Bsb Vs. Sky Case

Department of Managerial Economics and Decision Sciences

WAR OF ATTRITION OVER THE SATELLITE TELEVISION MARKET IN THE UNITED KINGDOM1

Satellite Television Market Prior to December 1996, the television market in the United Kingdom was comprised of four broadcasting channels: British Broadcasting Corporation 1 (BBC1), British Broadcasting Corporation 2 (BBC2), Independent Television (ITV), and Channel 4. BB1 and BBC2, whose viewing audiences in 1985 were 36% and 11% respectively, are public companies, broadcasting high-quality, public-service programming, and are financed solely through annual license fees paid by TV set owners. ITV, who captured 46% of the viewing audience in 1985, consists of several regional broadcasting private companies, financed solely through advertising revenues. Finally Channel 4 was launched in 1982 and is owned by the Independent Broadcasting Authority (IBA). In order to expand the choice of television viewers, industry experts believed that pay TV, such as cable and satellite television, would be the solution. Both technologies were seen as complements. And, the cable industry was still growing at a modest pace, but still lagged far behind the cable development in the US. Satellite television transmits signals from a station on the ground to a geostationary satellite (in orbit at 22,000 miles above the earth) to the viewers’ receiving antennae. Such a system could be implemented with low to high-powered satellites: the higher the transmission power, the lower the size of the antenna required at the subscriber premises. In 1981, Satellite Television PLC (SATV) had launched such a satellite television service, using spare capacity on a low-powered satellite. Due to its low transmission power, the signal had to be broadcast to cable systems rather than subscribers’ satellite dishes, which ultimately led to its commercial failure. News Corporation, owned by Rupert Murdoch, purchased a majority stake in Satellite Television PLC in 1983 for £10 million, renamed it Sky Channel, and revitalized its operations. Another satellite television service called Super Channel was launched in 1986 by ITV companies, but it encountered the same meager success and financial losses due to low penetration and lack of advertiser interest. 1

© Professor Nabil Al-Najjar and Professor Sandeep Baliga, Kellogg School of Management. This document was prepared for use in class discussion in Competitive Strategy and Industrial Structure (MECN 441) sections at Kellogg. Cedric Pauly provided excellent research assistance. Do not copy this document for any other use without our explicit permission. The document draws on Pankaj Ghemawat, “British Satellite Broadcasting versus Sky Television”, Harvard Business School 9-794-031 (August 1994), and “Games Businesses Play”, The MIT Press (1997).

In December 1986, the British government awarded a fifteen-year license to operate highpowered Direct Broadcast Satellite (DBS) to the British Satellite Broadcasting (BSB) consortium. BSB’s high-powered broadcast could be received by small, inexpensive individual dishes and was the latest effort to develop satellite television. In addition, BSB had the obligation to use a new transmission standard called D-MAC which was a building block for the high-definition television (HDTV).

The players BSB was a consortium of eleven companies led by the diversified Pearson group, who raised £222 million in its first round of financing. The other noticeable members include Granada and Anglia (two ITV companies), Virgin (a music company), Bond Corporation (diversified Australian group), Chargeurs (French textiles and transportation company), and Reed International (largest UK publishing company). The first round of financing was principally aimed at launching two high-powered satellites. The second round scheduled the start of the operations in fall 1989 at an estimated cost of £500 million. Fixed costs (programs, satellite, marketing, and overhead) represent 75% to 80% of the firm total costs. Due to the high fixed costs, BSB must establish a large customer base to be successful. The revenue structure would encompass a monthly subscription of £10, as well as advertising revenues. In addition, the 12 inches satellite dish would cost about £250. The operating break-even was targeted for year 1993. BSB commercial forecasts were as follows: 400,000 dishes by fall 1990, 2 million by 1992, 6 million by 1995, and 10 million by 2001. By 1987-1988, BSB management was very focused on solving their operational issues – among them the choice of ITT at the expense of Philips as the supplier of a key chip for deciphering DMAC satellite signals. But management was ”not very concerned about competitive threats until Sky came along “ as Richard Brooke, BSB’s treasurer, said. Indeed, in June 1988, Rupert Murdoch caught BSB completely by surprise by announcing that News Corporation would launch its own DBS service in the United Kingdom. News Corporation’s £3 billion Empire had been created and developed by Rupert Murdoch. Its operations started in Australia in newspapers and television, and expanded in the United Kingdom with the acquisition of the Sun, Times, Sunday Times and Today newspapers. In 1985 News Corporation acquired the Twentieth Century Fox studio and in 1986 it launched the fourth U.S. television network, Fox. News Corporation’s DBS satellite venture was called Sky Television. It would broadcast through a new medium-powered satellite, Astra, to be launched by the Societe Europeenne des Satellites (SES) in November 1988. The selection of a medium powered satellite allowed Sky Television to launch its satellite service ahead of BSB and to have a better cost structure as the company would only need to rent one of the four satellite channels for £10 million a year. Another advantage for Sky Television was that it was not required to use the D-MAC standard, and could therefore use the prevailing field-proven PAL standard. However this cost and fast roll out advantage came at the expense of a weaker signal, which required a larger satellite dish at the viewers’ home (though it was a cheaper dish) and also of a lack of scrambling capacity in the PAL standard. As the signal could not be scrambled, movies channels would have to be offered for free rather than subject to subscription, and may as well be an issue in trying to program recent movies as Sky

