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Response to

VIEWS: 110 PAGES: 50

									Response to
Culture, Media & Sport Committee
Inquiry into the commercial operations
of the BBC




October 2008
Select Committee inquiry into BBC commercial operations                                            2




Executive summary


1) The UK has a public service broadcasting system that is envied around the
    world, with a range of broadcasters and programme makers providing the
    public with high quality television that meets such public service goals as
    educating, fostering citizenship and representing diverse viewpoints. At the
    heart of this system is UK-made programming, as opposed to imported
    shows. UK-made programmes are integral to public service broadcasting’s
    ability to help us understand ourselves, our society, and, at its best, unite us –
    and being made in the UK is rightly one of the defining characteristics of a
    public service programme.1


2) Public service programming now faces well-documented funding issues. With
    pressures on advertising revenues increasing, Ofcom’s ongoing second
    review of Public Service Broadcasting predicts a funding gap of up to £235m
    per annum by 2012 just to maintain current levels of UK-made, public service
    programming.2 Channel 4 and ITV have already made widely-reported cuts in
    public service programme budgets such as news, programming from the
    devolved nations and English regions, and children’s content. Even the BBC,
    relatively well protected due to its funding from the licence fee, has made cuts
    in core programming areas following the last Charter settlement.



1
  All Public Service Broadcasters (the BBC, ITV1, Channel 4 and Five) have quotas for “original”
programmes, which the Broadcasting (Original Productions) Order 2004 defines as programmes
which have their first appearance on television in the UK. In practice, this means programmes
that are made in the UK.
2
  Second Public Service Broadcasting Review, Phase 2: preparing for the Digital Future, Ofcom,
September 2008, page 5.


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3) The industry must find self-help measures as far as possible to help alleviate
    this pressure, and it is therefore increasingly important that the BBC
    maximises the commercial value of its existing assets – i.e. its programmes.
    Resulting revenues should be re-invested back into making new UK
    programmes that deliver the goals of public service broadcasting. In so doing,
    the BBC returns an added value to licence fee payers, who will see those
    programmes on their television screens.


4) Under the BBC Charter, the BBC’s Public Purposes are of overriding
    importance, and commercial activities are secondary. 3 It follows that
    commercial activities should exist to maximise the revenues that can be
    reinvested in the pursuit of these Public Purposes – i.e. in the creation of
    public service programming and content that contributes to this pursuit.4


5) This is reflected in the BBC Trust’s guidance for the strategy of BBC
    commercial activities, which states:


    “At the highest level, the Trust will be concerned with the objective that the
    BBC should relieve pressure on the licence fee by seeking to maximise
    commercial revenue within appropriate areas and by returning value to
    licence fee payers by reinvesting profits in the BBC’s Public Services.”5


6) We are concerned that the BBC is not maximising the potential of these
    assets on a number of counts, and welcome the inquiry by the Culture, Media
    & Sport Committee. Firstly, BBC Worldwide currently has an automatic and
    exclusive “first look” to buy all programmes made by BBC in-house production

3
  Charter Article 3.
4
  Under section 4 of the Royal Charter, these are: sustaining citizenship and civil society;
promoting education and learning; stimulating creativity and cultural excellence; representing the
UK, its nations, regions and communities; brining the UK to the world and the world to the UK;
and helping to deliver the benefit of emerging communications.
5
  BBC Trust, Protocol B6 Commercial Strategy.


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Select Committee inquiry into BBC commercial operations                                        4



    departments. It then exploits these programmes commercially (for example,
    by selling Doctor Who to broadcasters and BBC Worldwide’s own wholly-
    owned channels in other countries), returning a share of profits to the BBC.
    However, many companies in the private sector perform the same function as
    BBC Worldwide with regard to programmes outside the BBC’s in-house
    production departments. Many of these third-party distributors would bid
    against BBC Worldwide for the right to license programmes made by BBC in-
    house if the BBC allowed them to, and the resulting competition for rights to
    BBC shows might well yield a higher return for the BBC. When high profile
    television shows are auctioned on the open market, it is not uncommon for
    bidding wars to take place. This has occurred when the BBC has
    commissioned programming from external suppliers, who have then
    auctioned the international rights to the show to the market, with the result
    that private sector distributors have outbid BBC Worldwide.6


7) Opening up in-house programming to such competition could potentially
    generate significant additional income for the BBC, which could then be
    reinvested in public service programme-making. The BBC invests £800m in
    in-house production a year compared to around £400m on external
    programming. Much of this will comprise high profile shows that are highly
    attractive to the market, given that they will have built audience awareness on
    BBC1 and BBC2, two of the UK channels with the highest audience share.


8) Just as importantly, without auctioning programmes on the open market, the
    BBC cannot be confident that it is realising the maximum possible added
    value on its assets. This is one area where the BBC’s regulations are
    inadequate. Under the Fair Trading Guidelines, the BBC is required to charge

6
  Under the Codes of Practice/Terms of Trade introduced in the 2003 Communications Act, and
regulated by Ofcom, independent suppliers retain control of certain secondary rights to
programmes that they create, including the overseas exploitation rights. The BBC, as primary
commissioning broadcaster, will receive a share of any revenues generated from subsequent
exploitation.


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Select Committee inquiry into BBC commercial operations                                   5



      BBC Worldwide prices that are in line with the market for its programmes; yet,
      for the majority of in-house programmes, the BBC has no way of accurately
      knowing the market rate as it has never tested what the market is willing to
      pay. To ascertain the correct market rate, the Fair Trading Guidelines merely
      task the BBC with occasionally benchmarking prices. This is a wholly
      unsatisfactory way to gauge prices for television programmes, which are not
      homogenous, exist in a fast-changing market, and may be subject to
      commercial confidentiality. It means that, under the current system, the BBC
      cannot guarantee that it is securing the maximum possible added value from
      its programme assets when its passes them on to BBC Worldwide.


9) The BBC has previously objected to an open auction system, whereby it
      would offer a programme to the market so that private sector companies
      could compete for it alongside BBC Worldwide, on the grounds of efficiency.
      We reject this: distributors in the commercial sector routinely conduct such
      auctions to sell programmes, as has the BBC itself, as we will outline.


10) We also have concerns over the transparency of the BBC’s commercial
      activities in a number of areas, including where profits that accrue from
      exploiting programmes are re-invested. As we have noted, this should be into
      the pursuit of the BBC’s Public Purposes, and in particular into the creation of
      public service content that delivers these Purposes. Currently, it is not clear
      where those profits are spent.


11) Nor is BBC Worldwide obliged to make public what it is paying for rights to
      BBC     in-house     programming.   The    Fair     Trading   Guidelines   call    for
      “transparency and accounting separation” between the BBC’s public service
      activities and BBC Worldwide.7 However, they do not require an appropriate
      level of transparency for transactions within BBC Worldwide (i.e. between its

7
    BBC Fair Trading Guidelines, 3.4.


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Select Committee inquiry into BBC commercial operations                      6



   divisions) that may have a bearing on the prices its pays the BBC or third
   parties. BBC Worldwide operates a portfolio of 29 channels around the world,
   and will pass on programmes that it buys from the BBC or other parties to
   these channels for broadcast for a fee. This fee is not disclosed in BBC
   Worldwide’s annual accounts, and it is unclear what value is attached to the
   programme when BBC Worldwide passes it on to its wholly-owned channel,
   and whether this is a genuine market rate. This means that BBC Worldwide
   may allow its channels to underpay for BBC in-house programming, which it
   in turn has acquired at relatively low cost through its exclusive first-look
   arrangement.


12) We have similar concerns regarding the transparency of BBC Worldwide’s
   investments in BBC programmes at production stage (as opposed to its
   purchase of completed programmes). This is a common practice and, in
   exchange for its investment, BBC Worldwide will take rights to the show for
   sale at a later point. The BBC will use the investment from BBC Worldwide to
   augment its core programme budget and fund the creation of a programme.
   We have no objection to the principle of BBC Worldwide investing in BBC
   shows at financing stage – indeed, BBC Worldwide revenues should be
   reinvested in the BBC’s core activity of making UK public service
   programmes. However, the BBC does not make clear how BBC Worldwide’s
   investments are spread between in-house programmes and external BBC
   commissions, or the proportion of the budget BBC Worldwide pays for
   investments in in-house programmes compared to external programmes.
   Were in-house producers securing a greater level of investment than external
   producers who have been commissioned by the BBC, they could have an
   unfair advantage when competing with external suppliers for BBC
   commissions. This would potentially undermine the BBC’s stated policy of
   commissioning the best ideas, no matter where they come from, so that the




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    licence fee payer benefits from the most diverse, engaging and innovative mix
    of shows.8


13) In terms of its regulatory framework, the BBC Charter and Agreement set out
    very broad requirements requiring the BBC to focus on its Public Purposes,
    and the Trust to be mindful of the BBC’s competitive impact and to adopt a
    statement of policy on fair trading.9 This is then implemented by the Trust’s
    Fair Trading Policy and BBC management’s Fair Trading Guidelines, which
    are approved by the Trust. Under the Fair Trading Guidelines, BBC
    Worldwide is required to meet each of four Commercial Criteria. Any BBC
    commercial activity must adhere to all four criteria, which are:


       “Fit with the BBC’s Public Purposes;
       Not jeopardise the good reputation of the BBC or the value of the BBC
        Brand
       Exhibit commercial efficiency; and
       Comply with the Trust’s Fair Trading Policy, the BBC’s Fair Trading
        Guidelines and, in particular, avoid distorting the market.”10

14) We are concerned that BBC Worldwide is failing to meet these criteria on a
    number of counts, and in some cases is in clear breach, particularly in light of
    its aggressive expansion strategy over recent years.


