Inquiry

CULTURE, MEDIA AND SPORT COMMITTEE INQUIRY INTO AUDIO-VISUAL COMMUNICATIONS AND THE REGULATION OF BROADCASTING

OFTEL’s Second Submission

March 1998

1 OFTEL welcomes the opportunity to present to the Select Committee its analysis of the future of electronic communications, including broadcasting, and its proposals for change.

2 Electronic communications are fundamentally changing. The process of change began earlier for telecommunications than for broadcasting, but both are now converging with digitalisation and the decline of capacity constraints. These changes mean that the basis on which broadcasting has been regulated as a national, public, wireless, point-to-multipoint service should change. Technologically-based distinctions between wired and wireless communication, and point-to-point and point-to-multipoint communication are eroding fast. And the boundaries between public and private communication and national and international services are blurring.

3 OFTEL’s remit as defined in the Telecommunications Act already addresses the converging electronic communications domain. The Act defines OFTEL’s jurisdiction as concerning systems “for the conveyance through the agency of electronic, magnetic, electromagnetic, electrochemical or electromechanical energy of (a) speech, music and other sounds, (b) visual images, (c) signals serving the impartation of any matter otherwise than in the form of sounds or visual images and (d) signals for the actuation or control of machinery or apparatus.” OFTEL, however, fully recognises that its expertise lies in economic regulation and consumer protection rather than in cultural and content issues.

4 In this document OFTEL uses the term electronic communications to mean all communications which use electromagnetic transmission. The term thus includes broadcasting and telephony and certain features of devices attached to electronic communications networks. OFTEL recommends that this definition of the electronic communications industry is adopted as the proper scope for policy making and legislation.

5 OFTEL suggests that the changes in legal instruments (legislation), the new rules, and regulatory structures proposed below need to be implemented at the earliest opportunity if the UK economy and individual citizens are to benefit fully from the Information Age. There are a number of reasons for this recommendation.

6 OFTEL recommends that the regulation of the electronic communications industry should be grounded in the following principles:

7 OFTEL welcomes the Competition Bill now before Parliament. It will provide a firm base for resolution in the public interest of many of the issues raised by technological change, new market structures, and new opportunities to create and abuse a dominant position.

8 Nevertheless, OFTEL recommends that legislation setting out further rules for the regulation of this sector are required. Specifically it is recommended that

9 In addition to the Competition Bill and these new economic rules, OFTEL recommends that three further types of rules are required: rules for the achievement of Government defined social goals: rules for the regulation of content: and rules for the regulation of ownership.

10 The social rules should aim to ensure that all UK citizens have access at affordable price to the information and communications services required for them to participate in society. This is about universal access. Government should define the constituents of universal access, and set out areas – like disconnection – where extra consumer protection is needed.

11 On content rules, OFTEL recommends that the regulator should not tilt at windmills and try to achieve what cannot be done. A shift from the broadcast transmission of content over relatively few channels – to which Government has controlled entry – to user browsable content including video on demand, means that content regulation must change. OFTEL recommends that the focus of regulation must shift from the direct regulation of content to regulation to enable control of access to content and from statutory to consumer-centred regulation. In consequence content regulation should be based on

Self regulatory classification of browsable or user selected content, referenced to content codes drawn up by self regulatory bodies in consultation with the relevant statutory body.

12 OFTEL recommends that because of the clear importance of electronic communications for the operation of a well functioning democracy, established rules on the concentration of media ownership should continue. However, it must be recognised that, as convergence progresses and people’s media diet becomes more varied, the effectiveness of ownership regulation will decline and may become less important. Nonetheless, ownership regulation provides an important democratic “insurance policy.”

13 OFTEL recommends that the following additional rules should be required during the period of transition (however long that might be) to the “open state.”

Rules to inhibit dominant incumbent firms from abusing their market power.

14 It follows from these recommendations that many established rules in broadcasting and telecommunications regulation will no longer be required and many will in any case be ineffective. OFTEL also believes that the time is ripe for simplification of the structures and institutions of electronic communication regulation. In particular OFTEL recommends the rules which regulators of electronic communications should apply are based on a general authorisation to enter markets rather than on the old principle of restricting market entry by licensing.

15 Section 6 addresses more precisely how the proposals above would meet particular competition, social and cultural concerns. Of key importance are recommendations in three areas.

How can consumers be given maximum choice of supplier, of information, and of services?

16 OFTEL recommends that new rules on opening up interfaces and making infrastructure available to third parties on fair, reasonable and non-discriminatory terms are required, so that others can supply services over existing infrastructure while rewarding investment in infrastructure creation. Specifically the general authorisation for operation of an electronic communications system should require publication of interface specifications.

How to guard against an unfair division of society into information “haves” and “have nots”?

17 OFTEL’s recommendations focus on getting everyone connected on an affordable basis to networks within an access control system, if necessary via Universal Service Fund arrangements. In addition, the public availability of terminals and training is required, with particular emphasis on those with disabilities.

18 OFTEL proposes that the Government should continue to support established not-for-profit public service broadcasters. It will be important to link the BBC licence fee more closely to the costs of its inputs. OFTEL believes that public intervention is necessary during the transition and probably also even in the “open state,” to ensure all UK citizens have access to the impartial high quality information required for their participation in economic, social and political life because mature electronic communication markets may not adequately supply “merit goods” and serve minorities. However, OFTEL recommends that Channels 3 and 5 should be freed from their obligations as public service broadcasters and the spectrum/franchises to run commercial terrestrial broadcasting services should be auctioned.

19 OFTEL recommends that there should continue to be a clear division of responsibility between Government and regulator, and that the regulatory structure and arrangements for consumer representation should be changed.

20 OFTEL agrees that Government should set the overall policy framework: define social policy goals eg: the composition of universal access; and ensure financial support for provision of services missing from the market – notably public service broadcasting. The Government also has the central role in overall radio frequency spectrum allocation policy and in national security matters.

21 The regulatory role is to ensure effective implementation of Government defined goals, to provide effective economic/social and cultural regulation of a specialised sector using their expertise and to do so independent of day-to-day control by Government.

22 OFTEL recommends that the existing structure of electronic communications regulation requires reform. It imposes significant costs on the UK economy and on Government. Moreover it does not provide for an active representation of consumer interests or clear and appropriate means for consumers to secure redress.

23 As set out in the diagram (click here to view diagram) OFTEL recommends that two regulatory commissions be established.

24 OFTEL recognises that there are some costs notably in the interaction between the different statutory objectives of two regulators but nevertheless believes that the benefits outweigh the costs of necessary overlap and rejects the alternative models of an infrastructure/services split, or a unitary body.

25 In addition OFTEL recommends the establishment of a statutory Electronic Communications Consumer Council to advise the regulatory commissions and act as a focal point for consumer representations and redress.

1.1 OFTEL’s Document Beyond the Telephone, the Television and the PC. II (the first part of OFTEL’s submission to the Select Committee) considered the technological developments which are changing the telecommunications, broadcasting and the IT industries. OFTEL also identified public policy objectives for the converged electronic communications sector.

1.2 In this paper, its second submission to the Select Committee, OFTEL puts forward concrete proposals for the achievement of these objectives. Notably, to establish a regulatory regime which benefits UK consumers and the broader economy and which will enable the UK to capitalise on its existing strengths in the electronic communications sector. Central to OFTEL’s analysis and its proposals is the recognition that historical, technologically-defined, distinctions between point-to-point and point-to-multipoint electronic communications, between national and international electronic communications, between wired and wireless electronic communications and between the content supplied in any particular media or mode of carriage are fast eroding. These changes have profound implications for public policy, industrial strategy, consumer interests and regulation in the United Kingdom.

“How can regulation maximise benefits to UK citizens and consumers in the new digital electronic communications marketplace?”

NOTE: In this document OFTEL uses the term electronic communications to mean all communications which use electromagnetic transmission. The term thus includes broadcasting and telephony, certain features of devices attached to electronic communications networks.

1.4 To address that question, OFTEL believes that because there is a fundamental change in both an eventual “open state”converged electronic communications environment and the more immediate problems of a period of transition must be considered. Although, in reality, this “open state” will not be a steady state (because technical change will continue) the change is so significant that it needs to be addressed independently of other possible, future changes. There are two fundamental transformations of the sector (which have already started) which are responsible for this, and against which all future policy options must be tested. These changes are:

1.5 The first condition will be met as a result of digitisation and continued investment in satellite, cable and other distribution methods, while the second will come about through the spread of access control systems to most distribution networks. A5-10 year time horizon for this transformation to take place is probably realistic. Until this happens the UK will be in a transition, where some, but not all, own access control systems (which allow them to enter into a direct commercial relationship with the suppliers of electronic information delivered over electronic networks) and transmission capacity is increased, but still does not meet all potential demands.

1.6 OFTEL believes that it is both possible, and realistic, that the positive potential of technological change will be realised through well-functioning competitive markets serving the interests of UK consumers. But the long term might conceivably be characterised by oligopoly by relatively few firms dominating markets. If this happens, consumers are likely to forego potential benefits in the form of new and improved services which are likely to arise only from vigorous competition. Additionally, there will be a continuing risk of abuse of market power to the detriment of consumers.

1.7 Accordingly, rules will be needed to manage the specific problems of transition to foster a positive open state and outcomes which will maximise benefits to consumers.

1.8 The pace of change does not leave much time to get the rules right. The fundamental changes have already started, and they undermine the foundations of the current regulatory regime. By the time a legislative slot is found for a new Electronic Communications Bill to put the regulation of the sector on a sound footing the commercial structure of the sector could already be set.

1.9 In this submission OFTEL proposes a portfolio of “rules” for the achievement of an outcome that maximises the benefits to consumers and UK plc (See Section 4). Getting the rules right is the most important part of getting regulation right. The institutional mechanisms for the application and enforcement of the rules is a secondary, albeit important, issue. However, OFTEL believes that institutional change is needed if the rules are to be fairly applied and effectively enforced. The submission is organised as follows:

2.1 Electronic communications, in the form of telephony, broadcasting and IT, contributes around 5% of UK GDP, provides around 700,000 jobs, and is growing fast. The UK is the EU leader in this sector which the 1993 Delors White Paper on Growth, Competitiveness and Employment identified as one of the most promising for wealth and jobs generation in the 21st century.

2.2 Electronic communications also has a wider influence on economic growth and prosperity because it provides major inputs to other industries. For example, telephony is a key input for insurance and banking, computing services are vital to a wide range of service and manufacturing sectors and UK broadcasting (and the saleable information sector generally) contributes to overseas trading partners’ perceptions of the UK. Information and communication technologies have significantly improved productive efficiency and the UK’s international competitiveness. If the UK can maintain its lead in electronic communications it will have a key source of competitive advantage in the 21st century.

2.3 Liberalisation and competition have improved productivity, lowered prices and stimulated innovation. For example, the price of telephony has halved in the last ten years and competition has fostered the development and introduction of new services. In broadcasting the growth of independent production, fostered by the opening of programme supply markets, has realised similar benefits. Prices of IT hardware continue to drop very rapidly.

2.4 The electronic communication industries also provide other important benefits to UK citizens, including improved access to valued entertainment and information from around the globe available 24 hours a day, on demand; and delivery of high-quality education services to remote locations. Choice and diversity has increased and is likely to increase through, for example, additional TV channels and the development of interactive services. The transformation of the sector will also make possible better delivery of Government services into the next century.

2.5 Because of its relevance to a wide range of economic sectors, and the opportunities it offers for innovation and growth, the electronic communication sector’s importance to the economy is likely to increase substantially over the next few years. Many of the fundamental changes to the sector which will shape its character are happening now. Getting the right regulatory and competition framework for this sector is vital.

2.6 The electronic communications sector is, and will remain, different from other sectors of the economy. Some of its distinctive features may be short term but others are likely to be permanent. These features have significant implications for regulatory practice. They are relevant both to an ‘open state’ – when there is universal access control (ie all consumers can enter into a direct commercial relationship with the suppliers of electronic information delivered over electronic networks) and no scarcity of transmission capacity – and to the period of transition.

2.7 What makes the electronic communications sector different from other sectors of the economy? Firstly, both the telephony and broadcasting industries have been shaped by their particular histories. In both sectors, Government sponsored the creation of dominant incumbents. First through publicly owned statutory monopolies and later, when commercial firms were permitted to enter markets, through public authorities’ limitation of market entry to favoured firms. The legacy of dominant incumbents continues to shape UK electronic communications and will do so for some time. Secondly, the economic characteristics of production and/or consumption of electronic communications are unusual. Not least because of what are called the network externalities (network access, interoperability and call termination) which arise because there are two ends to the call. Correcting the network externalities in the public interest requires commercial arrangements which are unlikely to arise without regulatory intervention. There are also regulatory issues concerning the realisation of the potential social benefits which arise from the non rival characteristics of information (whereby an extra unit of consumption of information – for example, one more person watching a television programme – can be achieved without an increase in costs).

2.8 In addition, the costs of providing wire-based services are such that most customers are unlikely to take service from more than one supplier – this, combined with the high costs of switching suppliers and/or externalities can lead to a bottleneck in access to networks. This provides a key basis for regulatory involvement. The same conditions apply to access control systems in broadcasting, that is, customers are likely to have only one set-top box. A further key difference between the electronic communications sector and other economic sectors, lies in the ‘market failures’ which exist. For example the various externalities, (costs and benefits which can not be reflected in price mechanisms), associated with the provision of telecommunications networks – to take one example, the separation of call payment from choice of terminating operator provides the latter with an ability to set high prices. In broadcasting, a sector specific feature (albeit one which may have beneficial social consequences) lies in the fact that it introduces economic inefficiencies to charge for marginal usage, because marginal costs are zero. This makes licence fee and advertising funding potentially attractive funding methods. On the other hand, these funding mechanisms do not reflect people’s willingness to pay and, because they do not allow consumers to signal their preferences via price, they result in a different economic inefficiency. However, direct payment will itself exclude some customers who could be served at no extra cost. So, although new technologies will allow pay per view and subscription-based charging, a tension between funding systems which offer access for all and those which necessitate the exclusion of some will remain. Striking the appropriate balance in the public interest may require regulatory involvement.

2.9 The broadcasting sector has, in addition, traditionally been distinguished from most other sectors by a number of public policy, rather than economic, considerations. These considerations include; concern over the content of programmes; a desire to ensure plurality and diversity of ownership in the commercial provision of content; securing commercially (and politically) neutral reporting; and a desire to ensure that some classes of information are made available to all citizens at affordable prices. These public policy concerns will remain, although some of them may be met through unfettered operation of the market if competition is effective.

2.10 Moreover, it is possible that effective competition will not develop in all sections of a converged digitalised electronic communications market. Five years or more into the future, the electronic communications sector may still be characterised by high barriers to entry in the provision of new transmission networks or new access control systems (although the networks which do exist may not be capacity constrained); by economies of scope and scale within transmission networks; commercial disincentives to interconnection and interoperability with competing networks (including transmission networks and networks of competing computers and computer software) and by very low (or zero) marginal costs of consumption of content. Moreover, even if content providers enjoy unfettered access to transmission systems, intervention and regulation are likely to be required to reduce negative externalities (too much "bad" content) and maximise positive externalities (ensure enough “good” content).

