Sector Insight: Pay-TV - Revenue race changes course

Pay-TV has grown swiftly in the UK, but as more players enter the market it faces a watershed.

THE BACKGROUND

With 43% of UK TV households now subscribing to pay-TV services and spending more than £4bn for the privilege, the market in the UK has reached a crucial stage. After four years of explosive growth, fuelled by the arrival of digital services, observers are predicting that this surge will now slow. BSkyB remains the dominant force, but the runaway success of Freeview, the recent launch of another pay-TV offering, Top Up TV, and the prospects of a Freesat free-to-air satellite service are set to bring about fundamental changes in the marketplace.

British households spent £4.41bn on pay-TV services in 2003, representing growth of 81% since 1999, according to a report by research firm Key Note.

This makes the UK one of the biggest and most dynamic pay-TV markets in Europe, accounting for nearly half the £10.2bn spent on pay-TV across the continent last year (Datamonitor).

However, this rate of growth is unlikely to be sustained. Key Note says revenue growth will slow to 56% between 2004 and 2008, with pay-TV households rising by 37% over the same period.

The set-top box giveaways that drove the land-grab for subscribers in the late-90s are over. The question now is how to sign up the other half of the UK population to digital TV. The first half enthusiastically embraced pay services, but the remainder could be harder to persuade, especially now Freeview has made free-to-air digital a successful reality.

For the pay-TV players, the problem is that the old business model of chasing new customers and then squeezing more revenue from them is beginning to creak. Sky's third-quarter results for 2003-04 illustrate this. The company added only 61,000 customers in the three months to 31 March 2004 (bringing its total to 7.27m), compared with 150,000 for the same period last year.

Having increased its average revenue per user (ARPU) from £364 to £382, Sky is on course to achieve its dual aim of increasing ARPU to £400 and having 8m customers by 2005. However, beyond this target, observers wonder where the next injection of growth will come from. Although the introduction of the £10m-marketed Sky+ personal video recorder has attracted 322,000 users, its appeal is primarily at the top end of the market.

Service packages

Cable firms are also struggling to increase ARPU from TV services. Telewest recently showed a modest increase to £254 a year, well behind Sky. With telephone and broadband services boosting Telewest's ARPU to £541, it is easy to see how the cable companies increasingly see digital TV as a way of attracting people into bundled 'triple-pay' packages, and not as a killer application in its own right.

As the rise of Freeview suggests, growth in this market seems to be at the low-value end. The digital terrestrial platform is bringing viewers into digital TV much faster than Sky, signing up 100,000 customers a month, giving it a total of 4m. According to Key Note, Freeview could be in 40% of TV homes by 2008.

Free-to-air digital terrestrial could soon be followed by free-to-air satellite, which would ensure better coverage. The BBC is enthusiastically calling for such a service, provisionally called Freesat, which it says will be crucial if the government is to achieve its 2010 analogue switch-off target.

Pay-TV operators are responding to the value trend by launching 'pay-lite' packages targeting low ARPU homes. Top Up TV is the most recent example. Launched in March, it offers Freeview customers another 10 channels, such as E4 and TCM, for £7.99 a month.

The service was initially available only to the 500,000 Freeview customers with what were ITV Digital set-top boxes. But from June, digital TV-owners will be able to access the service via a £40 plug-in device. Top Up TV has a breakeven target of 250,000 UK users within two years. Sales and marketing director Matthew Seaman says the service has found a gap in the market: 'There is a percentage of Freeview customers who would appreciate a little more choice.'

There has been speculation that Sky will respond with its own 'pay-lite' model. A Sky spokesman says it's an area of consideration, but only as part of an overall plan to segment prices and packages. 'It's a question of tweaking the mix at the top, middle and lower tiers. We'll look at everything, but in the medium term achieving 8m subscribers and £400 ARPU is uppermost in our minds.'

Meeting demand

Not everyone accepts the argument that 'lite' services are the main avenue of growth for pay-TV. Dan Marks, president of the Sci Fi Channel in the UK, says: 'I don't believe the growth of Freeview means growing ARPU for pay-TV services has reached a plateau. We are more at the beginning of that process. There are great opportunities in areas such as video on demand, and consumer demand is certainly there.'

The Sky spokesman agrees that premium services can grow. 'As well as there being potential at the lower end of the market, there is plenty of elasticity at the top,' he says. 'There are still customers ready to pay for the latest products and innovations. We don't see 8m customers as a ceiling by any means.'

Video-on-demand could be the area in which NTL and Telewest will forge a much-needed differentiation in the pay-TV market. Currently the Cinderella of UK pay-TV, cable has been losing share to Sky, with subscriber revenues between 2002 and 2003 down 3.1%.

Sky has an 81% share of UK pay-TV revenue, compared with 9.8% for NTL and 9.2% for Telewest. NTL has admitted it cannot compete with Sky simply by attracting customers to premium channels, so video-on-demand could be useful in re-establishing its credentials.

Cost of change

Telewest has estimated it will cost £50m to roll out a video-on-demand service to UK customers - an investment it will find hard to stomach having just been brought back from the brink of financial ruin.

The cable companies could be wrongfooted by a company many expect to become an important pay-TV player: BT. TV over the phone is already a reality in Paris and Lyon, where France Telecom has launched MaLigne TV.

With its wires routed into nearly every UK home and the technology in place to deliver 2.5MB/second services over ADSL, BT could enter the pay-TV and video-on-demand game and give not only the cable companies, but perhaps even Sky, a run for their money.

PAY-TV MARKET BY SHARE OF TOTAL REVENUE (%)

House- Subscriber &

Provider Total holds interactive

1 BSkyB 80.93 67.95 79.68

2 NTL 9.80 19.55 11.55

3 Telewest 9.21 12.40 8.69

4 Homechoice 0.04 0.04 0.05

5 Kingston interactive 0.03 0.05 0.03

Source: Key Note

ADSPEND BY SATELLITE AND CABLE TV COMPANIES

2003 2002

Company (£000) % (£000) % % change

1 Sky 23,085 35.6 33,583 51.5 45.5

2 UKTV 7,087 10.9 5,946 9.1 -16.1

3 Discovery 3,939 6.1 4,740 7.3 20.6

4 Viacom 2,594 4.0 2,260 3.5 -12.9

5 Flextech 4,375 6.7 2,131 3.3 -51.3

6 NTL 6,266 9.7 1,543 2.4 -75.4

7 Telewest* 1,654 2.6 1,244 1.9 -24.8

8 Granada+ 989 1.5 1,204 1.8 21.7

9 Walt Disney 1,531 2.4 908 1.4 -40.7

10 Hallmark Ent/ment 957 1.5 904 1.4 -5.5

11 Bid-up.tv 347 0.5 887 1.4 155.6

12 Channel 4 1,757 2.7 871 1.3 -50.4

13 Others 10,268 15.8 8,935 13.7 -13.0

Total 64,839 100 65,156 100 0.5

Source: Nielsen Media Research/Key Note

*excluding Flextech

+including Granada Sky Broadcasting

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