Fit with the BBC’s Public Purposes




8
  BBC director general Mark Thompson told the House of Lords Select Committee during the
Charter review: "It is in the interests of the licence payer that the licence fee investment should go
to the best ideas and the best talent." Mark Thompson oral evidence to House of Lords Select
Committee on the BBC Charter Review, First Report, Section 255.
9
  BBC Charter Article 23 and 24; Agreement Clause 66.
10
   BBC Fair Trading Guidelines, 2.3.


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15) We cannot see how several of BBC Worldwide’s current activities – including
      its investments in consumer magazine publishing in India, its acquisition of
      Australian book publisher Lonely Planet, and its acquisition of ownership
      stakes in production companies overseas - bear any meaningful relation to its
      Public Purposes. This creates several dangers, including an unnecessary
      financial and reputational risk to the BBC.


Reputation of the BBC


16) As noted above, the BBC’s involvement in a range of commercial ventures
      that are increasingly far removed from its core programming creates a danger
      of damaging the BBC’s reputation as the nation’s main public service
      broadcaster. As we detail, for example, BBC Worldwide’s current investment
      portfolio includes an ownership stake in the Freehand Group, the Australian
      production company behind Joker Poker, a well-known game show in
      Australia sponsored by an alcohol company and a casino group (in return for
      being associated with the show, promoting their brands in the show, and/or
      exposure in its publicity material). As an investor in Freehand, therefore, the
      BBC logo is clearly visible (as BBC Worldwide) on Freehand’s website, next
      to a publicity still from Joker Poker featuring a poker table with the logo of a
      casino group on it.11


17) Joker Poker is an example of “branded content” – i.e. where an advertiser
      sponsors or invests in a programme in return for exposure of its brand either
      within the programme or its publicity material, or both. We understand that
      Joker Poker would be classified in the UK as product placement, and would
      therefore be illegal for the BBC to make it in the UK. The BBC’s Editorial
      Guidelines, to which the BBC Trust’s guidance requires commercial services
      to adhere, state: “We must never include a product or service in sound or

11
     http://www.freehandtv.com.au/index.php?option=com_content&task=view&id=12&Itemid=26.


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Select Committee inquiry into BBC commercial operations                              9



      vision in return for cash, services or any consideration in kind. This is product
      placement. It is illegal to make any such arrangements in the EU.”12


Exhibit commercial efficiency


18) This section in the Fair Trading Guidelines requires BBC Worldwide to report
      annually to the Trust on the performance of each of its commercial Services.
      However, performance is judged against an extremely broad set of
      investment criteria in the Trust’s Commercial Protocols, including setting the
      minimum investment level for referral to the Trust’s Finance and Strategy
      Committee at £50m, an extremely high threshold in comparison to the
      commercial sector.13 Additionally, as we have noted above, BBC Worldwide
      does not make public the individual performances of its 29 UK and overseas
      channels, nor how much they pay for programmes acquired from the BBC.
      BBC Worldwide may be allowing its channels to underpay for BBC in-house
      programming, which it in turn has acquired at relatively low cost through its
      exclusive first-look arrangement.


Conclusions and potential solutions


19) In our view, therefore, the current regulatory and governance system of the
      BBC is failing on several counts. In some instances, BBC Worldwide appears
      to be in clear breach of the BBC’s Commercial Criteria, such as in the case of
      investments overseas that do not fit with BBC Public Purposes and/or risk
      damaging the BBC’s reputation. In other cases, the Fair Trading Guidelines
      are framed so loosely, or require inappropriate practices such as
      benchmarking prices to try to establish market rates, that it is almost
      inevitable that some of the BBC’s commercial activities will be inappropriate.


12
     BBC Editorial Guidelines, Page 118.
13
     BBC Trust Protocol C1, page 8.


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     Were a robust governance process in place it might be possible to require the
     BBC’s commercial activities to adhere to the spirit of the BBC Charter even if
     they were loosely worded. However, with members of the BBC Worldwide
     board sitting on the BBC board, and vice versa, there is no clear separation
     between the two (which in itself is a breach of the Fair Trading Guidelines).14


20) We suggest a range of measures to address these issues, including:


        The BBC Trust should amend its Fair Trading Policy and the BBC its Fair
         Trading Guidelines to ensure that the BBC maximises the added value of
         its assets. Instead of allowing the BBC to gauge a market rate for a
         programme by benchmarking, it should be required to put the rights to all
         in-house content out to tender in the open market so that it can guarantee
         that it is securing the maximum added value from their commercial
         exploitation on behalf of the licence fee payer. This should apply to
         finished programmes and to programmes where the BBC seeks a
         distributor as part of the financing package prior to or during production.


        BBC Worldwide should be required by the BBC Trust of divest itself of
         ownership stakes in businesses based overseas where it cannot
         demonstrate a clear and meaningful link with its Public Purposes.


        The BBC Trust’s Fair Trading Policy and the BBC’s Fair Trading
         Guidelines should be amended to require that the BBC’s commercial
         activities are subject to far greater transparency. This should include a
         greater level of transparency for investments, including reducing the £50m
         threshold referred to above. Also, greater transparency is important in

14
   The BBC Fair Trading Guidelines (Section 3.6) require clear separation between the BBC’s
public service and commercial activities. They require commercial services to operate “at arm’s
length” from public service activities, and to maintain “a clear and separate management
structure.”


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          prices that BBC Worldwide pays for rights to programmes from the BBC’s
          Commercial Agency, and in terms of investments at production stage in in-
          house compared to external programmes commissioned by the BBC. We
          are not aware of any public document detailing at any level the prices paid
          by BBC Worldwide to the BBC or third parties. If these are contained with
          PricewaterhouseCoopers’ annual audit on behalf of the BBC Trust, this, or
          the relevant sections, should be made public.


         Additionally, the BBC should provide greater transparency in where profits
          that accrue from the exploitation of its assets are invested. This added
          value should be re-invested clearly in public services activities that fulfil
          the BBC’s Public Purposes, particularly UK programme making.


         The BBC Trust should conduct a root-and-branch, public review of
          regulations and governance for BBC commercial services. The Trust is
          required to conduct a comprehensive compliance review involving public
          consultation every three years,15 but we ask the Committee to recommend
          that the Trust reviews BBC commercial activities not just in terms of the
          letter of the BBC’s (flawed) guidelines, but also in the light of the BBC’s
          high-level goals in the BBC Charter that require the BBC’s Public
          Purposes to take priority over commercial activities – which should entail
          maximising the added value of BBC assets for reinvestment in the pursuit
          of the Public Purposes. This should be explicit in the Fair Trading Policy
          and Guidelines.


21) There is inevitably tension between any policy of maximising revenues and
      the BBC’s status as a publicly-funded institution. These potentially conflicting
      incentives create the risk of damaging the BBC’s reputation as a public
      service broadcaster, a loss of focus on the BBC’s Public Purposes as laid out

15
     BBC Charter Agreement, section 65 (4).


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     in the Charter,16 and competition issues, amongst other matters. Adding to
     this tension is the existence, in BBC Worldwide, of a standing, commercially-
     driven subsidiary with its own cost base to justify.


22) However, the current system is offering the worst of both worlds: the BBC’s
     commercial activities are exceeding their remit and running the risk of
     damaging the reputation of the BBC; but at the same time they are providing
     no guarantee that they are maximising profits on behalf of the licence fee
     payer, and in our view are failing to do so.




16
  Under section 4 of the Royal Charter, these are: sustaining citizenship and civil society;
promoting education and learning; stimulating creativity and cultural excellence; representing the
UK, its nations, regions and communities; brining the UK to the world and the world to the UK;
and helping to deliver the benefit of emerging communications.