2.11 During the period of transition from the status quo to a mature “open state” (a period which will last for at least the next five years) there are likely to be significant sections of the population who neither have access to non capacity constrained networks nor to conditional access systems.

2.12 The economic value of radio spectrum is now well recognised. In 1995/96 the total contribution of radio based services to UK GDP was estimated at ?28bn, and to be growing at 11.5 % every year. In the fastest growing area of cellular telephony growth rates are over double this figure and most analysts expect this level of growth to be maintained over the next decade. As consumer demand for interactive multimedia services grows, demand for mobile multimedia services, as well as for services to home and office, is likely to rise in line with established trends for voice telephony. These trends will provide strong incentives to reallocate radio spectrum. Traditional, relatively inefficient uses of spectrum, such as analogue terrestrial broadcasting, will give way to high value added services, such as mobile multimedia, assuming spectrum prices reflect true market values. Reallocating spectrum offers Government the potential to realise greater revenues from a public asset and offers UK plc opportunities to do its business more efficiently (and develop a new portfolio of manufacturing and service products for export).

2.13 Digitalisation and alternative transmission media, such as fibre optic cable and communication satellites, will progressively reduce barriers to entry to conventional “one to many” broadcasting markets, and hence will reduce the importance of spectrum scarcity as a factor constraining access to this market. However, increasing demand for mobile provision of multimedia services, for which radio is the only viable medium, means access to spectrum will remain a bottleneck for providers of these services for the foreseeable future. Spectrum allocation problems show both that policy and regulatory issues must now be thought through in a “converged” way, and that a consistent policy and regulatory framework is required if access to the electronic communications market is to be both transparent, fair and equitable on the one hand and economically efficient on the other.

2.14 The Wireless Telegraphy Bill is expected to receive Royal Assent in the next few weeks. By introducing auctions for the allocation of major new radio spectrum an important step towards technology and application neutral allocation of a scarce public asset (and realisation of economic value for the public) is being taken. The first such auction, for the mobile multimedia service known as UMTS, is expected to take place early next year. For the first time the market rather than the Government will set the price of spectrum access. However, this represents only one step towards the creation of a true market in radio spectrum, an essential development if the full benefits of convergence are to be realised and a satisfactory return achieved from a public asset. OFTEL believes that further measures, to build on the Wireless Telegraphy Bill, are needed such as the introduction of secondary spectrum markets, so that spectrum can be traded between users to reflect shifting patterns of demand. The long term objective should be to remove the regulatory role as far as possible and rely on market forces, backed by general competition rules, to optimise use of this valuable public resource.

2.15 The future of analogue broadcasting spectrum is itself a sensitive issue affecting almost everyone in the UK who rely on it for access to their primary source of information and entertainment – terrestrial television. OFTEL will be responding fully to the joint DCMS and RA enquiry on spectrum allocation in due course. But, to foreshadow an important element of OFTEL’s response to the enquiry, OFTEL believes that, except when a specific public service obligation applies to spectrum users (eg the fire service, the police and public service broadcasting) spectrum should be priced to reflect its full economic value. OFTEL proposes that the value of spectrum be determined by establishing spectrum markets (ie auctions) subject to any necessary international considerations.

2.16 OFTEL also advocates a more flexible and transparent approach towards management of the radio spectrum. This should include, insofar as it is consistent with international constraints and obligations, removal of the existing demarcations between broadcasting and telecommunication services to facilitate the development of convergent multimedia services. This would build on the precedent of digital broadcasting licences which permit up to 10 per cent of transmitted content to be for non-broadcast applications and which make possible the inclusion of text and images in digital sound radio services. It would facilitate market entry for firms delivering interactive multimedia services, for which conventional wired infrastructures may not be suitable, and move towards "technology neutral" electronic communications policy and regulation thereby promoting efficiency and innovation.

2.17 The current two-tier licensing regime under which radio services are licensed under the Wireless Telegraphy Act and either the Telecommunications or Broadcasting Acts should be replaced by a single authorisation. It should make specific provision for consumer interests, an issue which is increasingly important in a free market environment and which OFTEL has already raised in connection with the current Bill.

3.1 OFTEL is in no doubt that regulation of telecommunications and broadcasting must change. Existing UK arrangements are not sustainable. Already there are strains in the system. There are overlaps and duplications in regulatory jurisdictions – for example, both ITC and OFTEL regulate electronic programme guides – leading to possible ‘double jeopardy’ for companies and confusion for customers. Rules are currently based on particular delivery mechanisms, not on the services delivered to end customers, and produce a tilted playing field inhibiting fair competition and consistent regulation.

3.2 In a “converged” digital world voice, data and audio visual content will all be delivered across many distribution networks. Individual messages will be routed across both wired and wireless transmission media – whether via terrestrial broadcast, mobile radio, satellite, cable, fibre or copper. Increasingly, these alternative message paths will both be substitutes for each other and interdependent on each other. More and more, consumers will actively engage with the services offered and choose the content they receive. These changes are already upon us. By the time any new primary UK legislation takes effect UK consumers are likely to be able to:

3.3 Multiple services will be delivered over the same system; most systems will be able to deliver all services, those operating many systems will not know what services are being carried over them at any particular time, and transmission capacity will not be scarce. Only regulation that recognises these fundamental shifts in electronic communications will be successful. Current regulation does not.

The changing regulatory mandate in broadcasting and telephony – redressing the new market failure

3.4 Under the “old” conditions, of spectrum scarcity and a reliance on advertising to fund commercial supply of audiovisual content, regulation has been used to achieve:

3.5 Prior to liberalisation, this mandate was delivered through a combination of publicly owned institutions (eg BT and the BBC) and a limited number of closely regulated firms (eg ITV companies). Both means of delivering this mandate – public provision and closely regulated firms – were conditional on Government control of entry to relevant markets. Government control of entry has been substantially eroded and will continue to decline as capacity scarcity diminishes and networks capable of carrying broadcast programme material become increasingly transnational. Technological change has played a major part in this (eg in the successful launch of Sky’s satellite television services to UK viewers in 1990 using a Luxembourg satellite and the consequential failure of the IBA licensed “monopoly” UK DBS service BSB) but so too has regulatory change – notably the European Union’s market opening initiatives of “Television without Frontiers” and the Full Competition Directive. This has been most striking in respect of the regime applying to commercial firms but its impact on public sector bodies such as the BBC is also significant.

3.6 In consequence, public policy goals which require a supplier to behave in a way that is not in its commercial interests can no longer be secured by attaching highly specific conditions to the licences of particular suppliers – since doing so disadvantages the licensed firms relative to competitors using alternative delivery means (and which are not constrained by similar licence conditions). Where companies face effective competition, their inability to finance additional obligations means that the regulator is often unable to enforce obligations prescribed in licences if the firm in question either petitions for licence conditions to be eased or simply decides to ignore the licence requirements. Anticipation of this result weakens the effectiveness of the obligations even further. This is not to say that the old regime has, or will, disappear overnight. Only that it cannot provide a long term basis for fair, consistent and effective regulation in the future.

3.7 Failure to establish a new regulatory framework that will work effectively is likely to have very serious consequences. A positive climate for investment is incompatible with regulatory uncertainty which, in turn, follows inevitably from a plurality of regulators each requiring different and possibly conflicting objectives to be met. Lack of investment now will result in the UK falling behind other countries in the provision of Information Age services and, because of the importance of electronic communications as inputs to economic activity in general, in other sectors of the economy.

3.8 The UK cannot wholly create its own electronic communications destiny. Its decisions, (or lack of them), will determine both the extent to which firms locate in the UK and the extent to which it can continue to influence international, and particularly European, policy and regulatory agendas. Failure to address these issues does not mean the status quo will continue. Rather it means that the status quo will fail, and change will be imposed on us by others.

3.9 At the heart of the existing regulatory failure is a reliance on the licensing (and hence control) of communication systems in order to achieve particular characteristics of the services delivered over them. When the organisation running the system does not know, and can not control, what services are running over it that organisation is not in a position to deliver the service specification. If such objectives are to be obtained from regulation then the provision of the service (not the transmission system) must be subject to the relevant rules. When service providers face competition then those rules must apply to all such service providers if they are to be effective. This means regulating them directly – which in the case of content providers would mean the regulation of all content providers (pictures, text, multi-media – because all of them will be capable of using all forms of content) who use electronic communication systems to deliver their messages to their customers. In a world of no capacity constraints (and hence the possibility of unlimited number of content providers, located anywhere in the world) this is neither realistic nor desirable.

3.10 Even when the existing regulation appears to directly addresses the service in question (eg the positive programming requirements in the Channel 3 and Channel 5 television licences) the service definition is co-extensive with definition of a delivery system and, more importantly, the power to impose these requirements arises from the scarcity of suitable delivery systems. As suitable delivery systems multiply and services and systems become "decoupled," and provision of services is less and less closely mapped onto particular, scarce, delivery systems, this regulatory approach comes under more and more strain, and is likely to fail.

3.11 Other issues arising from OFTEL’s review of the established UK regulatory regime are discussed below, and the principle policy issues which will characterise converged electronic communications markets are identified.

3.12 Interoperability of networks and of customer equipment has traditionally been assured through a standardised definition of the interface between customers’ equipment (be it a telephone or a TV) and the system to which it is attached (the telephone network, the particular frequencies used for TV broadcast in the UK respectively). Again, this mechanism assumes that the service being delivered is specific to the network to which the equipment is attached. Once system and services are “decoupled” established practices are insufficient to secure interoperability and to ensure that customers’ equipment will successfully deliver the service available over the network. However, this decoupling will not necessarily achieve interoperability through competition alone. Regulatory intervention is required to secure the public interest in new circumstances.

3.13 Moreover, services are being offered in such a way that it is the service provider(s), not the customer, who controls the specification and operation of the system. Many powerful new services can only work if a number of different players, none of whom can efficiently supply all elements of the delivery and service chain, agree to use interoperable equipment and software. This interdependence offers firms with market power at one point in the chain the ability to set the terms on which the whole chain operates. If the interoperability required to enable a complex system of interactions is to be achieved, without endowing particular firms with the ability to lever their bottleneck market power in one part of the system across the whole of it, regulatory intervention is required.

3.14 IT service providers are increasingly drawn into the provision of services based on, or which require interoperation with, public electronic networks. Historically the IT sector has not been subject to sector specific regulation like broadcasting and telecommunications. Isolated, non-networked systems, without any public character did not raise public policy concerns. Competition, and competition law, has hitherto been seen to be sufficient to secure the public interest in IT. However, extensive private networked systems, such as those used for computerised reservation systems, have already aroused significant competition concerns. Such systems are already subject to special behavioural rules (albeit resulting from the application of standard competition law rather than sector specific regulation). Similarly, although the internal operation of IT systems has not led to regulatory intervention (eg to impose standards), the emergence of very dominant positions by proprietory operating systems has lead to action under competition law resulting in restrictions on dominant suppliers.

3.15 The networks over which IT services are delivered are becoming more extensive (the Internet covers most of the world), more public (anyone can get access to the Internet) and the system – network and equipment attached to it – is becoming more generalised and not service specific. All these trends indicate that interoperability will become more and more an inescapable public policy issue. And because the range of services that can be delivered over systems such as the Internet is so vast, interoperability will necessarily be complex. The centrality of these systems to the information economy also means that interoperability issues have a significant impact on the rest of the economy.

3.16 If the networked part of the IT sector is becoming more like the telephony and broadcasting sectors then, inevitably, consideration must be given to whether it will also be subject to similar market failures and, therefore, whether regulating it in a similar way as the other sectors will be beneficial. The very close similarity of characteristics of public network IT services to the developments in electronic communication services suggests that similar regulation will be appropriate across all parts of the sector. Indeed, convergence is making them economically indistinguishable. Thus, market forces alone are unlikely to secure the positive outcomes which the public interest demands, whereas a well conceived system of rules applied by an effective regulator across the whole electronic communications sector including, therefore, the public network aspects of IT, could do so.

The existing regulatory structure has two, inter-related, fundamental weaknesses.

Additional patching and mending will not deliver a sensible regulatory structure, and nor is likely to actually deliver the objectives of the regulation. It will at best perpetuate the existing problems and is likely to make them a lot worse. Because of the centrality of this sector to the new Information Age, the consequence for customers, and UK plc, are very serious. A fundamental overhaul of the existing rules and regulatory institutions is necessary to ensure that UK plc maintains, and builds on, its comparative competitive advantage in this sector.

4.1 The previous section explained why existing rules and regulations for electronic communications are inadequate to meet contemporary and future challenges. In this Section OFTEL proposes a new set of rules for the regulation of electronic communications to meet the needs of the UK into the 21st Century, and describes briefly the mechanisms through which they could be applied. The next section explores the nature of the institutional structure best suited to deliver the new rules. The final section explains in more detail how these new rules would secure specific economic and social policy goals.

4.2 A stable and predictable regulatory regime is vital to foster investor confidence and enable infrastructure and service development to flourish. This regime should:

4.3 Although the long term distinguishing features of the electronic communications market mean that for the foreseeable future the sector will not conform fully to standard competitive market structures, as competition increases electronic communications markets will become more like other sectors of the economy. This means that electronic communication regulation should change. The frameworks and the detailed rules provided by the Telecommunications and Broadcasting Acts should be replaced by different – and slimmer – frameworks and rules appropriate to digitalised and converged electronic communications. The proposals for radio frequency spectrum allocation in the Wireless Telegraphy Bill should be extended to foster a fully functioning market in radio spectrum, including secondary trading, and consolidated with new legislation for electronic communications. This means a split in the Radiocommunications Agency between the functions which should remain a Government responsibility (eg international negotiations over allocation of the orbit/spectrum resource) and others which should properly form part of the remit of the regulator(s) of electronic communications.

4.4 Competition in both infrastructure and services has been an effective instrument for the achievement of public policy objectives in telephony and IT. Promotion and development of competition within the telephony and related markets has benefited stakeholders – consumers, investors and the national economy as a whole. Its most significant positive impact has been in the improvement of the quality, choice and price of services received by customers. Competition, complemented by regulatory powers to ensure achievement of social policy goals and to deal with the long term structural market failures which distinguish the communications market, is therefore likely to be the best means of stimulating innovation, quality, choice and lower prices for consumers in the future. In consequence, as competition increases sector specific regulation should be conducted with an increasingly light touch and with an increased reliance on general competition law.

