentives to, wholesale its content to ISPs at prices that would encourage ISPs to resell Sky services. That points towards reduced wholesale pricing.
As things stand, Sky’s subscriber numbers are falling – and prices for rights to content are increasing. So much so that Sky’s net profit after tax has dropped nearly a third over 12 months. This is part of an overall trend.
By encouraging wholesaling via having reasonable wholesale pricing, Sky can expand its footprint and revenues via its wholesale and retail business. That’s what’s happened for example to Sky’s equivalent in the UK, BSkyB. If the merger had been cleared, the trend would have been the other way.
A third fear is a little more distant. Sky still uses satellite to deliver most of its content, though that is slowly changing. If Sky, with that legacy technology, was to tie up with one telco in particular, that could reduce the incentives for them to make new products and options that are friendly to the ultra-fast broadband networks that are rolling out across New Zealand. We’d rather see those networks well used, than to see further incentives to buttress legacy technologies like satellite. We think it is important that the settings are such that fibre uptake is encouraged and this merger would slow down uptake.
Those fears were ones we and others raised in submissions to the Commission and from what we can tell of their process, including the “letter of unresolved issues” from 2016, the Commission did take them seriously.
What none of us know yet is precisely how the Commission concluded it couldn’t clear the merger. We don’t know whether Vodafone or Sky will appeal the Commission’s decision once the reasons become public.
So: what’s next?
The Internet is – usually – great at disaggregating things that used to be vertically integrated. While I can see why Sky would have wanted access to Vodafone’s greater tech savvy in developing more Internet-friendly products, and Vodafone wanted that “must have” content, that’s off the table at least in a merger context. The merger would have slowed or halted for some time that disaggregation, to the detriment of consumers and Internet users.
The value in Sky seems to be in (a) acquiring rights to content and in putting together packages that people want to buy, including “must have” content such as premium sports, and (b) its legacy distribution channel over satellite with locked-in rights for some years to come, and low incremental cost of adding extra customers.
The Internet seems like the perfect method to solve the future of Sky’s distribution side. It's more flexible than on-demand from a set-top box and Sky could use its expertise to keep refining and building the sorts of bundles people want, and finding the best value for the most people, agnostic about the distribution channels. That would let Sky let (c), the satellite infrastructure, fall away over time.
In the medium and long run, the big squeeze on companies like Sky is that ongoing disaggregation trend. It cannot be long before we see major New Zealand premium sports organisations trying their hand at offering content direct to the public, as is happening overseas. Sky (and Vodafone if it merged) have major premium sports rights locked in for 3 to 5 years, depending on the sport. They have some time to adjust. After that, though, life will get much tougher.
The Internet and modern technology make disaggregation of distribution channels trivially easy these days. Getting best-of-breed tech as the long tail of satellite contracts slowly falls away seems like it should be a priority. Even then, it’s not clear whether companies like Sky – in their current satellite based form – will be around in five or ten years.
The expert economists’ reports on behalf of those opposing the merger were strong in their view that, just as has happened in the UK, Sky – absent the merger with Vodafone – will move to expand its footprint and encourage wholesaling by ISPs, with services provided over the internet, by lowering its wholesale prices. It will move away from shoring up its direct customer footprint, by encouraging wholesaling, and viewers getting content via other retailers. That seems to be good for consumers and good for Internet users.
How about Vodafone? They’re a mixed bag: mobile and fixed networks, some content offerings, broadband packages, and an ongoing challenge in integrating and pulling together providers they have bought over the past few years.
Vodafone NZ can benefit from the trend towards content disaggregation, as it does what Vodafone Group is doing internationally: expand its offerings to include content. It will be easier for Vodafone to obtain a wider array of content to the extent that rights aren’t locked up in large pay-TV broadcasters. So while this particular effort hasn’t worked out as Vodafone may have hoped, it does not spell universal doom and gloom.
In the end, the Internet is changing everything. February saw Vodafone and Sky in the headlines. NZME/Fairfax will be later this month. That's a different challenge – the uncoupling of advertising revenue from content production. But it's still all about the Internet.
Jordan Carter is the chief executive of InternetNZ.