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Select Committee inquiry into BBC commercial operations                                13




Introduction and market overview


       1) Pact is the trade association that represents the commercial interests of
           the independent production and distribution sector. We have more than
           600 member companies across the entire UK, involved in creating and
           distributing television, film and interactive content.


       2) We welcome the opportunity to respond to this inquiry by the Culture,
           Media & Sport Committee, and will focus on the activities of BBC
           Worldwide. This section of our submission contains a brief overview of the
           export market for UK television programmes and an outline of the market
           and business model for exploiting the rights to UK programmes around the
           world. The sections after this outline our response to the Committee’s
           areas of interest as laid out in its formal announcement of the inquiry.


       3) The independent production sector has a turnover of more than £2 billion
           per annum, and accounts for around half of all new UK programmes
           broadcast each year.17 Broadcasters’ in-house production departments
           account for most of the remainder.


       4) This programming is a valuable form of intellectual property (IP). The
           rights to broadcast or remake these programmes are sold around the
           world by distributors, which effectively act as middlemen between
           producers (either broadcasters’ in-house production departments or
           independent companies) who create the content, and broadcasters in
           other countries that buy the IP rights so that they can air a programme.


17
     Independent Production Census 2007/08, Digital-i for Pact.


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                 5) Rights are typically defined by country, but also by the manner of
                      exploitation (e.g. television or DVD). Overseas broadcasters will buy the
                      right to, for example, broadcast a UK programme in Germany.
                      Broadcasters or producers in other countries will also buy the right to
                      remake a UK show for a local audience – a practice known as formatting.


                 6) The UK is a leading exporter of television programmes. UK programmes
                      have more than 13% of the global television exports market – second only
                      to the far larger US industry, as the table below shows. 18


                 Figure 1: Share of global television export market by country


                 80
                        67.0 67.3

                 60

                                                                     2003           2007
     Hours (%)




                 40



                 20
                                    13.1 13.1
                                                                                                     9.6 8.3
                                                 3.0 3.9      3.6 2.8       1.9 2.4        1.7 2.3
                  0
                          USA           UK          Ger         Can           Fra            NL        Oth



                      Source: Rights of Passage 2007, TRP for Pact




18
      Rights of Passage report 2007, TRP for Pact.


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Select Committee inquiry into BBC commercial operations                                                15



               7) The UK is also the global leader in exploiting format (remake) rights, with
                    a 53% share of the formats market, far larger than that of the US, as
                    illustrated below.19


               Figure 2: Share of global television format market by country

               60
                           53
                      51


                                                                              2003      2007
               40
     % hours




               20                       18    17
                                  15               14

                                                                                                        7
                                                              5         4    5    3      3         4
                                                                                               2
                0
                         UK            NL       USA               Fra       Argentina        Spa   Other

               Source: Rights of Passage 2007, TRP for Pact




               8) BBC Worldwide is the UK’s largest distributor, with exclusive access to
                    programmes made by BBC in-house production departments via a “first-
                    look” arrangement. BBC Worldwide will also seek to acquire programmes
                    made by external suppliers for the BBC and other broadcasters, on
                    commercial terms.


               9) Many companies in the commercial sector perform an identical function to
                    BBC Worldwide, acquiring the rights to programmes from other
                    broadcasters and also from independent producers. Under the Codes of

19
     Rights of Passage report 2007, TRP for Pact.


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       Practice/Terms of Trade introduced in the 2003 Communications Act,
       independent producers retain control of certain secondary rights to their
       programmes, including the right to exploit that programmes in overseas
       market. They typically license this right on to a distributor, either BBC
       Worldwide or a distributor in the private sector. The commissioning
       broadcaster will, however, receive a substantial share of any revenues
       that are generated as a result of this exploitation, regardless of who
       distributes the programme.


   10) Following the creation of the Codes of Practices, independent producers
       and distributors have noticeably developed the UK television export
       market, helping establish the UK as the world leader in format exports, for
       example.


   11) All distributors will charge a fee and deduct costs before returning the
       remaining revenues to the rights holder (this applies to BBC Worldwide,
       which will deduct such charges before returning profits to the BBC, and
       commercial sector distributors).


   12) We have attached an electronic copy of our recent report on UK television
       exports, the Rights of Passage report 2007. Please contact Adam Minns,
       Pact’s director of policy, for hard copies or any further information
       (adam@pact.co.uk; tel 020 7067 4381).




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Response to Committee’s areas of inquiry


The benefits and opportunities offered by the BBC undertaking a range of
commercial activities in the UK and abroad


     1) The UK is widely recognised as having one of the most vibrant, successful
        and creative television production sectors in the world. Decade after
        decade has produced programmes that have challenged and influenced
        UK society. Such home-grown programming is at the heart of public
        service broadcasting, essential to delivering the goals of public
        intervention in this area. UK programming is integral to informing
        ourselves about our society, representing diverse viewpoints within the
        UK, including the devolved nations and the English regions, and to
        interpreting international issues by using appropriate reference points. In
        this regard, UK-produced programming is fundamental to fulfilling the
        Public Purposes of the BBC under its Charter, and the four public service
        broadcasting purposes outlined by Ofcom.20


     2) Ofcom’s recent audience research shows that the public places great
        value on programmes made in the UK, with 83% of people saying that it
        was important or very important that programmes made in the UK and
        reflecting life in the UK are shown on the main television channels.21

20
   Under section 4 of the Royal Charter, the BBC’s Public Purposes are: sustaining citizenship
and civil society; promoting education and learning; stimulating creativity and cultural excellence;
representing the UK, its nations, regions and communities; brining the UK to the world and the
world to the UK; and helping to deliver the benefit of emerging communications.
Ofcom’s public service purposes are: informing our understanding of the world; stimulating
knowledge and learning; reflecting UK cultural identity; and representing diversity and alternative
viewpoints (see Second Public Service Broadcasting Review – Phase 2: Preparing for the Digital
Future, page 13).
21
   Second Public Service Broadcasting Review -Phase 2: Preparing for the Digital Future, Ofcom,
Page 31.


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     3) It is precisely this type of programming that is currently under threat.
        Ofcom has identified a shortfall in investment in public service
        programming of between £145m and £235m a year by 2012, largely due
        to the migration of advertising revenues away from the licensed
        commercial public service broadcasting channels (ITV1, Channel 4 and
        Five) towards the so-called multi-channel broadcasters on digital, cable
        and satellite platforms. The BBC is also under pressure, and has
        announced programme budget cuts as part of a cost saving exercise
        following the last Charter settlement. These broadcasters are responsible
        for around 90% of all investment in new UK television programming. 22


     4) Commercial       exploitation     of   BBC      programmes        therefore     has     an
        increasingly important role to play. Commercial exploitation should
        maximise the value of assets that the public has paid for – i.e. BBC
        programmes – and return the benefits to the public in the form of
        additional investment in public service programming, providing added
        value for the licence fee payer.


     5) Under the BBC Charter, the BBC’s Public Purposes are of overriding
        importance, and commercial activities are secondary.23 In our view, it
        follows that commercial activities should exist to maximise the revenues
        that can be reinvested in the pursuit of these Public Purposes – i.e. in the
        creation of public service programming and content that contribute to this
        pursuit.24



22
   PSB Review Phase 1: The Digital Opportunity, Ofcom, page 55.
23
   Charter Article 3.
24
   Under section 4 of the Royal Charter, these are: sustaining citizenship and civil society;
promoting education and learning; stimulating creativity and cultural excellence; representing the
UK, its nations, regions and communities; brining the UK to the world and the world to the UK;
and helping to deliver the benefit of emerging communications.


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     6) This is reflected in the BBC Trust’s guidance for the strategy of BBC
        commercial activities, which states:


        “At the highest level, the Trust will be concerned with the objective that
        the BBC should relieve pressure on the licence fee by seeking to
        maximise commercial revenue within appropriate areas and by returning
        value to licence fee payers by reinvesting profits in the BBC’s Public
        Services.”25


     7) The BBC has previously committed to maximising added value under its
        Fair Trading Commitment,26 and this aim was also outlined in the
        Government’s White Paper during the last Charter review process, which
        stated that the BBC’s commercial services had two roles in an
        international context: “Better promotion of UK culture, talent and
        intellectual property overseas; added value returned to licence fee
        payers.”27


     8) Key to our concerns, however, is whether BBC Worldwide is always the
        best vehicle through which the BBC should seek to maximise returns, and
        where those returns are being invested within the BBC.




25
   BBC Trust, Protocol B6 Commercial Strategy.
26
   BBC Fair Trading Commitment.
27
   A public service for all: the BBC in the digital age, DCMS March 2006, Section 3.6.1.