4.5 This approach has been successful in traditional telecommunications. As competition has increased, OFTEL’s regulatory focus has shifted from protecting consumers against potential monopoly abuse to promoting effective competition. OFTEL has done so by policing competition and fair trading rules and preventing anti-competitive behaviour in the marketplace

4.6 This shift in emphasis, together with the introduction of the Competition Bill, will have a profound impact on the way regulation works. OFTEL believes it to be a powerful model with general implications for the questions considered by the Select Committee. Sector specific regulation was set up at a time when UK competition law was relatively weak. In consequence, there was a danger that new entrants could not be confident of fair competition in markets where incumbents had such powerful established positions – positions which past Governments had seen as necessary to secure the public interest in both telecommunications and broadcasting. Thus, additional rules were applied to the incumbents to enable competition to thrive and to secure an effective market. In telecommunications, OFTEL was charged with the duty and power to foster and encourage fair competition through ex ante rules which proscribed anti-competitive behaviour more specifically, and thus more effectively, than the Competition Act 1980 and Fair Trading Act 1973.

4.7 The Competition Bill (if passed), in harmony with established EU competition law, could mark a critical step in the evolution of regulatory control in UK telecommunications as it removes many of the weaknesses of the existing general competition law. The Bill prohibits abuse of dominance and anti-competitive agreements. It gives sector-specific regulators, such as OFTEL, concurrent powers in their sectors with the Director General of Fair Trading to enforce these prohibitions. OFTEL’s enforcement powers proposed under this new Competition Bill will be more effective than enforcement under the Telecommunications Act 1984. It, along with other sector specific regulators, will have strong investigatory powers, power to make interim orders and will be armed with a powerful deterrent to anti-competitive behaviour through the new power of the Director General of Telecommunications to impose a fine of up to 10% of UK turnover.

4.8 In the terms of reference for the Utility Review, the Government has recognised the importance of a long term stable framework for regulation. It has stated that “arm’s length” regulatory independence will be maintained within a framework that clearly establishes the respective remits of Ministers and of regulators. OFTEL welcomes this approach which is well suited to the challenges of a converged communications market. The independence of the regulator from Government – and from the industry it is regulating – will promote a stable regulatory environment and thus encourage private sector investment in capital intensive industries.

4.9 But independence does not mean that regulators can ignore Government policy. OFTEL recognises that it is for Government to establish a policy framework and to define objectives, especially social and environmental objectives. The regulator’s role is to devise appropriate structures and procedures to secure these objectives.

4.10 Consumer and investor confidence depend on the existence of a consistent and coherent regime for regulation of electronic communications. The risk of confusion is real. There are no less than fourteen statutory and self regulating bodies for media and communications in the UK. General competition authorities and international bodies, such as the European Commission and the International Telecommunications Union, further complicate the picture. Individual firms may be subject to regulation by several different authorities and firms competing in the same market are subject to different regulatory regimes.

4.11 Ensuring that the regulatory regime reflects the relevant economic market makes for consistency and clarity. Convergence means that sectoral regulation, based on outdated technological distinctions between point-to-point and point-to-multipoint communication media, will become increasingly untenable. Just over the horizon are technological changes which will increase the transmission efficiency of Internet networks when handling point to multipoint information streams (ie broadcasting). This will dramatically increase the capability of these networks to deliver large amounts of real time broadcasting. A regulatory regime which ignores this, because it is based on the distinctions of yesterday, wastes resources; but even more seriously, may damage development of the communications market. At the very least, it would lead to the artificial segmentation of new technology to fit into an artificially sectionalised regulatory structure. At worst, divided powers and responsibilities could inhibit effective regulation of anti-competitive behaviour.

4.12 Some commentators suggest that overlaps and divisions of responsibility can be dealt with by working groups of different regulators. OFTEL believes this can only be a temporary measure. It does not solve the problem of different and conflicting statutory duties. Moreover, ad hoc working groups with no clear statutory responsibilities or accountability do not provide the clear and consistent regulatory environment which OFTEL’s experience suggests is essential to the satisfactory development of the UK communications sector.

4.13 OFTEL welcomes the Government’s commitment to reviewing communications regulation as part of its review of Utility Regulation. OFTEL’s response to that review emphasised the importance of transparency and openness in regulatory process and practice. OFTEL believes these are the keys to ensuring the accountability and legitimacy of any regulatory regime in the eyes of customers, industry and Parliament. In a rapidly evolving communications market it is particularly important for regulators to consult openly with both operators and consumers. OFTEL’s experience shows that open consultation strengthens effective regulation. The requirements for accountability and transparency should apply to all the regulatory elements, no matter what their precise relationship with Government and/or suppliers of communications services. Thus, if the BBC Board of Governors maintains its regulatory functions – for example by retaining responsibility for defining the BBC’s Public Service Broadcasting remit – then it too should adhere to the expectations of accountability and transparency which apply to other regulators.

4.14 Detailed prescriptive rules can themselves be a barrier to entry and inhibit the development of effective competition. In the new world of convergence, regulation should focus on encouraging competition, diversity, choice and innovation as well as on realising the social objectives mandated by Parliament. Old style regulation, based on controlling the activities of a handful of companies with privileged access to a scarce resource is no longer possible or productive. Getting the rules right is essential if UK citizens are to enjoy the benefits of the Information Age. Keep the ‘wrong’ rules too long and regulation will stifle the very innovation and competition it should encourage; lift the ‘right’ rules too early and competition may never fully develop.

4.15 The challenge of the future for communications regulation is to balance competition-based regulation with effective powers to deal with market failures and to deliver social goals whilst ensuring the protection of consumers.

4.16 In meeting that challenge OFTEL suggests that to avoid the dangers of over regulation the starting point should be: Where and why is regulation necessary – rather than how do we regulate a market.

4.17 To answer this question, distinctions must be drawn between rules needed during the transition from the status quo to a converged “open state,” (rules which are likely to be progressively lifted), and the rules necessary in the long term for effective regulation of a converged communications market.

4.18 To identify the right rules for the communications market OFTEL tested the existing detailed rules, for both the broadcasting and telecommunications, by asking “What rules are required, over and above general competition law, to promote effective and sustainable competition and to deliver social policy goals?”

4.19 In answering the question OFTEL took into account two considerations: First, the converged communications market will include certain public network aspects of the IT sector which, unlike broadcasting and telecommunications, has not experienced sector specific regulation. And, second, stronger competition law is being introduced in the Competition Bill – notably powers to deal with abuse of a dominant position and with restrictive agreements which have an anti-competitive effect.

4.20 OFTEL concluded that, in the “open state,” most of the detailed prescriptive rules currently applied in both telecommunications and broadcasting can, and should, fall away. They are not necessary in a well functioning market subject to general competition law. Only a small subset of the rules presently applied to the broadcasting and telephony markets are required in the “open state.” In the short term, during the transitional period, some further detailed rules are necessary. But even during transition many of the existing prescriptive rules can be discarded.

4.22 The Competition Bill will (if passed) introduce powerful prohibitions on the abuse of a dominant position and on restrictive agreements which have an anti-competitive effect, and gives sector-specific regulators effective powers to apply them. These provisions will enable a communications regulator to operate within a clear framework of rules to which dominant operators, or operators entering into agreements, must adhere. The attraction of this proposed new competition legislation is that it will provide incentives for firms to police their own activities and ensure they are consistent with published guidelines. More importantly, it will enable regulators to withdraw from detailed prescriptive regulation, which may impede the development of the market, whilst retaining powerful sanctions for an expert sector-specific regulator to impose on firms engaging in anti-competitive behaviour.

4.23 The consumer protection afforded by general laws, such as the Trade Descriptions Act, the Unfair Consumer Contract Terms Regulations and the Weights and Measures Act apply to transactions in this sector as to other sectors of the economy. They have not traditionally been applied or enforced directly by a sector-specific regulator (as competition law has been), but rules based very closely on general consumer protection law have been included in licences and therefore come within the regulator’s scope. The appropriate mechanism for applying these rules may come down to a question of convenience or certainty of application.

Rules to deal with “permanent” market failures in the communications sector.

4.24 Inherent characteristics of electronic media and communications mean that some market failures are endemic – i.e a competitive market would not redress these failures. Such failures are not necessarily the result of firms’ abusive behaviour and are therefore not caught by the prohibitions in the Competition Bill. They arise out of the nature of the industries in question. Accordingly, specific rules are required to cover particular bottlenecks, notably call terminations on telephony networks and access control systems on all electronic networks.

4.25 Such ex ante rules are required for those who act as “gatekeepers” but escape the legal/economic definition of dominance (though they have the clear potential to become dominant). Control of access gateways can distort downstream markets. If such distortion occurs it would be extremely difficult to redress after the event. In order to prevent such distortions ex ante rules should apply where the consumer, or other end-user of services, faces significant switching costs in moving to another supplier or service. The rules should be subject to a carefully defined “trigger” to avoid catching any operator unnecessarily. They must also be applied in a way which is technology-neutral (ie so that it is the market, not the regulator, who determines the relative success of any competing technologies). They should be the minimum necessary to allow the downstream markets to function normally, without unnecessary restriction or distortion of competition.

4.26 Specific rules for ensuring interoperability between different operators, between operators and service providers, and between different service providers are also required. Such rules are likely to become increasingly important in the networked IT field. As service providers provide an increasing diversity of services across undifferentiated digital networks, relying on intelligence in consumers’ equipment, it will become even more important to ensure that the entry barriers constituted by the technical/proprietary control systems embedded in customers’ equipment are not used abusively. OFTEL believes that specific rules to deal with this type of market failure will be required in the open state and beyond. It will be particularly important to build international consensus on the approach to this area.

4.27 Social and consumer policy objectives will not all necessarily be achieved through the operation of well-functioning competitive markets. It is crucial therefore that a regulator has sufficient powers to ensure that such Government-defined objectives are met. One of the most significant of these objectives is universal service. Universal service is a dynamic and evolving concept – currently access to voice telephony at affordable prices is defined as the key constituent of the universal service “basket” because it is necessary for full participation in society. But in the foreseeable future, access to a digital and/or high capacity line might be defined as part of the universal service obligation. Consequently, rules and regulatory powers must be sufficiently flexible to respond to changes in the market and the needs of the consumer. It is equally important that such rules are enforced in an efficient and cost effective way, that their effect is competitively neutral and they do not inhibit competition and choice.

4.28 Competition between content suppliers will deliver much of what is required – but not all. There may be too much uncontrolled content which could cause offence, giving rise to “negative content” regulatory requirements, and not enough of other kinds of content, giving rise to “positive content” regulatory requirements.

4.29 Because those operating electronic communication systems are unlikely to know what content is being transmitted across their system any negative content rules would need to apply to all content providers, irrespective of the specific means of delivery used. Supplying the missing bits – ‘positive programming requirements’ – in an “open state” converged market would require a “contract” between the Government (through the regulator) and the content supplier. To be able to negotiate such a contract, the regulator would need to have something of value to the supplier. Formerly that “something" was access to a scarce resource – the radio frequency spectrum. But, in a future without capacity constraints, the “something” of value is likely to be financial resources either derived directly from Government or indirectly via Government sanctioned mechanisms like the BBC licence fee. In return for the “something” of value organisations such as the BBC would fulfill a contract to provide the missing bits – notably the positive programming requirement which has characterised public service broadcasting.

4.30 The loss of the ability to apply detailed positive or negative content requirements on the suppliers of electronic communication systems means that consumers could loose out, in the sense that they would loose control over the type(s) of content they would wish to see, or let their children see. To balance this potential loss of control, rules are likely to be required to enable customers to have more control over what is, and is not, available to them. The technological changes that are driving the sector to the “open state” can also provide the mechanisms to give individual customers much more control over what is, and is not, available to them. The principle of consumer protection that can, and should, be applied in the “open state” is one of individual control, not control exercised by the regulator(s).

4.31 To the extent possible, competition policy will deliver sufficient diversity in supply to ensure that economic market power is not concentrated to such an extent that customers are exploited economically. A well functioning competitive market will deliver much more diversity than this. However, it is possible that even in the “open state” the competitive market is insufficiently developed to deliver enough diversity of supply to meet the cultural and political needs of a well functioning democracy. Under these circumstances additional specific rules on media (and cross media) ownership will be required. Because of the importance to a well functioning democracy of diversity of supply it would be dangerous to abandon the existing special controls before it has been demonstrated that the “open state” will deliver adequate diversity. In any event, these rules will be necessary during the transition phase.

4.32 However, it should be recognised that these rules also have some potential costs. To keep them for longer than is necessary runs the risk of making it more difficult for UK firms involved in electronic communications to compete effectively in the international markets, where other producers will not necessarily be subject to the same kinds of constraints.

4.33 OFTEL envisages three additional types of rules, needed for a limited period:

4.34 Some rules beyond general competition law are necessary to prevent the residual advantages of incumbents being exploited in a way which frustrates the development of competition or unfairly exploits the consumer. These rules are likely to be transitory in markets such as communications which are not generally characterised by natural monopolies. They include such provisions as retail price control, the establishment of accounting systems to prevent unfair pricing or cross-subsidy, and direct control of the terms and conditions of interconnection.

4.35 These special rules are required for a limited period to establish conditions for competitors to enter, develop and stay in the market. Competition law, with its emphasis on waiting until an abuse has occurred and focussing remedies on individual abuses, is inappropriate to deal with the long-term and widespread advantages enjoyed by historically incumbent firms. As markets becomes more competitive, regulation through these special rules should wither away in favour of the exercise of powers defined under the Competition Bill.

Rules to deal with joint dominance, to the extent that these are not effectively dealt with under general competition law

4.36 The current telecommunications, radio and broadcasting industries are characterised to a high degree by oligopolistic market structures (or “joint dominance”) with high entry barriers, often as a result of the allocation of a scarce but essential resource such as radio spectrum. Even a mature communications market may be characterised by oligopoly given the high costs of building alternative networks and operating systems, and of creating commercially attractive content. This gives rise to the need for extra forms of control, going beyond the powers in the Competition Bill.

4.37 The proposed prohibitions in the Competition Bill do not deal effectively with anti-competitive parallel behaviour by companies where there is no agreement between. This is a potentially significant gap in the regulator’s powers and it is recognised in the present proposal to keep the complex monopoly provisions of the Fair Trading Act ( FTA) in parallel with the new Competition Bill.

4.38 The new competition legislation may exclude vertical agreements from the general prohibition on making anti-competitive agreements; Government is seeking to define the extent of exclusions. Vertical integration and complex vertical arrangements are a common feature of the telecommunications industry and there is a high likelihood of situations arising under which vertical agreements could be used by those with market power (though not necessarily dominant in terms of EU jurisprudence) to foreclose entry to parts of the communications market.

4.39 There is a particular problem where a valuable and scarce resource has been allocated to a small number of service providers. In this case, it is necessary to control, through regulation, the exploitation of that resource. The implicit contract between Government (which allocates the valuable resource) and the service provider (who agrees to do something in return as a condition of licence) needs to be monitored and enforced. These rules generally relate to specific outputs such as positive programme requirements, coverage obligations, and/or cross-subsidies to certain customer classes.

4.40 Such rules should only be needed, however, for a limited period. Once transmission capacity becomes available as a result of technological changes, and radio spectrum becomes a fully tradeable commodity, the need for them will disappear.