Television’s programming would spill over to continental European countries with different regulations. Sky Television would consist of four channels: Sky Channel, Sky News, Sky Movies, and Eurosport, which could be later expanded with new channels from the Astra satellite. It was Rupert Murdoch’s promise of more public choice: “My contention is that broadcasting in this country has too long been the preserve of the old establishment […]. The public wants more choice. Advertisers want more choice”. Relative to BSB, Sky Television start-up costs were much lower, estimated at £100 million – versus £500 million for BSB – with a break even scheduled for the end of 1991. The service launch was scheduled for February 1989, a challenging nine month period, which was dependant on the success of Astra satellite launch. If this schedule was to be met, Sky Television forecasted the installation of 1 million satellite dishes by the end of 1989, and 5 to 6 million by the end of 1994.

Competition is killing both players In response to Sky Television’s launch, BSB revised its satellite dish installation upwards. It increased its commitment to the satellite business. The BSB commercial forecasts grew to 5 million dishes by 1993, and 10 million by 2003. The advertising and promotion budgets were increased as the planned launch date approached. Beside the marketing expenses, the war raged as well in the films bidding for exclusive television rights in the UK. Hollywood films were considered a key success factor in the satellite television business as they were the content that would drive the subscription revenues. The bidding war was exacerbated after Sky Television’s announcement in October 1988 that it would be able to scramble PAL signals. As a result, by the end of 1988, BSB and Sky Television had committed to buy for £650 million of programming from Hollywood studios, including £150 million of up-front payments. This amount was believed to be twice as high as the initial estimations and two to three times as high as the fares paid by U.S. cable companies; each party was blaming the other for this price escalation. BSB’s mounting costs required BSB to seek an additional £131 million of financing in January 1999. And, led Virgin to sell its stake in the venture to Bond Corporation, already the largest investor, for a small profit. The first merger talks between Sky Television and BSB were unsuccessfully initiated at that time by Virgin’s chairman, Richard Branson. Sky Television opened its commercial service in February 1989 as planned. However, the market reaction was lukewarm and only 600,000 dishes were sold by the end of 1990, 40% less than forecasted. Several reasons explained the slow sales ramp-up: a shortage of receiving equipment, patchy programming, rising interest rates and nice weather. In addition BSB launched a £20 million advertising campaign to promote the D-MAC standard over Sky’s PAL standard, which delayed their subscription decision and confused consumers because the Sky and BSB satellite dishes and receiving equipment were not compatible. Sky Television tried in vain to launch a direct door-to-door marketing campaign, but had to finally back off due to infuriated retailers. BSB did not have an easy ride either. First it missed its launch date in September 1989 due to delays in ITT’s chip development for D-MAC receivers. However it was very reluctant to switch to the PAL standard, as the D-MAC standard differentiated BSB from Sky Television. In February 1990, BSB concluded a second round of financing: the banks would lend BSB £450 million, conditional on timely achievement of operational targets, and the equity investors would

infuse an additional £450 million. Such a deal was complicated by the demise of the Bond Corporation, BSB’s largest shareholder. Granada, Pearson, Reed, and Chargeurs subscribed to the recapitalization plan, which made BSB the second costliest start-up venture in the UK, after the Channel tunnel. The capital raised was used to fund the “Operation Fastburn”, a heavy marketing and advertising campaign. BSB finally started its operation in April 1990. However, despite the “Operation Fastburn”, BSB initial sales were disappointing due to receiving equipment shortages, Sky Television’s aggressive response, customer perplexity and the economic recession. Between April and October 1990, BSB only gained 175,000 subscribers, whereas Sky Television gained 946,000 subscribers. The game was reversed from October to December 1990 as BSB gained 125,000 subscribers compared to 56,000 for Sky Television. In October 1990, BSB had already lost a cumulative £800 million and was losing money at a weekly rate of £6-7 million, compared to Sky’s weekly loses of £2 million. BSB’s CEO, however, remained optimistic before the 1990 Christmas season. He said: “This is the big game or no game…It’s like drilling for North Sea oil. Money goes out. Murdoch will have to carry the heat”. His optimism was driven by the cash crunch faced by Sky Television’s parent company, the News Corporation, and his belief that BSB had deeper pockets to survive the competition. Indeed, in addition to Sky Television’s investment, News Corporation had since mid-1988 invested $3 billion in TV Guide and Triangle Publications, and several hundred millions pounds in the upgrade of its newspapers business operations. News Corporation had since then been forced to renegotiate its multi-billion dollar debt while one of the covenants imposed by banks was to stop the drain of cash at Sky Television.

Epilogue On November 2, BSB and Sky Television announced their fifty-fifty merger into BSkyB. The merger was presented as the combination of BSB’s financial resources and Sky Television’s commercial acumen. Though the control was equally split; it appeared as a less-than-equal merger for BSB given its massive investment and the agreement that News Corporation would receive its share of positive operating cash flows earlier than BSB’s former investors. In addition News Corporation had to provide less than half of BSkyB’s immediate cash requirements, and its executives rapidly took over the exclusive management control of BSkyB.