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The potential risks to the BBC, licence fee payers and other stakeholders



Reputation


1) The BBC has a worldwide reputation as a trusted and independent source of
      content. The BBC’s Editorial Guidelines rightly warn that the BBC must be
      seen to be impartial and not influenced by commercial third parties at all times
      – including when engaging in commercial activities. They state:


      “The BBC’s global reputation is based on its editorial integrity and
      independence. Our audiences need to be confident that our decisions are
      influenced neither by political or commercial pressures, nor by any personal
      interest. We must not undermine these values by any actions which could
      bring the BBC into disrepute.”28


Risk to licence fee funds


2) In engaging in commercial activities there is a potential risk to licence fee
      funds. It is important therefore that the BBC ensures that there is adequate
      separation between its public service (licence-fee funded) activities and its
      commercial services such as BBC Worldwide, so that the BBC is not liable for
      BBC Worldwide losses.


3) In addition, the BBC can help minimise the risk to licence fee funds by
      ensuring that its commercial activities are based on exploiting its existing
      programmes assets, rather than making speculative investments in unrelated
      areas. In addition to the resulting financial risk, this increases the danger of
      the BBC having an undue and negative market impact.
28
     BBC Editorial Guidelines, Page 118.


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Select Committee inquiry into BBC commercial operations                                         21




Market impact


4) The BBC is a substantial public intervention in the market. It is the sole
     recipient of funds from the licence fee, which represents around 25% of total
     revenues in the television sector (including, for example, advertising and
     subscription revenues). As pressure on advertising revenues amongst
     commercial sector broadcaster increases, the BBC is likely to be in an ever
     stronger position due to the exceptional nature of its funding.


5) There is therefore a risk that the BBC’s commercial activities will distort or
     dampen competition in the commercial sector and use licence fee funds for
     commercial purposes, which would potentially breach European rules on
     State Aid, as the licence fee would count as public funding.29


6) These issues are at the heart of the BBC Fair Trading Guidelines, which
     require the BBC to be mindful of its impact on competition and ensure that its
     commercial activities do not have an undue advantage because of their
     parentage. The Guidelines state that the BBC’s commercial activities must
     not be: “given unfair commercial advantage which could unduly and
     negatively influence the market.” 30

Focus on Public Purposes

7) The BBC’s most important activities should be fulfilling its six Public Purposes
     as defined by its Royal Charter.31 This priority in enshrined in the BBC


29
   The BBC Fair Trading Guidelines, page 44, state that the BBC must comply with EU law on
State Aid, stating that: “Broadly, the EC Treaty prohibits any aid granted through State resources
in any form whatsoever which distorts or threatens to distort competition by favouring certain
firms or the production of certain goods.”
30
   BBC Fair Trading Guidelines, 2.30.
31
   Under section 4 of the Royal Charter, these are: sustaining citizenship and civil society;
promoting education and learning; stimulating creativity and cultural excellence; representing the


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Select Committee inquiry into BBC commercial operations                                          22



    Charter, which calls for the BBC’s “main object” to be the Public Purposes,32
    and is reflected in the BBC’s Fair Trading Guidelines, which state: “The BBC’s
    primary purpose is the promotion of its Public Purposes through the provision
    of output that informs, educates and entertains.”33


8) The BBC’s commercial activities are therefore required to be closely linked to
    its core Public Purposes. The BBC’s Charter Agreement requires that
    commercial activities “fit with” its Public Purposes.34 This is also expressed in
    the BBC’s Fair Trading Guidelines, which state that any commercial activity
    must: “fit with the BBC’s public purposes.”35

9) Yet the BBC’s commercial activities have in Pact’s view strayed into areas
    that are unrelated to its Public Purposes. As we will detail in the next section,
    BBC Worldwide is, for example, involved in consumer magazine publishing in
    India and has acquired Australian-based travel publisher Lonely Planet at a
    cost of around £90m.


Conflicting incentives


10) As we have noted above, the BBC’s primary concern should be its Public
    Purposes. In our view, it follows that commercial activities should exist to
    maximise the revenues that can be reinvested in the pursuit of these Public
    Purposes.


11) There is, however, a danger that, in maintaining an ongoing commercial




UK, its nations, regions and communities; brining the UK to the world and the world to the UK;
and helping to deliver the benefit of emerging communications.
32
   BBC Charter Article 3.
33
   BBC Fair Trading Guidelines, Introduction, page 3.
34
   BBC Charter Agreement, clause 69.
35
   BBC Fair Trading Guidelines, 2.3.


                                                                                            Pact
Select Committee inquiry into BBC commercial operations                      23



   subsidiary, the BBC will focus on maintaining and strengthening that
   subsidiary, rather than on the best way to maximise added value for the BBC.




                                                                           Pact
Select Committee inquiry into BBC commercial operations                                      24



The extent to which the BBC's commercial activities meet the criteria
required of them


1) As we have noted in section 1, commercial activities should exist to maximise
     the “added value” of BBC assets such as programmes, and return the
     resulting income to the BBC so that it can be re-invested in public service
     activities. 36


2) In addition, the BBC’s Fair Trading Guidelines stipulate that any BBC
     commercial activity must adhere to four Commercial Criteria, which are:


        “Fit with the BBC’s Public Purposes;
        Not jeopardise the good reputation of the BBC or the value of the BBC
         Brand
        Exhibit commercial efficiency; and
        Comply with the Trust’s Fair Trading Policy, the BBC’s Fair Trading
         Guidelines and, in particular, avoid distorting the market.”37


3) We note that the requirement under the Fair Trading Guidelines is for each
     activity to conform to all four of these Commercial Criteria.


4) Pact has concerns that BBC Worldwide is failing to meet the above
     requirements in three key areas:


             a. BBC Worldwide’s “preferred partner status”: BBC Worldwide
                 has a “first-look” arrangement with the BBC under which it can
                 exclusively bid for the right to act as the distributor for all BBC
                 programming made in-house. The BBC Fair Trading Guidelines
36
   White Paper on BBC Charter: A public service for all: the BBC in the digital age, DCMS March
2006, Section 3.6.1.
37
   BBC Fair Trading Guidelines, 2.3.


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Select Committee inquiry into BBC commercial operations                            25



               require that programmes sold to BBC Worldwide by the BBC are at
               market rates, yet they allow the BBC to gauge this market rate
               through occasional benchmarking. This means that the BBC has no
               effective way of gauging the market rate for prices to its
               programming, and therefore cannot guarantee that it is maximising
               the value of BBC assets, which should be its overriding goal.


           b. Scope: BBC Worldwide’s overseas investments in some cases do
               not fit with a Public Purpose, thereby breaching the first point in the
               BBC’s Commercial Criteria. Moreover, they represent in Pact’s view
               an unnecessary financial and reputational risk, therefore potentially
               breaching points two and three of the Commercial Criteria
               (reputation and commercial efficiency).


           c. Transparency: BBC Worldwide manages 29 different television
               channels around the world, but only publishes a public financial
               breakdown of these businesses by three geographic areas: Europe,
               Middle East and Africa; America; and Rest of the World. This
               means it is impossible to see whether these channels are paying
               BBC Worldwide market rates for the rights to BBC programmes,
               and therefore represents a failure to demonstrate commercial
               efficiency. Additionally, the criteria for reviewing the efficiency of
               commercial investments are in our view too broad, and the
               minimum threshold of £50m for investments that must be referred
               to the Trust’s Finance and Strategy Committee is too high. We also
               see a need for greater transparency in terms of BBC Worldwide’s
               investments in BBC in-house compared to external programmes at
               production stage. This is important in order to ensure that in-house
               and external suppliers are operating on a level playing field.




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Select Committee inquiry into BBC commercial operations                         26




5) The following sections deal with each area in more detail.


BBC Worldwide’s “preferred partner status”


6) BBC Worldwide is the BBC’s “preferred partner” for exploiting its content. This
   means that BBC Worldwide has first refusal on acquiring the commercial
   rights to any in-house programme for subsequent exploitation, such as the
   rights to sell Doctor Who or Top Gear overseas (to be clear, this is in addition
   to the rights that BBC Worldwide may acquire to programmes that are
   commissioned by the BBC from external suppliers in the independent
   production sector. These are subject to a greater level of competition from
   commercial sector distributors as the rights are owned and sold by the
   external producer).