4.41 More generally, OFTEL hopes that special rules to deal with joint dominance will not be needed permanently. In the longer term, either through the development of jurisprudence on the scope of “abuse of dominance,” or through changes in the competition law itself, that general competition law will be competent to deal with any remaining problems of joint dominance.

4.42 OFTEL’s approach implies that no other special rules are required and should no longer be imposed. That means getting rid of many detailed rules which have grown up over the years, both in telecommunications and in broadcasting. Some of the detailed rules may live on in a more flexible form as guidelines under the Competition Bill or under the rules of the proposed general authorisation; the rest should be dispensed with altogether.

4.43 Different types of rule call for different application mechanisms. The key provisions on competition are applied through general competition law, backed by criminal and civil sanctions; general consumer protection provisions are applied through the various general consumer protection laws. “Special rules” for electronic communications have traditionally been applied through a system based on a prohibitive licensing regime (ie a regime based on prohibiting everything that is not expressly allowed). OFTEL considers that a system based on general authorisations, with a limited set of general rules backed up, where appropriate, by detailed guidance, is more likely to foster investment, innovation, diversity and competition. Such a system also fits well with the approach of recent EU Directives. More detail on how this new system of rules and how they would operate is in Annexes B and C.

4.44 Rules to ensure the delivery of public policy goals could also be delivered through such a general authorisation system, though some or all of them might be better dealt with through quasi “contracts.” For example, as is the case now with the BBC, public service broadcasting’s “positive content” could be provided in exchange for exclusive access to a particular type of funding. Universal service in telecommunication services could be provided in exchange for receipts from a universal service fund.

4.45 “Negative content” rules are best applied through self-regulation tailored to give consumers control over the information they access, with a statutory backup. Such control can be achieved largely through systems of classification and filtering. Although the principal mechanism for this should be self-regulatory, the key rules would need to be defined either in a general authorisation (applicable to all) or in the criminal/civil law.

4.46 The only rules which require prior authorisation (or “individual licensing”) should be the additional rules applied to operators with access to a scarce resource such as broadcasting transmission capacity and other radio spectrum. Within a few years OFTEL expects transmission capacity to be widely available, and hopes that a true market in radio spectrum will have been established reflecting its economic value. Most of these special “scarce resource” rules (and therefore the need for prior authorisation) will therefore disappear.

4.47 No regulatory mechanism is fully effective unless there are sufficiently strong sanctions to inhibit breach of the rules and to punish any such breaches. The current UK telecommunications regulatory regime couples a multitude (probably a surfeit) of detailed individual rules with weak sanctions and unwieldy enforcement mechanisms. The Competition Bill sets the standard for a regime of general rules backed by strong sanctions, including third party rights. Similar sanctions and enforcement procedures should be available for sector-specific communications rules. More detail on how these might work is provided in Annex B. The next Section explains the structural and institutional arrangements best suited to apply the various legal instruments needed.

5.1 The previous Section set out OFTEL’s view of the regulatory functions that need to be undertaken in a converged digitalised electronic communications world and proposed general principles that should underpin regulation. In this section OFTEL considers how regulation should be conducted and evaluates alternative institutional structures for regulation. What should the regulator(s) do? And how many regulators should there be?

5.2 In Section 3 OFTEL has argued that the electronic communications sector, in both the long term and short term, requires special rules. Coherent, consistent and predicable regulation can only be delivered if the rules for the sector (and hence the remit of a sector specific regulator(s)) are congruent with the special characteristics of the sector – notably its distinctive economic characteristics and its social and cultural importance.

5.3 A perfect fit between the rule set and the special characteristics of the sector is almost certainly not possible. The special economic characteristics of the sector are pervasive and cover all content distributed by electronic communications systems. However, because many of the content concerns are essentially social and cultural in nature, congruence between sector characteristics and established rules dealing with content is less pronounced. Some content concerns do "read across" different types of content – for example issues relating to giving customers filtering type control – others vary by the type of content, not by its means of delivery – for example moving pictures are often seen to require more stringent regulation than pure text irrespective of the means of delivery. Therefore, OFTEL considers economic/social regulation and content/cultural regulation in this sector separately in the following analysis.

5.4 Technological convergence, and the common economic characteristics of the electronic communications sector, suggests that a consistent body of rules can be applied by the economic regulator to electronic communication networks and to the supply of services over those networks. Rules and regulation should thus cover all the electronic communications industries and not be restricted to definitions based on out-of-date technological divisions. Specifically, the regulators’ remit should include (using old definitions):

5.5 The legal and institutional framework which will be needed to apply the rules identified in Section 4 is very different to the current patchwork. The lynchpin of economic regulation should be the general competition law (enhanced by the current Competition Bill), which must be applied vigorously to electronic communications. The current system of concurrency (giving the sector-specific regulator concurrent powers with the Office of Fair Trading to apply the competition legislation in that regulator’s area of competence) should be continued. But it is vital that the scope of those concurrent powers matches the regulator’s powers under other legal instruments, which must be based on the scope of the emerging electronics communications sector as defined above, and not leave gaps which an operator with market power could exploit to the detriment of consumers. These powers must not, therefore, apply only to the "commercial activities connected with telecommunications," (the scope as currently defined in the Competition Bill) but cover "the supply, or securing of electronic communications services or the production, supply or acquisition of electronic communications apparatus, or activities connected with them."

5.6 General consumer protection policies must also be applied effectively in this sector. Traditionally the principle of concurrency has not extended to consumer protection law, though obligations specific to telecommunications providers based very closely on general consumer law have commonly been placed within licences as a convenient mechanism for applying and enforcing such rules. Some of these rules (for example, requirements relating to billing accuracy) could, and probably should, continue to be applied and enforced through general authorisations, where it is felt that this is the most convenient and certain way to ensure compliance in this sector.

5.7 These general laws should be supplemented with special rules defined in Electronic Communications legislation (and enforced through a system of general authorisations applied consistently to all those operating in this sector), and through “contracts” set up to ensure that Public Service Broadcasting is delivered in accordance with the wishes of Parliament.

5.8 Section 4 identified the types of issues that the special rules should cover. These issues fall into two distinct groups: economic issues and content issues. The economic/social issues range from dealing with anti-competitive behaviour, through protecting consumers from economic exploitation where competition has not developed, to ensuring access and a fair distribution of costs between customers (on the basis of directions or guidance from Ministers). The content issues concern the quality and character of material transmitted over networks (including the continuing role of "Public Service Broadcasting"), and the extent to which customers can control their exposure to particular types of material which they might find offensive.

5.9 Although both economic/social and content regulation seeks to secure and protect the interests of consumers, the criteria which inform regulatory decisions in the two domains are usually quite different. Regulatory intervention on content involves judgements on morality, national identity, the relative quality of a programme on opera compared to a music-based quiz show etc. Economic/social regulation, on the other hand, concerns economic efficiency, price levels compared to costs, economic market power, interoperability etc.

5.10 The different skills and competencies required for the two regulatory domains suggests strongly that different institutions are needed to carry out the different functions. However, the two sets of decisions cannot be made completely independently. A decision in one domain sometimes affects outcomes in the other. Objectives on content may need competition to be "distorted" if they are to be effective (eg making all TV households fund the BBC even if some don’t watch BBC TV). The institutional structure must be capable of efficiently resolving any conflicts which may arise from this interdependence.

5.11 It is unlikely that the skills required to effectively discharge judgements on content standards can be combined effectively with the skills required to discharge the economic/social functions. The dynamics of institutions suggest that if a single organisation is charged with both activities one type of consideration could come to dominate the other. However, if rules can be formulated so that the interdependence of economic/social and content regulation is minimised then the cost of conflict resolution will be low and will be offset by the desirable public character of regulatory conflict favouring transparency and accountability.

5.12 However, to choose more than one regulatory body is not to solve all the problems, as there is more than one way of dividing regulatory mandates. Accordingly, OFTEL evaluates below the relative merits of a division of regulatory functions between either a regulator of services (which would include content and competition between service providers) and a regulator of infrastructure; or a economic/social and content division of regulatory functions, as well as the merits and demerits of a single regulator.

5.13 Three main options for the organisation of the statutory duties to regulate the electronic communications industries are considered below:

5.14 Variants of each of these options exist. For example, a variant of option 2 would be for the economic/social issues to be taken on by the general competition authority rather than having a separate sectoral regulator. This might be a desirable long term goal, but in the short and medium run regulatory (as well as competition policy) functions will remain, which are better addressed by a sectoral regulator with concurrent powers under general competition law and with focus and expertise in regulating this complex economic sector.

5.15 The pros and cons of the three main options are summarised in the Table below. Option 1 – separate regulators for infrastructure and services – is not attractive. Indeed, in OFTEL’s view, it is likely to be less effective than the current regulatory structure. It would not solve the problems of overlap and potential inconsistency that are features of the status quo. And, in addition, it would introduce a more rigid distinction between infrastructure and services than currently exists, when many issues will arise from the interaction between the two, especially as firms operating in these markets are very often vertically integrated across this division.

5.16 Positive and negative programming rules and special rules on media and cross media ownership are implemented for cultural and moral reasons, but they often have significant economic implications. They are thus matters in which both economic/social and content regulators would have legitimate interests. Broadcasters’ (to use a convenient "pre-convergence" term) costs and/or revenues will be affected by any content rules applied. There could also be a significant impact on competition, especially if the rules are applied to some broadcasters or transmission systems, but not to others. Therefore, one question that provides a useful discriminator between options is whether the interactions and trade-offs between content and economic/social issues should be considered within the same organisation or as a debate between different regulators. If the calculation of such trade-offs were a central feature of the new regulatory regime, they would probably be best addressed by the same organisation, which would point towards a single regulator. Offsetting this is the need to ensure that the appropriate (ie different) regulatory skills are applied to content and economic regulation.

5.17 OFTEL believes that when capacity constraints have largely disappeared, and access control systems are ubiquitous, competition will deliver most of the diversity and plurality required in the public interest. OFTEL therefore favours Option 2, two regulatory bodies – one to deal with content issues (the “Electronic Communications Standards Authority”) and the other to deal with economic/social issues (the “Electronic Communications Commission”).

	Pros	Cons
Option 1: Separate infrastructure and services regulators	Closest to current split between OFTEL and ITC. Different issues tend to arise in relation to infrastructure and services.	On many issues difficult to draw boundary between infrastructure and services. Even where can draw boundary, issues arise from interaction between the two, eg vertical integration. Since the infrastructure/service split would be more stark than the status quo, this option is likely to be less effective than the current structure. Does not solve problem of regulatory overlap so risk of double jeopardy and inconsistent economic regulation remains. The means to enforce the services regulator’s content rules, such as negative programming controls, often rely upon jurisdiction over the transmission system, which would be the responsibility of the infrastructure regulator.
Option 2: Separate economic/social regulator (covering both infrastructure, access and services) and content regulator (covering PSB and negative programming controls)	Can address leveraging of market power from services to infrastructure and vice versa. Different skills and approaches required for effective economic and content regulation. Allows separate voice for each of the different approaches. This might ensure more transparent debate about trade-offs. Can address leveraging of market power from services to infrastructure and vice versa. Feasible – precedent in the water industry: separation of economic regulator and water quality regulator.	Content regulator might not take full account of effect of decisions on economic issues (and vice versa), eg watershed and restrictions on minutes of advertising are present for content reasons but clearly have economic implications. The boundary may not always be clear and who draws the boundary?
Option 3: Single regulator (covering infrastructure, access and services, and economic/social and cultural content issues)	Can address leveraging of market power from services to infrastructure and vice versa. Full implications between economic and content issues can be taken into account and appropriate trade-offs made. Avoids (most) problems of defining the regulatory boundary. Feasible – broadly follows the model of eg CRTC in Canada.	Economic issues too different from content issues – danger that one aspect would tend to dominate the other. Does not give separate voices to the economic and content aspects. Danger that a single regulator would become too large and bureaucratic.

5.18 How should the interests of consumers best be represented? Even with a clear primary duty placed on the regulators to act in the interests of consumers, consumers will need an effective voice if regulatory arrangements for electronic communications are truly to work in their interest. OFTEL believes that a statutory Electronic Communications Consumer Council (ECCC), with its own independent resources, is the best means to ensure effective consumer representation.

5.20 The ECCC could comprise, say, 12–15 members who would be appointed by the relevant Secretary of State following open ‘Nolan’ type procedures. Members could be selected based on their understanding and experience of consumer policy issues and to ensure that a spread of interests was represented (different consumer segments, different geographic regions, etc). It would be up to the Council to decide whether to set up sub-committees on specific issues – for example, the needs of elderly or disabled consumers, low income households, or the protection of minors.

5.21 The Council would have a right to be consulted formally by the statutory regulators on all key issues affecting consumers, and would have rights of access to information held by those regulators where it was relevant to the issue under discussion.

5.22 The Council would subsume the work of a number of existing consumer advisory bodies in telephony and broadcasting.

The electronic communications sector should have two principle regulators, and their respective responsibilities should be as follows:

1 A content/cultural regulator – the Electronic Communications Standards Authority – whose primary responsibility would be to ensure that customers get access to the type of content they need and are not exposed to content they do not want (including ensuring that children are adequately protected from harmful material). This would be achieved by ensuring that there is delivery of public service broadcasting content and ensuring that customers can control the type of material they have access to. The primary focus of this body would be the content standards of content providers; and.

2 A economic/social regulator – the Electronic Communications Commission – whose primary responsibility would be to ensure that customers are offered competitive supplies of electronic communication systems (and their constituent parts), and maximum access to services provided over those networks. This would primarily be achieved through the competitive supply of these services.

In addition, there should be a statutory consumer council – the Electronic Communications Consumer Council – to represent the views of consumers in this regulatory process. Its remit would cover the activities of both regulatory bodies, as well as dealing with any other consumer protection issues (eg those dealt with the non-sector specific enforcement authorities). Its primary focus would be the individual consumer of electronic communication services.

6.1 In this section OFTEL considers how specific policy objectives might be achieved under the general framework of the regulatory rules set out in Section 4. It is not an exhaustive list of all the problems that are likely to arise, and the level of detail in the analysis varies – there is more detail where difficult issues are being dealt with or where the suggested solutions are very different from the current approaches.

6.2 Ideally, any service provider should be able to reach any customer over any network and any customer should be able to reach any other customer. In practice, incompatible technical standards and the commercial interests of dominant firms, (who might be quite small but able to exercise effective control over one element of a complex interconnected network) get in the way of the realisation of this ideal.

6.3 Digital networks will be able to deliver a multitude of different services. Whether or not consumers will actually be able to receive these services, once connected to a network or networks, will depend on whether there is end to end interoperability. Accordingly, ensuring that everything can work together and that no firm can obstruct realisation of an “any to any” network – ie successful general interoperability – is a key regulatory mandate.