7) We understand the process by which BBC Worldwide acquires rights to
   programmes made by BBC in-house production is as follows. The BBC’s
   programmes are commercially exploited through its Commercial Agency. This
   is done by selling the rights to commercially exploit that IP to third parties.
   BBC Worldwide will be asked by the Commercial Agency to make a bid for
   such properties on an exclusive basis – i.e. before any other party has the
   opportunity to make a rival offer for those rights. If the Commercial Agency is
   not satisfied with BBC Worldwide’s offer it is common for BBC Worldwide to
   have a further exclusive period – an exclusive “second look” - in which it may
   raise its bid. Again, no other third party company will be able to compete to
   represent BBC programmes at this stage.


8) Finally, if BBC Worldwide chooses not to make a further higher bid after its
   second exclusive period, or the Commercial Agency is still not satisfied with
   the offer, a programme may be put out to tender on the open market. This



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Select Committee inquiry into BBC commercial operations                               27



     rarely happens. BBC Worldwide chief executive John Smith told the review
     conducted by Lord Burns in 2004 that, under this arrangement, “roughly 20%
     of all the rights that come off the machine every year are acquired by the
     private sector.”38 We believe this even this 20% figure may include
     programmes made by external producers as well as BBC in-house, and that
     closer to 10% of in-house programmes is offered to market. We are writing to
     BBC Worldwide for clarification.


9) The preferred supplier status of BBC Worldwide calls into question whether
     the BBC is maximising the value of its assets, as without exposing those
     assets to genuine competition in the marketplace it is impossible to accurately
     gauge their real worth. The Fair Trading Guidelines require that the BBC
     charge fair prices for these programmes, stating that fair prices: “should
     broadly be in line with the overall market context where there is an external
     market for comparable goods or services and where public data is
     available.”39 They add that, to establish the market rate, the BBC may use
     “benchmarking exercises or market testing.”40


10) This in Pact’s view is an unsatisfactory way to gauge the value of IP, which is
     not a homogenous product. Occasional benchmarking cannot capture the
     complexities of a rapidly evolving market, or take into account deals that are
     confidential.


11) Furthermore, if competitors in the commercial sector were genuinely able to
     compete on a level playing field for rights to BBC in-house programmes, it is
     highly likely that certain properties would be subject to bidding wars between
     different companies, thereby greatly increasing the potential returns to the
     BBC and, by extension, the licence fee payer. When programmes

38
   John Smith, BBC Charter Review Seminar: Commercial Services, 22 September 2004.
39
   BBC Fair Trading Guidelines, 3.12.
40
   Ibid, 3.15.


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Select Committee inquiry into BBC commercial operations                                     28



     commissioned by the BBC from external suppliers have been auctioned in the
     open market, private sector companies have in cases outbid BBC
     Worldwide.41 Additionally, companies in the private sector would be
     encouraged to develop ways to exploit BBC content that BBC Worldwide
     might not consider or be well placed to develop. Enabling a wide range of
     companies to compete for BBC rights will present the BBC with new ways of
     exploiting its content.


12) Crucially, without exposing in-house programme assets to real competition,
     the BBC cannot guarantee it is maximising their added value. The assets in
     question are substantial. The BBC is the biggest investor in new UK television
     programming, and invests twice as much in in-house programming (£800m
     pa) as it does not external commissions (£400m), as shown below.


     Figure 3: Investment in new UK programming by broadcaster


            1400
            1200
            1000
             800                                                         external investment
       £m




             600                                                         in-house investment

             400
             200
                0
                     BBC       ITV        C4       Five

     Source: Ofcom, Communications Market Report 2008, page 184 (adjusted data)


41
   Under the Codes of Practice/Terms of Trade introduced in the 2003 Communications Act,
independent suppliers retain control of certain secondary rights, including overseas rights, to
programmes they make (although the BBC will receive a substantial share of any revenues from
their exploitation as the commissioning broadcaster).



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Select Committee inquiry into BBC commercial operations                                      29




13) BBC in-house programming therefore represents around 30% of all new UK
     programming made by all broadcasters. Much of this programming will have a
     strong market presence, as it will have aired on the BBC1 or BBC2, which
     have a high audience share, and will be highly attractive to distributors in the
     commercial sector.


14) BBC Worldwide has previously objected to opening up in-house programming
     to an auction process on the grounds of efficiency.42 We do not accept this.
     Auctioning rights is common practice across the industry, and could involve
     as little as notifying potential bidders with an email. Our proposed system is
     already practiced by other parts of the BBC, including the Commercial
     Agency itself. Bidding might be conducted where appropriate on groups of
     shows rather than individual programmes. However, even under an open
     auction for individual programmes, it is reasonable to expect increased
     revenues resulting from the ensuing competition would more than cover any
     (moderate) overhead costs incurred by the BBC’s Commercial Agency. We
     will detail our arguments on this in the section on the future of the BBC’s
     commercial activities.


15) The BBC has also suggested that only its own commercial subsidiaries can
     be trusted to safeguard the BBC’s reputation. This does not bear scrutiny in
     the market place, where private companies regularly licence the use of
     properties around the world to third parties with no discernable damage to the
     quality of the show or their reputation. It is common practice for clauses to be
     included in any licence agreement to safeguard this. As we detail later in this


42
  Chief executive John Smith told Lord Burns’ review in 2004 that auctioning rights on an
individual spot basis so that all companies, including BBC Worldwide could compete for them:
“would be very fair but highly inefficient.” John Smith, BBC Charter Review Seminar: Commercial
Services, 22 September 2004.


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Select Committee inquiry into BBC commercial operations                                     30



     section under Scope, BBC Worldwide’s claim to be the guardian of the BBC
     brand is questionable.


16) BBC Worldwide has also argued that it must have high profile BBC shows in
     order to maximise the commercial value of its less commercially attractive
     properties, or offset losses on non-commercial properties with profits from hit
     shows. This argument does not take into account the likelihood of certain
     properties commanding a higher price if they were exposed to competition
     amongst buyers, and the overall return to the BBC being greater as a result.
     We also note that BBC Worldwide’s ability to use hit shows to leverage the
     sale of other shows is already subject to competition rules, and making the
     supply of one product conditional on the customer accepting another product
     could amount to abuse of a dominant market position. We will outline these
     arguments in more detail in the section on the future of the BBC’s commercial
     activities.


Scope


17) Under the Fair Trading Guidelines, BBC Worldwide’s activities are required to
     “fit with” the BBC’s Public Purposes.43 As we have outlined, this is important
     on a number of grounds, including minimising the risk to public funds and of
     an undue and negative market impact, as well as ensuring the BBC maintains
     a focus on its core Public Purposes. The BBC Trust elaborates on this in its
     Fair Trading Policy, stating that a commercial activity must connect with the
     Public Purposes other than in purely financial terms:


     “The Agreement specifies that a Commercial Activity is to be considered to fit
     with the BBC’s Public Purpose activities if it is appropriate to be carried on in


43
  The BBC’s Fair Trading Guidelines, section 2.3. Also see Charter Agreement, Section 69. Our
highlighting.


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Select Committee inquiry into BBC commercial operations                           31



      association with the promotion of the Public Purposes; and it is connected,
      otherwise than merely in financial terms, with the ways in which the BBC
      promotes its Public Purposes.”44


18) With this in mind, we question the grounds for some of BBC’s Worldwide’s
      investments overseas. BBC Worldwide has adopted an aggressive expansion
      strategy in recent years, investing in anything from Australian travel book
      publisher Lonely Planet, to the Indian version of Hello! magazine, through to a
      string of production companies dotted around the world.

19) We cannot see how BBC Worldwide’s consumer magazine joint venture in
      India fits with its Public Purposes. Called Worldwide Media, the joint venture
      includes the Indian versions of Hello! and Grazia magazines. Arguably, the
      BBC’s ownership of such celebrity-focused magazines actually conflicts with
      the second Commercial Criteria of not jeopardising the reputation of the BBC.


20) BBC Worldwide has previously said that its joint venture with the Times of
      India is marginal to its other activities, and the Charter Agreement makes
      allowances for commercial activities that do not fit with the BBC’s public
      purposes if they are peripheral to other activities that do meet those
      requirements. However, the sole purpose of this joint venture is publishing
      consumer magazines in India, while the reported cost of BBC Worldwide’s
      ownership of Lonely Planet is £90m – which would represent around 10% of
      BBC Worldwide’s total annual sales of £916m for the year to March 2008.

21) For the same reason, we are also concerned by BBC Worldwide taking
      ownership stakes in production companies overseas. BBC Worldwide has
      done this, we understand, in order to control the remaking of BBC
      programmes for local markets in overseas countries (known as “formatting”),


44
     Fair Trading Policy, BBC Trust, Section 27.


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Select Committee inquiry into BBC commercial operations                                    32



     and to have privileged access to the output of that company so that it can
     exploit the rights internationally.