6.4 With the development of more and more complex services being delivered over digital networks interoperability becomes more rather than less important. Issues of interoperability also impact on the creation of economic bottlenecks within these complex systems – where the total system consists of digital transmission network(s) and includes the complex equipment at both the customer’s and service supplier’s ends of those networks. So, for example, whether or not a bank can offer its customers home banking services will depend on the bank’s computers successfully interacting with customers’ computers. This ability may, in turn, depend on the particular device the customer has and on the operating system and software used. And the secure digital signatures required for development of electronic transactions also depend on both parties being able to successfully interact with a common independent “trusted” third party.

6.5 Once a critical mass of end users is using a particular type of hardware, operating system and/or software there will be a tendency for new services to be provided using that same format. This will tend to maximise the number of customers able to successfully use that service. A feedback loop is created, reinforcing the original position of the hardware, operating system or software platform which might ultimately lead to the exclusion of competing platforms from the market.

6.6 This process of de facto standardisation will often work to the general customer’s advantage. However, there is no sharp line between customers’ benefits from standardisation and the undue inhibition of competition and development of innovative services which standardisation may engender. In addition, where a "standard" is a proprietary standard, significant market power for that supplier is likely to be created. The supplier may try to abuse that market power. One particular type of hardware – equipment with access control technology – makes exercise of this type of control relatively easy because the primary function of the hardware is to control users’ access to services.

6.7 On the other hand, the creation of a critical mass of addressable customers is likely to require significant investment, of both money and creative skills, by a supplier. A blanket prohibition on exploiting this investment would result in under investment. A balance needs to be struck between the commercial incentives to innovate and invest in the necessary "infrastructure" (which now includes the equipment at both ends of the network), and customers’ interest in easy access to a complete range of services and further service innovation.

6.8 This problem of balance is similar to issues of interconnection and interoperability of telecommunication networks. OFTEL’s experience is that regulatory intervention in interconnection issues is likely to foster more positive outcomes than unconstrained commercial negotiation and believes this to be generally true for interoperability and bottleneck control issues. Indeed, OFTEL has adopted this approach in relation to gateway control to and through digital networks. OFTEL does not envisage a need to regulate the services carried over such networks.

6.9 This regulation is not primarily concerned with standard setting or regulating established monopolies. It is concerned with opening up interfaces and making that infrastructure available to third parties on fair, reasonable and non-discriminatory terms. So that others can supply services over existing infrastructures while rewarding investment (both money and innovation) in infrastructure creation.

6.10 Competition law will deal with many interoperability issues because firms with an economic incentive to obstruct interoperability are often dominant and their behaviour will constitute abuse of their dominant position. The terms of the general authorisation for operation of electronic communications systems should require publication of interface specifications. The international nature of service provision means that close liaison will be required with international agencies and regulators overseas.

6.11 Asking how to achieve fairness in a converged digital electronic communications environment is a deceptively simple question. This simple question hides complex issues. People can only benefit from electronic communications if they have access to network(s). They benefit most with direct network connection but, for some services, access to a convenient public point of connection may be an acceptable substitute. But people must also understand how to use the services and system including the terminal equipment. And they must be able to afford essential services whether these are information or other types of service.

6.12 Fairness demands that everyone can afford access to essential networks and services. Unless they do society may divide into – “information haves" and "information have-nots.”

6.13 The value of networks increases exponentially as more and more people are connected to them. Society as a whole benefits (and not just to those who are direct beneficiaries of universal service policies) from universal connectivity.

6.14 And, as essential services are increasingly delivered over networks, service providers will find it increasing expensive to meet users’ needs by other means. Universal connectivity offers significant spin off benefits for essential services providers such as central and local Government.

6.15 Universal service at affordable cost is a goal both for the means of communication – access to networks and for access to content – that is to the information necessary for full participation in society.

6.16 Competition in networked telecommunications has gone a long way to ensure that most people have access to essential facilities and services without regulatory intervention. Some technologies, like satellite communications, provide universal coverage of much of the population as soon as they are provided to any single consumer. But there is no doubt that there are parts of the country and sections of the population where, because of the terrain, population wealth, population density or other factors, the costs of extending network service to all exceed the additional revenues earned from extended provision.

6.17 But it is not obvious what services, what level of service and what price of service should be included in the universal service “basket.” Deciding the contents of the universal service “basket” should be done by elected representatives in the light of expert regulatory advice on costs and benefits. The regulator should be responsible for ensuring that universal service is delivered and funded efficiently; that unfair burdens are not imposed on any single company or group of companies; and that any net costs are funded by all network operators in a fair, proportionate and non discriminatory way.

6.18 Considerations of universal service at affordable prices are likely to continue for a number of specific services. For example, for voice telephony to the urban poor and also for delivery of television services to “remote” areas, albeit these are likely to be of diminishing significance. In addition, OFTEL believes that considerations of universal service to some kinds of content are likely to apply to access to Public Service Broadcasting (PSB) for the foreseeable future.

6.19 Thus the transmission capacity in the universal service basket will include capacity to deliver voice telephony and PSB. However, in the future it may be appropriate to include additional capacity to deliver a richer set of essential services.

6.20 Access to services and infrastructure is a necessary but not sufficient condition of universal service. In addition to access to connectivity, consumers need to know how to use connectivity. Everyone knows how to use a telephone and television set but only teenagers know how to programme a VCR! Some intervention by Government or regulator could be needed to minimise the numbers of information have nots and ensure people can use essential services. Competitive supply will help ensure keen prices and user friendliness. However, there may be potential consumers who can neither afford the direct costs of the equipment needed to become individually connected nor develop unassisted the skills required to make use of connectivity.

6.21 Government can help by ensuring terminals and training are publicly available – for example, at access points such as libraries. The Government could also ensure that the social security system recognises the changing requirements for access to information (by, for example, including the cost of connectivity – eg to voice telephony and to public service broadcasting – in supplementary benefit calculations).

6.22 Competition will meet most of these needs. In the short run, the Government should ensure the provision of publicly available terminal points to fill in the gaps. In the long run, provision of essential equipment at affordable prices should be part of the universal service basket. The education system must be able to deliver appropriate training.

6.23 The disabled have special needs. Some needs, such as those related to provision of basic telecommunications services and teletext subtitling of television programmes for the deaf, can be dealt with by inclusion in the universal service “basket.” Responsibility for meeting other needs of the disabled may fall on the suppliers of specially adapted equipment. The Disability Discrimination Act places a general responsibility on all to meet the needs of the disabled and a communications regulator can monitor, and even enforce compliance, with these requirements. Regulation could also encourage industry initiatives to ensure that special equipment is affordable (for example, through collective bulk purchasing) and facilitate any special training in use of such equipment.

6.24 Pervasive, quasi-universal, access to networks and to the terminals and skills required to make them work, is creating an extremely powerful, and cheap, distribution network for all types of information and entertainment. Although Internet access is still confined to a minority of UK homes, the UK is ahead of most (but not all) EU countries in Internet penetration and growth of an on line industry sector. Moreover, domestic Internet penetration is growing fast.

6.25 Universal service to the Internet means that public information can be provided (eg by Government, museums, commercial firms and private individuals) and accessed at very low costs.

6.26 Technological change has also reduced the costs of creation and dissemination of information (from efficient word processing software through to digital TV cameras). Thus the costs of information creation and dissemination will fall – making affordability easier. But competition for scarce talent may put up the price of these inputs, increasing the affordability problem.

6.27 Although electronic communication systems do, and will, provide abundant information free at the point of use, this information may not be sufficient to enable everyone to participate fully in society. Government and/or regulatory intervention will be required if essential information is to be accessible to all, either free or at affordable prices. A key role of public service broadcasting is to ensure that information, which otherwise would not be affordable by all viewers and listeners, is provided on an affordable basis. And of course, to discharge this mandate public service broadcasters must be sufficiently well funded to produce, acquire and distribute the information specific to their mandates.

6.28 Technical change is reducing the costs of creating and supplying information – general affordability should become less of a problem. Where affordability remains a problem, the public service broadcasting mandate should include delivery of information at affordable prices.

6.29 Two elements of public service broadcasting can usefully be distinguished: universal service, discussed above, and positive programming requirements – the provision of valuable additional content and high quality content – beyond what the market would deliver.

6.30 Well functioning markets for electronic communications will mean that most, but perhaps not all, policy goals can be met through the operation of markets. Accordingly, important roles remain for regulation and for intervention through publicly funded public service broadcasting. However, changes to electronic communication markets mean that the role and institutional forms of public service broadcasting should be re-assessed. Although we need public service broadcasting we don’t necessarily need exactly the same public service broadcasters. In the long run public service broadcasting should be defined in terms of principles and goals rather than institutions.

6.31 Important regulatory responsibilities arise during the transition from the status quo to a fully competitive market. In the short term, it makes sense for public service broadcasting to continue to be defined by reference to the programmes, channels and services delivered by particular institutions, mandated to provide the socially desirable content and universal service which profit maximising broadcasters will not provide. OFTEL’s analysis of public service broadcasting is set out in Annex A.

6.32 Currently, the not for profit public service broadcasters, that is the BBC, Channel 4 and S4C and the for profit broadcasters, the Channel 3 and Channel 5 franchisees, are charged with positive programming requirements. Satellite or cable broadcasters are not so charged (though it is important to note that all broadcasters are charged with observing negative programming requirements).

6.33 Broadcasting regulation has succeeded in securing provision of “positive programming” by commercial broadcasters only because these broadcasters have valued access to the radio frequencies used for terrestrial broadcasting, (which has enabled them to reach all, or a majority, of UK homes), sufficiently for them to provide “public service” positive programming as part of the price paid for their entitlement to use the spectrum asset. The spectrum asset will continue to be valuable to broadcasters in the immediate future, but its value to them is likely to diminish as alternative distribution methods gain greater salience in the market. Moreover, other potential users of spectrum are likely to value spectrum highly. Accordingly, the ability of broadcasting regulation to extract the positive programming “price” (as well as significant franchise fees) will decline. In consequence, socially desirable positive programming may be under supplied and commercial firms charged with positive programming responsibilities may perceive themselves to be unfairly burdened.

6.34 OFTEL believes that in the medium term the bargain whereby commercial firms have been given exclusive access to a privileged market position in exchange for the discharge of a "public service" mandate cannot be sustained. Attempts do so are likely to distort broadcasting markets and lead to insecure, and possibly inadequate, supply of the positive programming which these measures were designed to achieve. However, the spectrum asset itself is likely to retain, and perhaps increase, its value. Consequently, there are opportunities for Government to realise a higher return from its control of the spectrum asset via spectrum markets than has been achieved through franchise auctions.

6.35 In a relatively short time profit maximising advertising funded terrestrial broadcasters will face effective competition from unconstrained broadcasters operating outside the existing positive programming requirements. For example, BSkyB’s advertising revenues grew by 34 per cent in the second half of 1997 (whereas its overall turnover grew by 20 per cent). Within the next 5 years it is likely that competition from unconstrained content suppliers may mean that Channel 3 and Channel 5 are unable to reconcile compliance with positive programming requirements and their commercial interests. Indeed, there are some signs of these pressures already. The time may therefore be ripe to review the sustainability of the positive programming regime applied to Channels 3 and 5 before the next franchising period (ie before 2002).

6.36 The problems of securing sufficient positive programming from commercial broadcasters do not apply to not for profit public service broadcasters – the BBC, Channel 4 and S4C nor to the Gaelic Broadcasting Fund. The ‘contract’ which currently obtains between Government and these institutions, whereby these institutions provide positive programming (and universal service within their mandated territories) in exchange for guaranteed funding can be carried forward to provide a secure basis for the continued provision of public service broadcasting.

6.37 But, to be able to fulfil their side of the ‘contract’ and satisfy positive programming requirements, not for profit public service broadcasters must be adequately funded. The BBC, the largest public service broadcaster, is funded from the licence fee which is pegged to the RPI. This "peg" gives the BBC appropriate incentives to improve efficiency by adopting cost reducing technology and removing inefficiencies. However, at some point efficiency gains can no longer be secured without damaging the capacity of the organisation to fulfil its mandate. And because there is a tendency for broadcasting costs to rise faster than the RPI, because broadcasting is generally more labour intensive than the economy as a whole and labour wage rates tend to increase in real terms, reindexing the licence fee to a different peg is likely to be required. When the licence fee arrangements are next reviewed a peg linked to input prices should be adopted. For example, the average earnings index rather than the RPI.

6.38 Whilst the BBC needs to be sufficiently well funded to discharge its positive programming requirements, there is a concern that its licence fee funded services are universally accessible on an affordable basis. These conflicting pressures on the level of the licence fee are resolvable by recognising that different approaches can be adopted to ensure the provision of positive programming requirements and universal access. For example, legitimate concerns about the affordability of the licence fee can be addressed through the use of special pricing schemes targeted at the minority that face affordability issues.

6.39 The cultural content regulator of the electronic communications sector must monitor the extent to which positive programming requirements are effectively fulfilled and ensure that the content and character of public service channels is of a genuinely public service kind. So that competing firms can be confident that there is no improper cross subsidy of public broadcasters’ commercial activities from their privileged access to funds granted to fulfil a public service remit.

6.40 In the medium term, ie during transition, the public service broadcasting mandate should reside with non-commercial broadcasters (or programme suppliers) – the BBC, Ch4, S4C and the Gaelic Broadcasting Fund. Commercial broadcasters should be just that. They should compete on a level playing field with other commercial content providers paying market rates for access to transmission capacity and be charged with the same negative programming requirements. The BBC should be adequately funded to discharge its mandate. Regulation should ensure that public service broadcasters do not distort competition beyond the extent required for them to fulfil their public service remit.

6.41 Soon, audiovisual content providers will not require access to scarce transmission capacity to reach customers. (This is already the case for low quality moving pictures delivered over the Internet.) Therefore, as a class, these firms will not require "special licences" to operate. Unless the Government wishes to create a general prohibition on the unlicensed dissemination of content over electronic communications networks (a rather draconian measure!), rules applied to content providers must, in the future, be embodied in generally applicable laws rather than in specific licences.

6.42 Those operating electronic communication systems will not generally know what content is being transmitted – this is a transaction between the content provider and the customer. Short of Government requiring service providers to intercept and read the messages, communication system operators cannot be charged with direct responsibility for the content of communications, just as the Royal Mail is not responsible for the content of letters.

6.43 Electronically communicated content will increasingly approximate to the condition of print media. In consequence, only negative rules are likely to be effective (content providers shall not ...), and should be embodied in law. (Although even when such provisions are embodied in UK law they are not likely to be effective against content providers located outside the UK. Effective enforcement of content rules embodied in UK law is therefore conditional on international co-operation and consensus.)

6.44 Locate the controls on illegal content on the providers, or consumers, of that content – this means in the general law, not in sector specific regulation. Providers of electronic communication systems shall have a duty to cooperate with law enforcement agencies (as in other areas of commercial activity), but should not be considered responsible for the content transmitted over their systems.