22) Pact has no objection in principle to BBC Worldwide investing where
     appropriate in a UK-based production company, providing this is subject to a
     clear and rigorous accountability process. This can help the BBC fulfil its
     Public Purpose of stimulating creativity, which calls for the licence fee to be
     used to support UK creative talent and the UK’s creative industries. But we
     cannot see how investments in overseas production ventures fit with this
     Public Purpose, which is clearly aimed at supporting and stimulating UK
     creativity, not the creative industries in other countries. The Government’s
     White Paper on the Charter required the BBC to: “use its unique position to
     inspire, support and showcase the best of the UK’s creative talent.”45 Its
     rationale was that:

     “The creative industries are already important to the UK economy, and the
     government wants them to make an even greater contribution in the future.
     Between 1997 and 2003 the creative sectors grew twice as fast as the overall
     economy. They employ around 1.8 million people and account for a twelfth of
     our economy, more than in any other country. The UK’s current strength in
     creative industries is a real opportunity. We need to build on this strength and
     capitalise on growing markets.”46

23) Another of the BBC’s six Public Purposes is “bringing the UK to the world and
     the world to the UK.”47 Although this clearly has an import/export element, it
     should not give BBC Worldwide carte blanche to engage in any activity of its
     choosing. In describing this Public Purpose, the Charter Agreement stresses
     the goal of making UK people aware of international issues and culture, and


45
   A public service for all: the BBC in the digital age, DCMS March 2006, Section 3.4.1
46
   Ibid, Section 3.4.4.
47
   BBC Charter Agreement, Section 10


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Select Committee inquiry into BBC commercial operations                                       33



      bringing high quality international news coverage to international audiences. 48
      In our view, investing in an overseas company does not deliver on this Public
      Purpose. Programmes made by these companies may never appear on UK
      television, and therefore do not contribute to raising UK people’s awareness
      of international issues. Nor are the companies concerned known for their
      news programming.

24) The White Paper on Charter renewal explicitly refers to the role of BBC
      commercial activities in regards to this Public Purpose as: “Better promotion
      of UK culture, talent and intellectual property overseas; added value returned
      to licence fee payers.”49

25) We cannot see how investing in overseas companies promotes UK culture,
      and view the potential for added value to be derived as a result as highly
      questionable. Selling the rights to remake BBC programmes to these
      companies would constitute creating added value from BBC assets. Investing
      in the company is an entirely different proposition, as we will outline.

26) BBC Worldwide may argue that it stands to recoup a higher level of return on
      its format (remake) rights by owning a producer in an overseas market, as it
      will also receive production fees from remaking its show. Yet by investing in
      one company, the BBC creates the incentive of automatically channelling all
      remakes of BBC programmes through that entity, rather than auctioning the
      rights on the open market (in some cases, is part of the contract that the
      company in question will have exclusive “first look” at remake rights to BBC
      properties). Having an automatic partner in a local market means that the
      BBC is missing out on the opportunity to benefit from competition between
      broadcasters and producers in that market for the remake rights to BBC
      shows. Distributors with a high-profile property for remaking in an overseas


48
     Ibid, Section 10 (b)
49
     A public service for all: the BBC in the digital age, DCMS March 2006, Section 3.6.1.


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Select Committee inquiry into BBC commercial operations                          34



   territory often create an auction between various parties, with the price for the
   property rising as a result.


27) Moreover, there is a considerable financial cost in taking share of ownership
   in a production company. We would argue that taking an ownership stake in a
   company in fact exposes the BBC to a greater financial and reputational risk
   than simply licensing a format. The UK independent production sector has
   stabilised following the introduction of the Codes of Practice/Terms of Trade
   in the 2003 Communications Act, but independent television production
   around the world is notoriously volatile and, given general economic
   conditions, private sector investment in media stocks has cooled significantly
   over the last 12 months on a worldwide basis. We assume that funding for
   BBC Worldwide’s equity stakes in overseas production companies is raised
   through debt financing, in which case BBC Worldwide should be made to
   disclose in detail the terms of that arrangement in order to provide
   assurances that it is operating in a manner comparable to the market. In the
   case that BBC Worldwide used equity from profits on its other activities, this
   represents a direct reduction in the returns that BBC Worldwide has
   generated for the core public service activities of the BBC. In either case,
   BBC Worldwide is assumed to be exposed to the significant risk of its
   investments making a loss, again resulting in a reduction of the profits it can
   return to the BBC for reinvesting in public service activities.


28) The BBC has previously suggested that it requires an ownership stake in
   overseas production companies in order to control the production, through
   that company, of local versions of BBC shows, and thereby protect the BBC
   brand. This ignores the fact that private companies regularly licence the
   remaking of properties such as Who Do You Think You Are? and Who Wants
   To Be A Millionaire? around the world, with no discernable damage to the
   quality of the show or the reputation of the original broadcaster. So has the



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Select Committee inquiry into BBC commercial operations                               35



     BBC previously – in fact it still licences formats to many of its hit shows, such
     as The Weakest Link and Strictly Come Dancing, to third parties in dozens of
     countries, with no negative impact on its reputation.


29) By taking equity in a company, the BBC actually increases the risk to its
     reputation. By aligning itself with one producer in a market, the BBC is not just
     missing the opportunity to spark a bidding war; it is also failing to sell the
     remake rights to the most suitably qualified producer for that particular show –
     the skill set for remaking a quiz show is radically different to that required for a
     drama, for example. This could in turn have a reputational impact if the BBC's
     automatic partner does a poor job on a show in a genre in which it has little or
     no experience. This is quite possible; it is extremely unusual in the production
     sector for companies to stray outside their specialist genres. Pact’s annual
     census of the UK independent production sector shows that companies work
     on average in two genres.50


30) Additionally, as a co-owner of a company, the BBC does not just have to
     manage production on one show, but to an extent becomes responsible for
     and, most importantly, associated with that company’s entire output. In
     Australia, for example, BBC Worldwide has taken 25% equity in The
     Freehand Group, which is producing a local version of the BBC show, Top
     Gear. One of Freehand’s most well-known programmes is Joker Poker, an
     entertainment show based around gambling and sponsored by a whiskey
     company, Wild Turkey Bourbon, and casino groups. According to the Sydney
     Morning Herald, Wild Turkey invested up to A$1m to fund one version of the
     show.51




50
   Independent Production Census 2007/08, Pact, page 46.
51
   http://www.smh.com.au/news/business/advertisers-take-own-shows-into-prime-
time/2006/07/26/1153816252624.html.


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Select Committee inquiry into BBC commercial operations                               36



31) The BBC is therefore linked to a well-known show that involves, promotes
     and/or is associated with gambling and alcohol. On the company website for
     Freehand, the BBC logo is clearly visible as a stakeholder (as BBC
     Worldwide), next to a publicity still for Joker Poker prominently featuring a
     poker table with the logo of Crown Casino on it.52

32) Joker Poker is an example of “branded content” – i.e. where an advertiser
     sponsors or invests in a programme in return for publicity within the show
     and/or its publicity materials. We understand that in the UK Joker Poker
     would be classified as product placement and that the BBC would therefore
     be prohibited from making it in the UK. The BBC’s Editorial Guidelines state:
     “We must never include a product or service in sound or vision in return for
     cash, services or any consideration in kind. This is product placement. It is
     illegal to make any such arrangements in the EU.”53


33) We note that the BBC Trust’s guidance on fulfilling this Commercial Criterion
     explicitly requires commercial services to adhere to Editorial Guidelines,
     stating: “The assessment of the proposals should comply with the editorial
     controls set out in the BBC’s Editorial Guidelines.”54

Transparency

34) BBC Worldwide’s Channels Division manages a portfolio of 29 channels
     around the world, including BBC America and a 50% share of UKTV. Our
     concern is that the amount paid by each channel for rights to a programme is
     not made public. BBC Worldwide’s annual report merely groups its channels
     by US; Europe/Middle East/Africa; and Rest of the World. In the case of BBC
     in-house programmes, BBC Worldwide’s channels may be underpaying for
     programmes as BBC Worldwide does not have to compete with distributors in

52
   http://www.freehandtv.com.au/index.php?option=com_content&task=view&id=12&Itemid=26.
53
   BBC Editorial Guidelines, Page 118.
54
   BBC Trust. Protocol D6 – The BBC’s Commercial Services, page 11.


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Select Committee inquiry into BBC commercial operations                        37



      the commercial sector for the rights, and may pass on programmes to its
      channels at a subsidized rate.


35) We have similar concerns regarding the transparency of BBC Worldwide’s
      investments in BBC programmes at production stage. It is common for BBC
      Worldwide to invest during the production process in both in-house and
      external programmes commissioned by the BBC as part of the financing
      package for a show – it spent £85.1m on such activity in 2008.55 In exchange
      for its investment, BBC Worldwide will take rights to the show for sale at a
      later point.