6.45 Negative content rules, applied to all content providers concern offensive material ranging from information that cannot lawfully be supplied to protecting people from exposure to material they, but not others, might find offensive. The international “any to any” connectivity provided by the Internet means that comprehensive application of content codes and “prior restraint” to prevent screening of material prohibited by regulators is no longer possible. Instead, OFTEL proposes a system which strengthens people’s ability to control for themselves the material to which they, and/or their children, have access. To ensure that users can control what they consume a reliable system is required which can inform people about the content accessible to them and which enables them to filter content on their own behalf and on behalf of those for whom they are responsible (eg children). Two elements are required for such a system to be successfully implemented. First, customer controlled software filters that blocks access to material which is found offensive and, second, a rating system to classify content and allow the customer controlled software filters to work.

6.46 Even without a reliable rating system service providers and/or suppliers of navigation software (ie not content providers) are already supplying crude access filters. These operate either on a customer defined "OK list" – or "walled garden" (ie only certain, pre defined, content is available to a designated terminal) or on a "Not OK list" (ie certain pre defined content cannot be accessed). Access control technology is likely to make customer controlled filtering relatively simple – the technology is (or will soon be) there. But, for filtering to work efficiently, content must be comprehensively classified (and classification codes recognised by receivers in customers’ homes). This inevitably raises the questions: Who should classify? What criteria should be used?

6.47 Mechanisms, beyond the provisions of the law (which would, of course, remain), range from a partnership between a statutory body and a self-regulatory agency, (such as OFTEL’s partnership with ICSTIS); hybrid regulation, whereby industry bodies are charged with statutory duties (such as the British Board of Film Classification, a self-regulatory body charged with statutory duties for video classification); to straightforward statutory regulation (eg by the ITC).

6.48 For classification to work, categories need to be defined and agreed. Since their purpose is to assist consumers in controlling their information environment, a major and continuing input from consumers is required. However, consumers cannot ensure that content providers comply with agreed definitions. Material could be classified by a statutory body formed for this purpose but the large number of content suppliers, the need to classify live content and the sheer volume of content to be classified and its international nature means that a, nationally based, statutory classification body is unlikely to work. A robust solution is likely to be based on self classification by content providers using a classification code developed by a self-regulatory body in conjunction with a statutory regulator. Much material will remain unclassified. Both because its authors do not wish to classify it (an individual’s home page with family snaps and news for example) and because it does not satisfy classification criteria – it may contain material which many, perhaps most, people would find offensive. However, customer controlled filters could be programmed to prohibit access to all unclassified material. And, if desired, to prohibit access to all 18 plus material; or all material with bad language; or all material containing advertisements etc. No system, short of draconian abridgement of citizens’ rights to freedom of information, can prevent people from accessing offensive (and even unlawful material). But this system will do much to guard against unwanted exposure to offensive material. Recourse to the courts (by individuals or, if Government thought it appropriate, by a regulatory agency) would enforce prohibitions on the publication of unlawful material.

6.49 But if content providers are responsible for classifying their own material how can customers be sure they do so and do so appropriately? Certainly, content providers have a collective interest in proper classification. In general, the better the information is classified the greater the pool of potential customers. Moreover, where service providers offer filtering services to their customers they also have a commercial interest in ensuring that classification is undertaken correctly. Service providers interests could be harnessed to promote correct classification.

6.50 In addition, general consumer protection legislation could apply – correct categorisation would be part of a general statutory duty not to mislead consumers (for example, similar requirement are imposed by the Trade Descriptions Act). The combination of the collective self interest of content providers, the commercial interests of providers of filtering services and the application of general consumer protection law is, OFTEL believes, likely to be powerful. But it may not be wholly sufficient to ensure correct classification in the consumer interest. Accordingly, a statutory regulatory backstop to underpin the classification system is required. Technical innovation makes this relatively easy to achieve.

6.51 For the reasons outlined above it is inappropriate, and impractical, to directly regulate content providers and require all material to be classified according to an imposed set of definitions. Such rules would be draconian and ineffective. For there are too many content providers and any content provider seeking to escape UK regulation can easily locate outside the UK. On the other hand, service providers offering filtering services are likely to be fewer, and those offering services to UK customers are likely to be located in the UK. Statutory regulation can capitalise on these factors to support the effective operation of self regulation.

6.52 Filtering service providers should have a quick and easy way to remove classification codes from content that appears to be misclassified. (It is important to note that the removal of the classification does not result in that material being unavailable to customers – it just alerts them to the fact that it is unclassified and, therefore, might be information that they do not wish to see, or do not want their children to see.) They could clearly elect to do this pro-actively, or in response to complaints from their customers. Appeal would be, in the first instance, to the classification self-regulatory body.

6.53 If stronger regulation was required it would be possible to require filtering service providers to remove classification codes from misclassified material through powers contained in the general authorisation needed to run electronic communication systems. (Again, this would not make the material unavailable, just advise users that it was un-classified.) The final decision as to whether or not particular content was misclassified could be made by the statutory regulator. This approach would have the advantage of removing classification codes from all material found to be misclassified when accessed through any filtering service provider.

6.54 The technology required to give customer’s control of access to content exists, or will shortly exist. OFTEL’s experience of content regulation in an analogous case, Premium Rate Services, suggests that a combination of self regulation and customer choice with a regulatory back stop provides customers with appropriate levels of content control without unduly compromising content providers’ ability to provide customers with lawful messages.

6.55 To implement such a system for a converged environment the statutory regulator, in conjunction with a content self-regulatory body, should formulate and publish guidance on classification; content providers would be required to add content codes to the material they make available, unless they wish their content to be designated "unclassified;" customer controlled filtering systems must be capable of recognising the electronic codes, or "tags" attached to material; where service providers or customers believe material to have been misclassified they may apply to the self-regulatory body for the material to be declassified; in cases of dispute between the content provider and self-regulatory body the statutory regulator should adjudicate.

6.56 The Government and content regulator should encourage self regulation which results in the self classification of content. The competitive market will deliver filtering services and/or filtering software based on that classification. Misclassification should be regarded as an offence, similar to existing labelling and/or trade descriptions law on other services and products.

6.57 If convergence means an explosion in the number of sources of information why should we be concerned about concentrations of media ownership and control? Should not regulators withdraw from ownership regulation as the electronic communications market diversifies and provides more and more outlets and more and more sources of information.

6.58 Are established rules on cross media ownership required when competition law is to be strengthened? Are they required when convergence and digitalisation will enable consumers to access a vast pool of browsable content from all corners of the earth?

6.59 OFTEL believes that, on balance, they should be retained. First, because competition law is designed to inhibit the exercise of improper market power in the interests of economic efficiency. Whereas, an economically efficient media market may be insufficiently diverse and pluralistic to ensure that citizens can fully participate in public life and exercise their political rights in a well informed way. Concentration of ownership and control in the media may be economically efficient but may unacceptably lead to some interest groups, either political or commercial, using media influence to wield political power. Moreover, general competition law may not be able to ensure plurality as it tends to focus on single markets while media markets often produce unique products for which there is no satisfactory substitute. Second, whilst new media will expand the sources of content and outlets for content they may not, at least for some time, reduce the high share of consumption represented by the established media which are the subject of ownership regulation – ie newspapers, terrestrial television and radio. Perhaps this issue will become less important and media consumption will become more pluralistic. Then ownership concentration rules might be allowed to wither away, but until this is the case OFTEL believes the current regulation should remain in place. OFTEL recognises that there is some economic cost to this in terms of developing global media companies, but believes that, at the moment, this price is worth paying to promote plurality of ownership.

Answer: General consumer protection law will apply, togther with some other rules

Consumers will need the protection of the existing general law: but they may also require something additional. Set out below are how the new rules would deal with some specific examples.

6.60 If access to some classes of electronic communications is essential for fully functioning citizenship, then disconnection from these communication media and networks, for whatever reason, compromises individuals’ ability to participate in society and exercise their political rights.

6.61 Moreover, because individual consumers are weak relative to network and service providers regulation must be consumer centred and ensure that disconnection policies are fair – reflecting the needs of both consumers and producers – and that consumers have access to simple and effective means of redress and complaint resolution.

6.62 As use of telecommunication networks for commercial transactions increases, larger and larger volumes of valuable information about consumers will be generated. This information may be used unfairly and indeed against consumers’ own interests. Rules are needed to ensure that consumers can maintain control of information about themselves, and the uses to which it is put.

6.63 In principle, this is no different from other areas of commercial activity where information about consumers is generated and which fall under the Data Protection Registrar’s remit. But OFTEL has found competition issues relating to data generated from customers’ use of distribution systems being used "upstream" by suppliers. Regulation must ensure that information is not misused within vertically integrated firms in the interests of fair and effective competition.

6.64 Many, if not all, of the complex clues customers use to evaluate risk are absent from transactions conducted over electronic networks. Creating transaction security will be important. OFTEL believes that such mechanisms should be a Government, or general consumer protection, responsibility rather than the mandate of a sector specific regulator(s).

6.65 Similar issues arises in respect of misleading advertising. General rules should apply to all advertising media.

6.66 The role of a sector specific communication regulator should be to ensure that regulation does not inhibit customers from protecting themselves from exposure to unwanted material and that advertising standards rules can be enforced.

In the analysis of PSB, a distinction should be drawn between the "open state" and the transition period. In this context the "open state" is defined by the achievement of a mature multi-channel market, characterised by the absence of significant capacity constraints and the near universal availability of control access systems. The transitional period to the open state will be characterised by continued significant capacity constraints and non-pervasive penetration of control access systems.

The "open state" will require a fundamental reconsideration of the role and institutional structure of PSB. PSB in the digital age should principally be defined in terms of principles and goals rather than institutions. Two strands to PSB can usefully be distinguished. First, universal service, which has a geographical dimension (access by all parts of the UK to one or more transmission systems) and an affordability dimension (affordable access to a set of basic services). Second, positive programming requirements, which relate to the provision of valuable additional programmes and the maintenance of high quality programming that the market would not otherwise deliver.

At the appropriate time, taking account of the characteristics of the prevailing multi-channel broadcasting context, assessment of the delivery and funding of PSB, as defined, is required. Should the PSB status quo prevail? Should PSB disappear? Or should it be delivered by new institutions? What should be the role of commercial broadcasters in delivering PSB? The long run future is as yet too uncertain to give firm answers to these questions.

During the transitional period, PSB could be defined by reference to the existing institutional structure and funded by the mechanisms currently in place. But PSB should be identified only with the non-profit organisations (BBC, Ch4, S4C, Gaelic Broadcasting Fund) and positive programming requirements should be removed from Channels 3 and 5 when their licences come up for renewal. The requirement for universal service to Channel 3 could, however, remain if the Government decided that this were appropriate (and, if necessary, a Universal Service Fund could be set up to fund the net costs at the margin to Channel 3).

The BBC’s licence fee (and the funding mechanisms for other public service broadcasters) should provide incentives for improved efficiency, but should be sufficient to enable the positive programming requirements to be adequately fulfilled. Legitimate concerns about universal service, notably the affordability of the licence fee to all consumers are best addressed through pricing schemes targeted at the minority with affordability difficulties.

The regulators will have a role to ensure that public service broadcasters do not unduly distort competition and the development of new markets.

The assessment of the efficiency and effectiveness of the delivery of PSB would be assisted by the use of published performance indicators and research findings in conjunction with public consultation.

A.1 Public Service Broadcasting (PSB) is a widely used term but one for which there is no widely accepted definition. It is a concept that may be easier to observe in practice than to define in theory, although different individuals will have different views about what broadcast channels or programmes constitute PSB. At the minimum it involves special rules applied to broadcasters, such as positive programming requirements or Government intervention in the workings of the market, in order to influence broadcasters’ portfolio of content and consumers’ access to services. The definition of PSB used here excludes negative programming rules, such as taste and decency considerations, not because they are not important but because they should apply to all broadcasters and not only to public service broadcasters.

A.2 Public service broadcasting (PSB) developed in a broadcasting world of capacity constraints. These arose from spectrum scarcity associated with the use of analogue transmission technology. Is there a role for PSB in the digital age, when capacity constraints will have declined and perhaps ceased to exist? Some argue that there is no need for PSB and that competition and free markets will deliver the breadth and depth of services that consumers demand. But others contend that converged digital markets will fail to deliver the services that best meet society’s needs (which may not be the same as individuals’ wants) and see a vital continuing role for PSB. But whichever view is taken, it’s clear that convergence and digitalisation entail such profound changes to electronic communications markets that the role and structure of PSB is ripe for review. Change may mean that a vital service is undermined or marginalised; viewers might be lost to the emerging competition from new broadcasters and/or new channels; the prices of inputs paid by public service broadcasters might rise faster their revenues (partly because the cost of scarce talent is bid up by new broadcasters). Or change may mean that PSB is simply redundant.

A.3 OFTEL believes that decisions on the role and structure of PSB can only sensibly be made if a distinction is drawn between, on the one hand, the short and medium run and on the other hand the long run. In this context OFTEL considers the long run to be marked by the establishment of a mature multi-channel broadcasting market, characterised by few capacity constraints and widespread availability of access control systems – referred to as the "open state. " The long run, as defined here, may therefore be eight or more years in the future. During this period of transition, electronic communication markets will change incrementally. Consumers will have access to a variety of new transmission media enabling them to receive, manipulate, transmit and transform information including new, and perhaps more effective ways, to deliver existing types of broadcasting content as well as new types of material. In this timescale, current institutional structures will be up for review. For example, the current BBC Royal Charter expires in 2006 and the Channel 3 franchises expire in 2002.

A.4 In the long run the shape of the sector and the technological context that will prevail is uncertain. The open state could be characterised by well functioning electronic communication markets in which, by definition, there is a very limited role for public intervention and where regulation is legitimate only if conducted with a very light touch. Or it could be characterised by oligopoly with a consequential vital potential role to be played by regulation and by intervention of a PSB kind.

A.5 Both scenarios demand consideration of the legitimate role for PSB in a multi-channel world without major capacity constraints and clear definition of PSB’s mandate and objectives. Only this will allow the relative efficiency and effectiveness of PSB to be monitored systematically. It will also assist consideration of different options for delivery and funding of PSB to be considered. Given the uncertainties about the converged digital open state, OFTEL does not consider it appropriate to set out firm policies for PSB in the long run. Instead, relevant matters are analysed and possible policy options identified.

A.6 In the short and medium run much of the familiar UK broadcasting framework will remain, although in a context of rapid change. In these circumstances, PSB institutions (ie the BBC, S4C, Channel 4 and the Gaelic Broadcasting Fund) producing broadly the existing mix of output should be retained. Further consideration is required to ensure continuity of PSB funding, to improve the delivery of PSB and to ameliorate undesirable distortions of the market.

A.7 In the next section OFTEL considers the role and delivery of PSB in the open state, which sets out an analytical framework for considering the issues. The analysis of transitional arrangements for the short and medium run is the subject of the final section.