36) The BBC will use the investment from BBC Worldwide to sit alongside its core
      programme budget and fund the creation of a programme. We have no
      objection to the principle of BBC Worldwide investing in BBC shows at
      financing stage – indeed, BBC Worldwide revenues should be reinvested in
      the BBC’s core activity of making UK public service programmes. However,
      the BBC does not make clear the split between BBC Worldwide’s investments
      in in-house and external programmes. Nor does it make public the proportion
      of the budget BBC Worldwide pays in either case. Were in-house producers
      securing a greater level of investment from BBC Worldwide than external
      producers who have been commissioned the BBC, this could give them an
      unfair advantage when competing with external suppliers for BBC
      commissions.


37) This would potentially undermine the BBC’s stated aim of commissioning the
      best ideas, no matter where they come from, so that the licence fee payer
      benefits from the most diverse, engaging and innovative mix of shows. BBC
      director general Mark Thompson told the House of Lords Select Committee



55
     BBC Worldwide Annual Review 2007/2008, page 38.


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Select Committee inquiry into BBC commercial operations                                 38



     during the Charter review that: "It is in the interests of the licence payer that
     the licence fee investment should go to the best ideas and the best talent." 56


38) Finally, the criteria used for reviewing BBC Worldwide’s investment’s, for
     example in overseas production companies or in Lonely Planet, are extremely
     broad as set out in the Trust’s Commercial Protocols (C1 and C2) – and
     arguably require less detail than a publicly-listed company would have to
     provide its shareholders. These Protocols also include setting the minimum
     investment level for referral to the Trust’s Finance and Strategy Committee at
     £50m, an extremely high threshold in comparison to the commercial sector. 57
     This threshold would probably be high enough to mean that BBC Worldwide’s
     investments in production companies overseas were not referred to the
     Finance and Strategy Committee.




56
   Mark Thompson oral evidence to House of Lords Select Committee on the BBC Charter
Review, First Report, Section 255.
57
   BBC Trust Protocol C1, page 8.


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Select Committee inquiry into BBC commercial operations                            39



The appropriateness and effectiveness of the governance framework for
the BBC's commercial activities



      1) We have outlined in the preceding section our concerns that BBC
          Worldwide is acting in an inappropriate manner in a range of areas – i.e.
          its preferred partner status, scope of investments and transparency. In our
          view, the regulatory and governance framework is logically failing as these
          activities have been allowed to happen.

      Separation


      2) The BBC Fair Trading Guidelines require clear separation between the
          BBC’s public service and commercial activities. They require commercial
          services to operate “at arm’s length” from public service activities, and to
          maintain “a clear and separate management structure.”58


      3) However, the relationship between BBC Worldwide and the BBC has
          become blurred, with BBC executives sitting on the BBC Worldwide board
          and vice versa. John Smith, chief executive officer of BBC Worldwide and
          a member of the BBC Worldwide Board, sits on the BBC Executive Board,
          while Jana Bennett, Director BBC Vision and a member of the BBC
          Executive Board, sits on the BBC Worldwide board. Zarin Patel, BBC
          Group Finance Director, also sits on both boards. We cannot see how the
          BBC can ensure an appropriate level of separation between its two
          activities under these circumstances.


      Framing of regulations




58
     BBC Fair Trading Guidelines, 3.6.


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      4) Along with the issue of separation, in our view the regulations governing
          BBC Worldwide contained in the Fair Trading Guidelines are also
          inadequate. In the case of separation issues outlined above, the
          Guidelines are in our view simply being breached. In other cases, they
          outline the appropriate high-level requirements, e.g. the broad headlines
          of the Commercial Criteria, but fail to create an adequate framework to
          ensure that these requirements are being adhered to. In some instances,
          the Guidelines are framed too loosely and are therefore potentially open to
          abuse. In other areas, they contain a reasonable level of detail, but still fail
          to address the real issue, and so fail to achieve their own goals.


      5) As an example of where the framing is too broad, one of the four
          Commercial Criteria in the Fair Trading Guidelines – to which all
          commercial activities must adhere – is to “fit with” the BBC’s Public
          Purposes.59 The Trust states that this means that an activity “must link
          clearly with the way in which the BBC promotes its Public Purposes.”60
          Although it is clear that a commercial activity does not have to be directly
          tied to a specific channel, what it means to “clearly link with” a Public
          Purpose may be open to interpretation and offers no more clarity than “fit
          with.” In our view, investing in publishing consumer magazines in India,
          Lonely Planet and overseas production companies are either breaches of
          this Commercial Criterion or, at best, evidence that it is framed so loosely
          as to fail to prevent inappropriate activity.

      6) In other cases, the Guidelines are detailed but fail to achieve their stated
          aims, as the guidance they offer is inappropriate. The BBC Trust’s
          Protocol requires BBC commercial services to maximise added value for
          the benefit of the licence fee payer, and the Fair Trading Guidelines
          stipulate that any services, including programmes, that the BBC supplies

59
     BBC Fair Trading Guidelines, 2.3.
60
     Fair Trading Policy, BBC Trust, Section 28.


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       to its commercial subsidiaries must be at prices that are in line with market
       rates. But the Guidelines then allow the BBC to establish the prices of its
       assets by occasional benchmarking, which is inadequate as a way of
       ensuring that prices are in line with the market. As a result, the BBC
       cannot guarantee it is charging market rates or maximising the value of its
       assets.


   7) Additionally, the Fair Trading Guidelines focus on ensuring a (right and
       proper) separation between BBC public service and commercial
       subsidiaries such as BBC Worldwide; however, they do not require
       sufficient transparency of accounting between individual commercial
       services operated within a commercial subsidiary, such as BBC
       Worldwide’s extensive portfolio of channels in overseas markets. Nor do
       they call for an appropriate level of detail in BBC Worldwide’s financial
       reporting on its investments.




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 Select Committee inquiry into BBC commercial operations                           42



 The future of BBC Worldwide and other BBC commercial subsidiaries



1) We have stressed that we see the commercial exploitation of the BBC’s assets
   as hugely important to the future of public service broadcasting, and this should
   in our view continue, within appropriate limits. However, for Pact, the key issue
   is the nature of future commercial exploitation, and more precisely the nature of
   the appropriate vehicle for that exploitation. It should be not assumed that BBC
   Worldwide is automatically the best partner for the BBC, which should consider
   harnessing the wider commercial sector to a far greater degree.


 BBC Worldwide’s “preferred partner status”


2) We have argued that BBC Worldwide’s preferred partner status means that the
   BBC has no guarantee that it is maximising the added value of its programme
   assets. We consider that an open auction system that required all rights to BBC
   in-house programmes to be put to tender so that third parties in the private
   sector could compete to distribute them, alongside BBC Worldwide, would
   address this. Such a system would:


      Maximise competition, allowing the BBC to achieve the best possible added
       value on its assets for the licence fee payer.


      Encourage innovation by allowing a wider range of distributors to develop
       ways to exploit BBC shows, again increasing potential returns to the BBC.


      Enable the BBC to guarantee and demonstrate that it is achieving the best
       possible prices for its rights.




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 Select Committee inquiry into BBC commercial operations                                 43



         Help the BBC to fulfil its Public Purpose of stimulating creativity by allowing
          private companies access to a substantial source of content, at the same
          time as maximising returns to the BBC.


3) BBC Worldwide has acknowledged that such as system would be very fair, but
      has historically objected on the grounds of efficiency. Chief executive John
      Smith told Lord Burns’ review in 2004 that auctioning rights on an individual
      spot basis so that all companies, including BBC Worldwide, could compete for
      them: “would be very fair but highly inefficient.”61


 Efficiency


4) We do not accept that opening up the auction process for BBC in-house
      programmes so that commercial sector companies can compete on a fair basis
      need be inefficient to the BBC. Auctioning rights to the market is standard
      industry practice, and is conducted by hundreds of private sector distributors
      around the world. Our proposed system is already practiced by other parts of
      the BBC, and has in the past been used by the Commercial Agency itself.
      When seeking suppliers to make a BBC show such as Question Time, the BBC
      conducts a public tendering process involving the private sector on a regular
      basis. There is also clear precedent for an open auction model within the BBC’s
      Commercial Agency, which until relatively recently would conduct auctions
      involving the private sector for book publishing rights.


5) Bidding might be conducted where appropriate on groups of shows – e.g. all
      BBC drama over a season – subject to competition rules. Under an open
      auction for individual programmes, it is reasonable to expect increased
      revenues resulting from the ensuing competition would more than cover any
      overhead costs incurred by the BBC’s Commercial Agency.