A.8 In the digital converged world many channels can be expected. Some will address niche interests and others will provide mass appeal programming. Some, perhaps many, electronic information, education and entertainment services will not be provided through channels at all, but by users selecting from a vast international pool of browsable information. Some channels are likely to be financed primarily by advertising, some primarily by subscription, and some primarily by pay per view (PPV). Additionally, there may be special arrangements for public service broadcasting (such as the licence fee). Each of these funding methods has different characteristics and exerts different incentives on the broadcaster. For example, profit maximising advertising funded broadcasters will seek to deliver audiences to advertisers. In contrast, broadcasters funded by subscription, or pay per view, have a much stronger incentive to take account of the intensity of enjoyment of consumers for the programmes they show, at least to the extent that consumers’ intensity of demand is reflected in the consumers’ willingness to pay. But by charging for channels or programmes, pay TV broadcasters may exclude some consumers who are not willing to pay the price charged but who would value its consumption. These arrangements may cause welfare loss. This is a significant policy issue especially because the marginal cost per additional consumer is zero (or very low) since the cost of channels and programmes is entirely (or very largely) fixed.

A.9 Predicting the future is an uncertain business. At least two possible ‘open states’ can be envisaged (and many cases in between) with different implications for the role and function of public service broadcasting.

A.10 In either case, it would be desirable for there to be clarity about the objectives and role of PSB in this future world. These should be defined in terms of principles and objectives rather than institutions. This task is not straightforward because of the elusive nature of some of the characteristics involved which are not easily amenable to detailed specification. In the next section OFTEL suggests a starting point for identifying a possible role and the objectives of PSB. The appropriate extent of PSB could be very different depending on the nature of the broadcasting markets that had developed. For example, under the first illustrative scenario set out above (‘the Peacock vision’) public service broadcasting would only have a minor, vestigial role. But under the second illustrative scenario the role of PSB is potentially much larger. Given the uncertainties involved, it does not seem appropriate at this stage to specify a particular solution. Rather the intention is to suggest a taxonomy as a starting point – further development of the analysis would be required and detail much would be need to be added.

A.11 In OFTEL’s view the possible objectives for PSB in a competitive market and with the removal of capacity constraints can usefully be classified into two categories:–

A.12 Conceptually, the categories are distinct, since the set of services to which it is considered that all consumers should have access need not be restricted to the positive programming requirements. For example, if the need for positive programming requirements were narrow, because competition were serving effectively the vast majority of consumers’ demands, universal service to a wider set of services would be likely to be considered necessary. Set out below is an outline of the arguments underpinning each category, ie possible reasons why even a competitive market may fail to deliver the most desired economic and social outcome. In each case sceptics would point to counter-arguments in and/or question the extent of PSB that would be supported by these justifications – to maintain a balance to the debate, the counter-arguments are also briefly mentioned.

A.13 The likely importance of subscription and pay per view broadcasting in the long run has led some to worry that certain consumers may be priced out of access to key programmes. The concerns expressed are that some individuals may consequently be unable to participate fully in society as citizens and that the opportunities for social cohesion will be diminished.

Universal service:
It is socially valuable for universal service to be provided, both in terms of:–

A.14 Sceptics might question the relevance or extent of universal service concerns. On event listing, the danger is that listing usually disadvantages rights holders and has an adverse impact on the underlying activity concerned. It may therefore act against the public interest in the longer term.

A.15 Competition and commercial, profit maximising, companies may fail to produce some programmes (or type or style of programmes) that would improve welfare, ie some programmes might be socially desirable but not profitable for broadcasters and so not available in the absence of PSB. Three arguments can be identified why this might arise: missing programmes, merit goods and diversity.

A.16 Sceptics would question whether there are many ‘gaps’ left by the competitive market to be filled by PSB and might expect diversity to be delivered by the competitive market.

17 The particular cost and demand characteristics of broadcast programmes mean that a competitive market could produce insufficient quality programming. PSB would then have a role as a quality benchmark that would maintain the quality of the commercial programming with which it competed. Three reasons for a lack of quality can be distinguished.

A.18 Sceptics would argue that there are other forces at work, such as the need for broadcasters to compete for viewers by offering quality programmes. They would also question the definition of ‘quality’ being used and be concerned about unjustified elitism and paternalism.

A.19 This section illustrates some of the ways in which the PSB mandate outlined above could be delivered. The discussion is not intended to be exhaustive.

A.20 Traditionally, universal service to PSB services has been ensured by the build out of a comprehensive terrestrial broadcasting infrastructure for free to air broadcasting beyond the extent to which profit maximising broadcasters would have built. Formerly, the transmission infrastructure was owned and operated by public service broadcasters (the BBC and IBA) but latterly the complementary systems developed by the BBC and IBA have been privatised. Universal service to public service broadcasting may henceforth involve subsidies to broadcasters (or the providers of transmission) to ensure that PSB channels are transmitted to parts of the country that would otherwise be unprofitable. The subsidies would be the net costs at the margin incurred by the providers of universal service recoverable from general taxation or a Universal Service Fund (a levy on the generality of viewers).

A.21 The other aspect of universal service is affordability, which could be addressed through targeted assistance to the poor to ensure that all are able, in an environment where access control systems are pervasive, to access a minimum set of programmes and channels. This could involve a special low price for access to a defined set of services on the basis of some criteria, which might for example include means testing. Funding such schemes could either be via general taxation or a Universal Service Fund.

A.22 Universal service should be delivered using the most efficient transmission media. For some consumers or for some types of material a transmission medium other than traditional broadcasting might be the most effective, such as Websites or WebTV. The new transmission media provide opportunities for developing new means of distributing existing material and may suggest creation of new material suited to the novel characteristics of multimedia distribution and transmission. Deciding which new, or alternative, transmission media are valid components of PSB and which constitute an unwarranted expansion of PSB into a domain where it is inappropriate will not be easy. These are decisions to be made at the time by the public service broadcasters and their regulator in the light of the defined objectives of PSB.

A.23 In theory, the positive programming requirements of PSB – additional programme and quality – can be provided in several ways, such as:–

A.24 As a solution for the long run, option (iii) does not seem attractive in principle or in practice. Commercial profit making broadcasters will be influenced by the particular incentives of their type of funding. In addition, they may be unwilling to take on positive programming requirements when they face strong competition from other broadcasters unencumbered by such obligations. Furthermore, the policy instruments available to encourage such broadcasters to take on positive programming requirements are already diminishing and are likely to be absent in the long run.

A.25 Option (ii) has some attractions, since tendering tends to encourage efficient delivery, but faces the difficulty that it can be very difficult for the commissioning body to specify its requirements in its contract with the commercial provider. Some aspects of the PSB role may be amenable to detailed specification, but other aspects may not be. Where the programme requirements are difficult to specify (eg what constitutes a high quality programme?), attempts to follow option ii could be wasteful, eg the danger is that the programmes funded relate to characteristics that can be described in a contract, so what is provided is what is describable rather than what is desirable.

A.26 Option (i) is the primary way that PSB is currently delivered in the UK and most other countries. Variants of the option involve the institution itself producing much of its own programming (eg BBC) or commissioning the entirety of its output from commercial programme makers (eg Channel 4). The institution will operate according to a defined public service remit. However, the PSB remit will typically be broad, leaving great discretion to the PSB institution as to how best to fulfil its public service function. This is a double-edged sword. It could be desirable where the institution has appropriate incentives and/or organisational ‘culture’, given that detailed specification of the requirements of PSB can be very difficult. On the other hand, there are dangers that the discretion given to the institution could be abused. If option (i) were to be continued into the long term, this suggests that highly desirable features would be clarity in the definition of the role of PSB and the institution’s part in fulfilling it, transparent monitoring of its effectiveness, with public accountability and responsibilities to consult and explain decisions.

A.27 If more than one PSB institution were to be retained, each of the strands to the positive programming requirements might be best addressed in different ways or by different institutions. One could have a greater focus on the need for additional programmes and another could address more closely quality aspects.

A.28 The short and medium run is the transitional period to the open state, and will be characterised by the continued existence of significant capacity constraints and the absence of near universal access control systems. The objectives of PSB in the short and medium run can be thought of as providing universal service and satisfying positive programming requirements. However, the context of the transition to the mature multi-channel world suggest a different approach to PSB in the short and medium run. During the short and medium run a significant, though declining, number of consumers will continue to face capacity shortages in the transmission media that they use. The existing terrestrial broadcasters will continue to play a very important role and will be the only universally available channels. PSB also needs to be seen in the context of the existing set of broadcasting institutions.

A.29 In the short and medium run an important aspect of PSB is that it should provide what profit maximising advertising funded broadcasters would not supply. Subscription and pay per view channels and programmes will be growing in importance during this period, but they will not be universally accessed. It also makes sense in the short and medium run to treat PSB as defined by the programmes, channels and services delivered by not for profit broadcasting institutions (BBC, Channel 4, S4C, Gaelic Broadcasting Fund). These institutions command widespread public support and should continue broadly in their current form during transition (the cases of Channels 3 and 5 are discussed below). Evidence for public support for the existing PSB institutions can be found in their maintenance of relatively high audience shares and broad satisfaction expressed in responses to audience research.

A.30 But defining PSB as a set of institutions inherited from the past is unsatisfactory (and so is not appropriate for the long run). This definition is circular – the BBC delivers PSB because it is defined as a public service broadcaster. Furthermore, it is not universally agreed that all programmes transmitted by public service broadcasters should be considered public service broadcasts. Arguably, much of public service broadcasters’ output is ‘commercial’, ie would be expected to be produced in a normal functioning market without capacity constraints. Only some should be classified as public service broadcasts – that which would not be supplied without special rules or non-commercial institutional arrangements. (This is not to rule out the possibility that an effective way to deliver PSB is as part of channels that broadcast a range of programming, including ‘commercial’ programming). In the long run these weaknesses in the transitional approach will become more pronounced, as the spread of access control systems makes the purchase of subscription and pay per view programming more common.

A.31 In the UK there are 4 institutions that clearly have a public service remit:–

A.32 Additionally, some public service obligations are borne by Channels 3 and 5 insofar as their policies and practices involve a deviation from profit maximising behaviour. The PSB remit of Channels 3 and 5 is enshrined in the undertakings made by franchisees in their bids for franchises and in the conditions of licence prescribed by the ITC under the Broadcasting Acts 1990 and 1996.

A.33 The 1996 Broadcasting Act also provides for the discharge of a public service remit by a variety of other means, such as the listing of events and the requirement for holders of digital television multiplex licenses to transmit programmes in Scots Gaelic supplied free of charge by the BBC, Channel 4, Scottish Channel 3 franchisees and any other television broadcaster so required by the Secretary of State.

A.34 The activities of these institutions depend, in part or whole, on three types of finance:–

A.35 How far is advertising finance compatible with a PSB role? In theory there is the potential for incompatibility between the incentives derived from advertising finance and the delivery of PSB. Advertising financed broadcasting tends to reflect the interests of advertisers which need not be the same as the interests of viewers and listeners, the final consumers of broadcasting. What matters to commercial profit making broadcasters funded by advertising is the ‘eye-ball’ value, not the willingness to pay of viewers, which reflects more closely their intensity of enjoyment. Advertising financed broadcasting is likely to be skewed: towards programming that is acceptable to the greatest number of viewers and listeners and/or attractive to relatively wealthy sections of the viewing and listening public, which appeal to advertisers rather than the programming that viewers and listeners most want. In sum, advertising financed broadcasting sells audiences to advertisers rather than programmes to viewers and listeners.

A.36 Yet in practice there are numerous empirical instances of public service broadcasters funded by advertising. Indeed the BBC is almost alone among public service broadcasters in having no advertising revenue. Channel 4 is a public service broadcaster that is advertising funded, though unlike Channels 3 and 5 it is a non-profit distributing company. Channels 3 and 5 are officially regarded by the ITC as advertising financed public service broadcasters.

A.37 Given the characteristics of advertising finance, the delivery of a public service mandate by commercial broadcasters (Channels 3 and 5), that is their divergence from the conduct that would be adopted as a matter of profit maximising behaviour, depends on the incentives provided for them to do so. Thus far, these incentives have been of two kinds, both of which depend on the Government’s ability to control entry to broadcasting markets:–

A.38 The Government’s ability to deliver both elements of its side of the ‘contract’ with commercial television broadcasters is declining. Hence, the importance of Channels 3 and 5 as elements of the UK public service broadcasting system can be expected to decline. Furthermore, these broadcasters will face increased competition from the new entrants that will take advantage of the increased broadcasting capacity available. The new entrants will be free of PSB obligations, but their continuation for Channels 3 and 5 may hamper these channels in their attempts to respond to the new competition. Given their somewhat equivocal position in terms of PSB, the decrease in the policy instruments available and the decline in the incentives for commercial broadcasters to discharge a public service mandate, there is an argument for Channels 3 and 5 to be relieved of their remaining PSB obligations.

A.39 This would mean the removal of the positive programming requirements when the Channel 3 licences come up for renewal in 2002. Channel 3 will continue to be universally available up to this date. However, the importance of Channel 3 in the transition may mean that the Government might consider that it should continue to be universally available throughout the UK. If necessary, the maintenance of universal service for Channel 3 might require a Universal Service Fund to be set up, as Channel 3 faces increasing competition from new entrants. This approach would mean that PSB would be identified much more closely just with the four non-profit institutions listed above: BBC, Channel 4, S4C and the Gaelic Broadcasting Fund. The ‘contract’ with the public service broadcasters would require them to fulfil the public service remit and in return obtain preferential funding mechanisms, such as the licence fee.

A.40 The approach set out above would suggest a continuation of the existing funding mechanisms in the short and medium run. One question that arises is the sustainability of the existing funding mechanisms. The discussion here focuses for convenience on the licence fee and the BBC, although questions of sustainability of funding may also arise for other public service broadcasters. Increases in the licence fee are currently linked to the RPI (though licence fee increases have been brought forward to assist the BBC’s preparations for the launch of digital TV).

A.41 There are two main reasons why costs will tend to increase faster than the RPI and one reason why costs may decline. First, broadcasting is more labour intensive than the economy as a whole, and labour costs tend to rise faster than the RPI. Second, one might expect the price of inputs in scarce supply, such as ‘talent’, to be bid up as there are increases in competition and in the amount of available broadcasting capacity to be filled by programmes. (The word ‘talent’ is being used here to cover both those individuals with skills to originate and produce broadcasting material and other sources of programming that may be in limited supply, such as rights to Premiership football.) To some extent the supply of ‘talent’ may be capable of expanding, since higher rewards will tend to attract more ‘talent’ including from overseas. But it is unlikely that supply will be able to expand as rapidly as the demand for ‘talent’ from broadcasters. These cost increases should be offset by improvements in productivity, which might come from advances in technology and/or from the removal of inefficiencies in the production process. The net effect of these influences is not certain, but a tendency for costs to increases faster than the RPI cannot be ruled out. Future reviews of the licence fee (and the funding mechanisms for public service broadcasters other than the BBC) will need to assess whether the indexation mechanism should be more sensitive to the price of inputs.

A.42 One potential danger with increasing the funds available to the public service broadcasters is that their increased ability to pay could further bid up the price of ‘talent’. This is less likely to occur where the public service broadcaster were bidding for ‘talent’ that were relatively elastic (ie where rising rewards would bring forward an increasing supply of ‘talent’). In cases where the supply of ‘talent’ were very inelastic and the content or event were of national significance, complementary action using event listing might be considered.

A.43 When the relevant authorities address the question of future funding of the public service broadcasters, OFTEL suggests that the distinction between the positive programming requirements and universal service strands of PSB should be recognised. Attempts to hold down the (uniform) licence fee to keep it affordable for the poorest runs the risk of underfunding the public service broadcasters and consequently having the positive programming requirements inadequately fulfilled. Legitimate concerns about the affordability of the licence fee to all consumers are best addressed using pricing schemes targeted at the minority that have genuine affordability problems. The licence fee paid by the generality of consumers, who do not have problems of affordability, should be sufficient to allow the BBC to fund its legitimate PSB activities, whilst the funding mechanism should ensure that incentives are provided for efficiency improvements.

A.44 There is a concern that public service broadcasters do not engage in anti-competitive behaviour. The fair trading commitments pioneered by the BBC are helpful in making and policing a distinction between the BBC’s public service and commercial activities. The BBC’s Fair Trading Commitment, which the Governors are responsible for ensuring is implemented, promises:–

A.45 Nevertheless concerns about the implications of the public service broadcasters on competition are likely to continue to arise. Not least because, in essence, PSB is a deliberate distortion of the market whereby Government has a ‘contract’ with the public service broadcasters. The Government seeks to influence market outcomes and provides public service broadcasters with guaranteed funding, either from the licence fee or public funds, to do so. Any such problems will be particularly troubling if the market distortion is undue or not necessary for the fulfilment of the PSB remit.

A.46 In recent years concern about the adverse impact of public service broadcasting on the operation of broadcasting markets has grown. The Government has encouraged the BBC to increase its commercial revenues and to realise value from the BBC brand. In doing so the BBC, of course, competes directly with commercial rivals and does so with the advantage of the BBC brand – a brand and reputation created and maintained by the BBC’s public service broadcasting activities. Thus, no matter how scrupulously the BBC adheres to its fair trading policies, there is an inevitable ‘cross subsidy’ of its commercial activities by its public service activities. Moreover, when the BBC markets commercial products, and competes in commercial markets (whether for broadcasting services, magazines, toys or T shirts), it characteristically does so by linking the commercial product and/or service provided to elements of its public service remit. This is not necessarily to deprecate the BBC’s activities – it is realising value (often outside the UK) from its brand and in doing so has followed encouragement from Government so to do. But such activities have an inevitable impact on commercial markets and an impact which obtains when the BBC adheres scrupulously to its fair trading undertakings as well as if it should not. There is a role for a regulator to ensure that the activities of the public service broadcasters do not unduly restrict the development of effective competition.

A.47 Imprecision in the definition of PSB in the short and medium run makes monitoring of the appropriateness and effectiveness of PSB delivery difficult. If PSB is defined as what a set of institutions does, or as a bundle of broad principles, eg "inform, educate, entertain," assessing how well the PSB institutions are fulfilling their public service remit is difficult. However, performance measures can provide useful assistance. Examples of possible useful performance indicators are:–

A.48 Whilst PSB is identified with particular institutions, such as the BBC and Channel 4, that deliver a range of programming, (including some that could be considered commercial), audience share remains a relevant indicator of performance. For example, BBC’s current shares (about 44% for TV viewing, 47% of radio listening) are relatively high. But further more precise definition may be required channel by channel, since different services play different roles in delivering PSB.

A.49 Another relevant criterion is reach, the proportion of a total population that consumes 15 minutes of a given service (or services) in a week. This would be more relevant to channels and programmes meeting minority demand, such as those addressing the additional programme aspect of PSB.

A.50 ‘Appreciation indices’ for programmes have been developed by broadcasters by polling viewers and listeners on the extent and intensity of their appreciation of programmes. Formerly the research was undertaken by the BBC and the commercial television regulator independently; latterly it has been undertaken jointly. Appreciation research revealed that there may sometimes be little correspondence between a programme’s share of consumption and the level of appreciation it achieved from those who did consume it. That is, a programme which achieved a high share may sometimes achieve a mediocre appreciation index and, to the contrary, programmes that achieve low shares may sometimes achieve high appreciation indices. This finding suggests some empirical support for the theoretical proposition that audience maximising programming is programming that is acceptable to a large number of people but is not necessarily the programming that they most want or value.

A.51 A combination of share, reach and appreciation indices could provide a portfolio of performance indicators to guide broadcasters in their activities and provide an objective measure of the extent to which public service broadcasters were achieving their mandate. However, the balance between each of the components of the basket of indices would need careful consideration and different regimes would be appropriate for different broadcasters and different services. BBC 1 would have a different mandate ‘basket’ to BBC2, Radio 3 would have a different ‘basket’ to Radio 1, S4C would have a different basket (and different audience constituency to reach) to Channel 4, and so on. It needs to be recognised, however, that some important elements of the public service broadcaster’s mandate are not easily susceptible to measurement by consumption based criteria.

A.52 Characteristics such as programme quality, range and diversity are difficult to measure (and the use of spurious indicators runs the risk of encouraging activity to satisfy the inappropriate measure rather than the underlying objective). A different type of approach would be to set out desirable characteristics of programmes, which are inevitably subjective.

For example, the BBC defines, inter alia, what viewers and listeners can expect from the BBC as:–

A.53 It seems inescapably necessary for some authoritative body to assess how far public service broadcasters do discharge their responsibilities. Currently the BBC Governors, the S4C Authority, and the Channel 4 Governors have direct programming responsibility and a host of regulatory bodies have a variety of post hoc responsibilities for assessing programming quality.

A.54 To assist the monitoring of the delivery of PSB, OFTEL would support the increased use of:–

In this annex OFTEL fills out its proposal for a fundamental shift from a system based on individual licensing to one based on general authorisations. The new regulatory system will be governed by a slim set of general rules backed up by detailed guidance, and with effective sanctions and enforcement mechanisms to ensure that the rules are robustly applied.

B.1 Telecommunications and broadcasting are both currently regulated through licensing. The key licences are individualised and are usually specific to particular firms which are subject to a tailored set of rules. The IT industry, on the other hand, is largely unregulated by Government and no licences are required. Even within telecommunications licences are only required for the operation of systems: those offering services over other operators’ systems (eg mobile service providers) do not require to be licensed and therefore escape sectoral regulation.

B.2 The principle underlying the Telecommunications Act is that anyone operating a telecommunication system without an appropriate licence is committing a criminal offence. Licences may be granted to individual operators or to anyone of a class. In practice all the major "public" systems are operated under individual licences. Until the 1991 Duopoly Review, these licences were only given to BT, Mercury and Kingston. Their licences contained a large number of detailed rules, dealing with a wide variety of different issues, from specific rules to prevent anti-competitive behaviour and to enforce universal service, to rules on wiring, maintenance and priority fault repair. Over the years the number of detailed conditions has grown as new problems emerged which were not adequately covered by the original detailed rules, and as EU Directives necessitated amendments to implement EU stipulations. In 1996 a serious attempt was made to simplify licences and remove detailed rules while introducing a general Fair Trading Condition. However, this made only a small dent in the length and complexity of licences. For example, the BT licence contains over 80 conditions, some of which are several pages long.

B.3 Since the decision to liberalise telecommunications in 1991, there has been a strong presumption in favour of granting licences to all serious applicants. There are now over 250 PTO licences (as well as many hundreds of other individual licences of less significance). The more recent licences were deliberately drawn up with as few obligations as possible, and with some of the more onerous obligations not kicking in unless and until the operator in question attained a position of market power. Even so, with the inexorable expansion of licences to deal with emerging problems, particularly to deal with the demands of EU Directives, even these so-called "slimline" licences have become very hefty documents. A broadly similar trajectory has been followed by the ITC. Channel 3 and 5 franchisees have detailed licences, whereas other firms are subject to less fully specified "generic" licences.

B.4 For historical reasons (the later licences take account of more recent regulatory thinking) the content of telecommunications licences varies considerably, largely according to their date of issue. Some much needed standardisation is being introduced this year, thanks to the stipulations of the EU Licensing Directive for transparency, non-discrimination, objectivity and proportionality. The rules will, therefore, reflect the fact that OFTEL is no longer dealing with a small collection of individual players, but with a multi-operator industry. The mechanisms for changing the rules are, however, still geared to the former. It will therefore be extremely difficult to modify the rules as the market develops – even when large parts of the industry are clamouring for change – without recourse to elaborate and lengthy investigations by the MMC.

B.5 Sanctions for breach of licence conditions, and mechanisms for enforcement, remain unaltered from 1984. No sanction applies until the end of a procedure with many steps: the alleged breach must have been investigated by OFTEL, the operator must have been given the chance to show either that the breach has not occurred or that it will not occur again, an Order must have been issued by OFTEL, and the operator must then have breached that Order. No third party rights to damages exist until that last stage.

B.6 This enforcement regime is in stark contrast to the sanctions proposed in the Competition Bill, under which general prohibitions on abuse of dominance and the making of restrictive agreements give rise to immediate rights for injured third parties, and which allow the competition authorities (which include the sector-specific regulators) to impose fines for breaches from the date of occurrence of the breach, not from the (much later) date of the issuing of an Order following investigation of the breach. Relatively mild sanctions for breach of licence conditions contrast with the potential for criminal sanctions applied to those who stray (sometimes unwittingly) into areas which are outside the scope of their specific licence. The Competition Bill also gives enforcement authorities rights to search premises and impose interim measures. These measures go beyond the measures available to regulators enforcing licence conditions and, quite properly, these new measures will be balanced by entitlement to appeal to the new Competition Commission’s Appeal Tribunal.

B.7 The licensing and enforcement mechanisms described above are no longer appropriate to the new world of convergence and competition, where the focus of regulation should be to encourage competition, diversity, choice and innovation, while delivering an agreed set of social objectives, rather than on controlling a handful of companies with privileged access to a scarce resource. Particular problems with the current mechanisms include the following:

B.8 The extent of these problems should lead us to re-consider the underlying regulatory mechanisms. The mechanisms for the new world should be designed to fit the type of rules needed in the future. They should avoid the pitfalls in current licensing regimes as described above.

B.9 Is a system based on licensing needed? OFTEL believes that licensing is only appropriate where Government is seeking actively to discourage a particular activity in the absence of clear evidence that certain essential pre-determined conditions have been met. (For example, for safety reasons Government wants to discourage people from driving a car until there is evidence that they have passed a driving test.) Such a prohibitive approach to telecommunications was adopted in 1984 from fear that new telecommunications operators might seriously – and harmfully – disrupt the market or compromise the integrity or safety of existing telecommunications networks. Those fears have now largely disappeared. Instead, public policy is to encourage, rather than discourage, the proliferation of network and service providers, subject to minimal controls to ensure interoperability etc, while exerting the toughest controls only on those with market power.

B.10 It is clear that effective regulatory mechanisms, beyond those in the Competition Bill, to impose rules on the communications industry are required. They must be effectively applied and enforced. Licensing can in certain circumstances be a convenient mechanism. It gives Government and/or regulators different levers (eg choice as to who to allow into the industry, who to force out of it, what rules to apply to individual players within it). It is particularly useful when different rules are required for different operators (eg precise roll-out or coverage obligations to operators in exchange for access to an exclusive privilege, such as the current regional cable TV franchises, or to a scarce resource such as radio spectrum which is not otherwise “paid for”). But such exclusive rights are expected to disappear within the next three years, and other market mechanisms are being established to ensure the efficient use of (and payment for) radio spectrum. The rationale for the heavy-handed "prohibitive" approach of licensing is fast disappearing.

B.11 There is an alternative approach, foreshadowed in the EU Licensing Directive, which may be more appropriate to the new world of communications. Under this approach various types of communications activity would be governed by "general authorisations," set out in legislation. Such authorisations would be subject to general rules, also embodied in legislation. These rules will be of a general nature, and backed up by detailed guidance from the regulator. This echoes the approach of the Competition Bill and of the regulation of banks and building societies.

B.12 In the building society/banking field, for example, there is a general requirement to act "prudently." Guidelines issued by the regulators (the Board of Banking Supervision or the Building Societies Commission) provide very detailed guidance on what constitutes "prudence" in different circumstances. Such guidelines have a presumptive but not an overriding or mandatory effect: it is open to individual organisations to demonstrate that they have met the general requirement of prudence in a different way.

B.13 Such an approach could be applied to electronic communications. General authorisations could cover activities such as running public telecommunications networks, providing telecommunications services, broadcasting networks and broadcasting services. General rules to cover such matters as cross-subsidy, accounting separation, undue discrimination and price publication (for those with market power), interoperability and bottleneck control, and social objectives, could be contained in legislation. If the rules are written in a suitably general form, frequent changes are unlikely to be necessary even in a fast moving market. The detail of everyday regulation would be transacted through the accompanying guidelines, which the regulator would be required to keep up to date.

B.14 Breach of a rule could give rise to third party rights to redress and compensation and, where appropriate, to immediate sanctions imposed by the regulator. As with the Competition Bill (and railway regulation), the regulator should have the power to impose a fine. A breach could also give the regulator the opportunity to impose a specific condition (eg to enable it to monitor future behaviour closely). Ultimately, recurrent and/or severe breaches would enable the regulator to revoke the applicability of the general authorisation to the organisation in question. But targeted sanctions make it likely that this remedy would seldom be needed. All such decisions by the regulator would be subject to the normal rules of due process, and could be appealed to an independent body, as under the Competition Bill.

B.15 OFTEL’s approach is foreshadowed in EU Directives on telecommunications, in particular the Licensing Directive, which specifically encourages “general authorisations.” EU Directives seldom include the extensive detail characteristic of UK licences. Accordingly, EU requirements could be satisfied by ensuring that the general rules described above, to be included in UK legislation, were drafted to comprehend EU requirements.

C.1 In Section 4 OFTEL set out the categories of rules that would apply to those involved in the provision of electronic communication systems and the provision of services over those systems. This annex sets out in tabular form what the major rules in each category would look like. The Table is confined to the rules for which the economic regulator (Electronic Communications Commission) would be responsible. It includes rules where concurrent powers with the general competition authority (Column 2) exist. It does not include general consumer protection rules that apply to the economy as a whole and are enforced by consumer protection agencies (eg Trading Standards Authorities). However, where consumer protection rules are currently the responsibility of the sector regulator they are included in the “Social Rules” column.

C.2 The Table does not contain the positive programming content “rules” as OFTEL proposes that these should exist in a “contract” between the government (through the Electronic Communications Standards Authority) and public service broadcasters.

C.3 The Table deals only with rules, not the process by which they are applied. Annex B sets out in more detail the application of the rules.

3 Joint Dominance (competitive supply, but very limited number of suppliers)

4 Permanent Market Failures (including network externalities and bottleneck control)