 61
      John Smith, BBC Charter Review Seminar: Commercial Services, 22 September 2004.


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 Select Committee inquiry into BBC commercial operations                        44




6) From BBC Worldwide’s point of view, an open auction process would not
   necessarily require any substantial changes to current practice – providing its
   current practice is robust. Currently, when BBC Worldwide formulates a bid for
   a property from the Commercial Agency, it is necessary for it to evaluate the
   potential revenues that can be derived from the market place for each of the
   various rights to a programme in order to reach an overall offer. BBC
   Worldwide’s chief financial officer, David King, stated in 2004:


   “The way the process works is that the Commercial Agency bring programmes
   to [BBC Worldwide] and offer rights...The basic principle of the process is [BBC
   Worldwide] then assesses the programme across the television, video, audio,
   book and other medias to determine what value it thinks it can derive from the
   market-place from selling those programmes, those books, etc.”


7) There should be little if any change to this process for BBC Worldwide even if
   private sector companies are also formulating bids for a property, and we
   cannot see how an open tendering process for BBC in-house programmes
   would automatically increase costs


Reputational risk


8) An argument put forward by the BBC is that only the BBC and its commercial
   subsidiaries can be trusted with the BBC brand. As we have mentioned, this
   does not bear scrutiny in the market place, where private companies regularly
   licence the use of properties around the world to third parties with no
   discernable damage to the quality of the show or the reputation of the original
   commissioning broadcaster. Additionally, BBC Worldwide’s association with a
   production company involved in branded content involving alcohol and




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 Select Committee inquiry into BBC commercial operations                         45



   gambling concerns shows that it is no guarantor of the BBC’s reputation for
   public service.


Scale


9)BBC Worldwide has also suggested that its scale makes it the best-placed
   organisation to exploit BBC content, and that without access to hit shows it
   cannot effectively market less commercially attractive properties, or use
   revenues from hit shows to offset investments in other properties.


10) In considering this argument, it is important to bear in mind that BBC
   Worldwide’s ability to demand a buyer purchase a less attractive programme in
   order to buy a hit show is constrained under competition rules. BBC Worldwide
   should not insist that a buyer must acquire one show if it wishes to buy another
   – i.e. force a buyer to buy a low profile programme in order to buy a hit show.
   This could represent “tying”, i.e. making the supply of one product conditional
   on the customer accepting another product, and could amount to abuse of a
   dominant market position.


11) In terms of BBC Worldwide’s ability to cross-subsidize less commercial
   properties with more valuable ones, this argument fails to take into account the
   potential for the BBC to recoup profits on its hit programmes from a third-party
   distributor in the commercial sector, and reinvest them itself in appropriate
   areas of programming. The BBC’s Commercial Agency already has to
   administer revenues generated by private sector distributors on the limited
   amount of in-house programming that it does put out to the market.


12) Most importantly, however, the BBC’s argument does not take into account the
   fact that, under the current system, it cannot guarantee that it is achieving the
   market rate for its assets, or that its assets might command a higher price if



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   they were exposed to competition amongst buyers, with the overall return to the
   BBC being greater as a result.


Scope


13) We have also outlined concerns regarding BBC Worldwide exceeding the
   BBC’s core public service remit and making investments that are unrelated to its
   programme assets or its Public Purposes. In our view, this amounts to a breach
   of the Fair Trading Guidelines’ stipulation that all commercial activities “fit with”
   the BBC’s Public Purposes.62


14) In the specific case of investments in overseas production companies, it is not
   necessary or appropriate for the BBC to take ownership of a company in order
   for it to derive added value from BBC programme assets. The BBC should
   divest itself of such interests. Going forward, it would be far safer financially and
   reputationally for the BBC to simply licence the right to make a local version of
   shows to another company after conducting an open auction. This is common
   industry practice. The BBC would be able to insist on approval over any editorial
   issue, or any matter that might compromise the BBC reputation, without making
   a long-term investment.


15) More generally, we call for the BBC to reduce its investments in overseas
   ventures. BBC commercial activities should focus on generating added value for
   existing programme assets, not long-term overseas investments.


Transparency


16) We have expressed concerns over a lack of transparency within BBC
   Worldwide, particularly in relation to its portfolio of overseas channels, and in

  62
   The BBC’s Fair Trading Guidelines, section 2.3. Also see Charter Agreement, Section 69.


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 terms of the broadness of the investment criteria for BBC commercial activities.
 The Fair Trading Guidelines focus on ensuring a separation between BBC
 public service and commercial activities; they do not in our view explicitly
 require sufficient transparency of accounting between individual commercial
 services operated by a commercial subsidiary such as BBC Worldwide, which
 may have a bearing on prices BBC Worldwide pays to the BBC. Nor do the
 Guidelines require sufficient detail in terms of comparing investments that BBC
 Worldwide makes at production stage in in-house and external BBC
 commissions. We therefore ask the Committee to recommend that the Trust
 review and, if appropriate, tighten the transparency and reporting requirements
 for BBC Worldwide.




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 Select Committee inquiry into BBC commercial operations                                     48



How the money returned to the BBC by its commercial operations is invested


 1)    Public service programming faces well-documented funding issues.
       Increasing pressures on broadcasters’ advertising revenues (due to the
       growing number of channels across which advertising budgets are spread)
       are already impacting on UK programme budgets, with less commercial
       public service genres such as news and children’s the first to be cut.


 2)    Ofcom’s ongoing second review of Public Service Broadcasting predicts a
       funding gap of up to £235m per annum by 2012 just to maintain current
       levels of UK-made, public service programming on the four main public
       service broadcasters (BBC, ITV1, Channel 4 and Five). 63 The table below
       illustrates Ofcom’s forecasts for the decline in spend on new UK
       programming, based on four different models.


       Figure 4: Spend on new UK programming


             3

            2.5

             2                                                                Gradua l
      £bn




                                                                              Medium 1
            1.5
                                                                              Medium 2
             1                                                                Radical


            0.5

             0
                   2007          2012          2016          2020

        Source: Ofcom PSB Review Phase 1: The Digital Opportunity, page 67 (adjusted data)

 63
   Second Public Service Broadcasting Review, Phase 2: preparing for the Digital Future, Ofcom,
 September 2008, page 5.


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Select Committee inquiry into BBC commercial operations                                           49




3)    Ofcom does not envisage the digital, cable and satellite channels plugging
      the gap: their spending is predicted to remain at 10% of overall investment
      in new UK programming, just as it has done over the last decade.


4)    The pressure on Public Service Broadcasting is therefore very much a
      pressure on investment in the making of (UK) public service programmes.
      As we have outlined in this submission, we see UK-made programming, as
      opposed to imports, as at the heart of public service broadcasting, essential
      to delivering the goals of public intervention in this area - such as informing
      ourselves about our society; representing diverse viewpoints within the UK,
      including the devolved nations and the English regions; and to interpreting
      international issues by using appropriate reference points. UK-produced
      programming is therefore fundamental to fulfilling the Public Purposes of the
      BBC under its Charter, and the four public service broadcasting purposes
      outlined by Ofcom.64


5)    Commercial exploitation of BBC assets can help offset these declines by
      reinvesting profits into the areas of public service programming and online
      content most under threat, i.e. core public service genres and areas such as
      programming from the devolved nations and English regions outside
      London and children’s. These programmes are crucial to the BBC’s delivery
      of its Public Purposes, as defined by its Charter. And in focusing on



64
  Under section 4 of the Royal Charter, the BBC’s Public Purposes are: sustaining citizenship
and civil society; promoting education and learning; stimulating creativity and cultural excellence;
representing the UK, its nations, regions and communities; brining the UK to the world and the
world to the UK; and helping to deliver the benefit of emerging communications.
Ofcom’s public service purposes are: informing our understanding of the world; stimulating
knowledge and learning; reflecting UK cultural identity; and representing diversity and alternative
viewpoints (see Second Public Service Broadcasting Review – Phase 2: Preparing for the Digital
Future, page 13).


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Select Committee inquiry into BBC commercial operations                        50



      programming, this investment ensures that licence fee payers can see the
      benefits on screen.


6)    It is currently unclear where profits from commercial activities are re-
      invested as the BBC does not disclose this information. BBC Worldwide
      declares how much it invests at production stage in BBC programming as
      part of the financing package in its annual report (although not, as we have
      noted, the breakdown between in-house and external BBC commissions).
      However, the BBC does not reveal where profits (e.g. royalties from
      programme sales) are re-invested. In our view, these too should be
      reinvested into programming.


7)    We propose therefore that the BBC be required to declare where profits
      from commercial exploitation are being re-invested in order to help ensure
      that the licence fee payer is benefiting from this added value.




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