Call for comments on a proposed framework for the sale of commercial advertising in the local availabilities of non-Canadian services

Mr. Robert A. Morin
Secretary General
Canadian Radio-television and Telecommunications Commission
Ottawa, Ontario
K1A 0N2

Dear Mr. Morin:

1. Friends of Canadian Broadcasting is an independent watchdog for Canadian programming in the English-language audiovisual system, supported by 100,000 Canadians.

2. FRIENDS' interest in this process is solely in support of Canadian programming and the impact that any major change in Commission policy may have on the production, promotion and presentation of Canadian programming in all its forms. A financially healthy and viable private broadcasting and specialty sector is critical to the attainment of this goal.

3. FRIENDS believes that a balance of economic and negotiating strength must exist between programmers and distributors. Our major concern is that this gap is widening at an exponential and alarming rate in favour of the distributors. BDUs are no longer just gatekeepers of what we see and hear on television. They have also expanded to become the largest providers of Internet services in the country, while at the same time building an Internet-based phone service.

4. As stated in its Public Notice, the Commission has historically examined the sale of local avails in non-Canadian services in a variety of ways, and in all cases has concluded that the detrimental impact on conventional broadcasters, and their ability to fulfill their regulatory obligations, as well as provide an ongoing positive contribution to the broadcasting system, would far outweigh any benefit to others.

5. We believe that implementation of the proposed plan would have a significant negative impact on conventional television broadcasters at a time of great financial peril, likely resulting in further reductions in local service and adverse impacts on specialty services. Reduced revenues to each sector would have a substantial and negative impact on investments in Canadian programming.

6. In Broadcasting Public Notice CRTC 2005-88 the Commission examined the following key factors as part of its deliberations:

• Economic need
• Estimated commercial advertising revenues and impact on specialty and conventional television
• Impact on Canadian content
• Impact on the viability of new Canadian services
• Impact on the availability of promotional opportunities for Canadian services
• Impact on Commission polices
• Impact on the structure of the Canadian broadcasting system
• Promotion of non-programming services on broadcasting services
• Uncertainty regarding the future impact of the proposed policy change

7. FRIENDS recommends that these factors remain the criteria which should guide the Commission in making its final determination. We therefore advance our comments using the above factors as organizing headings:

Economic Need

8. By any measure, BDUs are in a healthy financial position. Thanks to the Internet, their emerging Internet telephone business, as well as digital and high definition services, BDUs are positioned for substantial organic growth. This begs the following question: "Why would allowing BDUs to sell advertising in direct competition with broadcasters be in the public interest"?

9. According to the Commission's data,¹ in 2007 (the most recent year for which data have been published), Class 1, 2, and 3 BDUs generated total revenue of $ 7.1B with operating margins of 40 % and PBIT margins of $ 1.5B or 21 % for all services.

10. While basic and non-basic cable services may be considered a mature business, annual growth still exceeds 6%. And the advent of digital, high definition television, as well as video on demand services represents significant new business opportunities. With the release of their 2008 subscriber statistics on January 9, 2009, Rogers, for example, announced that digital subscriptions have grown by almost 15%, bringing overall digital penetration to 67%. Approximately 33% of all Rogers digital customers subscribe to high definition services.

11. While the number of homes currently receiving their television signals over the air has declined to approximately 10%, the transition to digital over-the-air television is expected to motivate still more households to abandon over-the-air in favour of BDU distribution, creating yet another opportunity for extraordinary growth in the BDU sector.

12. BDU revenue from non-programming services has continued to grow from $1B in 2003 to almost $3B in 2007, and as a percentage of total revenue from 23% to 39% over the same period. Operating margins for non-programming services were 67% in 2007. Furthermore, it is apparent that both Internet-based home phone services and high-speed Internet represent significant growth opportunities for cable. In 2007, cable telephone customers increased by 28%, bringing penetration to 36% from 28% while high-speed Internet connections rose by 8%, bringing high-speed penetration to 68% of all basic customers².

13. In CRTC 2005-88³ which rejected the Canadian Cable Telecommunications Association's claim that access to local availabilities should be granted based on economic need, the Commission stated that:

"Margin of profit before interest and tax (PBIT margin) and return on average net fixed assets (RANFA) are two of the measurements used by the Commission to assess the financial health of a BDU. For the cable industry as a whole, the PBIT margin and RANFA have both increased over the past two years due to continued revenue growth, a reduced rate of growth in operating expenses, and a decrease in depreciation expenses. The PBIT margin of Class 1 cable BDUs increased to 23.2% in 2004 as compared to 17.5% in 2003 and 15.4% in 2002. The RANFA of Class 1 cable BDUs reached a level of 20.4% in 2004 as compared to 14.2% in 2003 and 11.5% in 2002."

14. The data published by the Commission for 2007 aggregates Class 1, 2 and 3 systems. Because it does not break out Class 1 systems separately, a direct comparison is not possible. However, since Class 1 systems represent the vast majority of revenue and expense, the point and conclusion remain valid.

15. In the period from 2003 to 2007, BDU revenues have increased at an average annual rate of almost 13%, while PBIT margins have increased at an average annual rate of almost 18%.

16. Class 1, 2, and 3 systems generated total revenue of $ 7.1B in 2007 with operating margins exceeding 40% and PBIT margins of $1.5B or 21% for all services, while the return on net fixed assets increased to 23%.

17. All of this is happening at a time when BDUs told the Commission during the BDU hearing that customers would reduce or disconnect their service if the Commission approved fee for carriage. Yet, some major cable companies are currently implementing fee increases in excess of 5% for various services, including basic cable.

18. Based on the foregoing, it is impossible to conclude that there is any argument whatsoever for ‘economic need' on behalf of the BDUs.

Estimated commercial advertising revenues and impact on specialty and conventional television

19. By contrast, the entire private television broadcasting sector in 2008⁴ generated revenues just over $2.1B, primarily from advertising revenues, which unlike subscriber revenues, are highly sensitive to economic conditions.

20. Operating margins for private television from 2004 to 2008 have slipped from 15% to under 4%, while PBIT margins have eroded from 11% to almost nothing ($8M). This means that PBIT for the entire private OTA television sector was less than two days' PBIT for the cable industry last year.

21. In 2007⁵, specialty services generated total revenues of $ 2.2B, of which approximately 43% derived from advertising. Operating margins for 2007 were 26% while PBIT was $ 531M (or 24.3%).

22. From these data it is clear that both private conventional television broadcasters and specialty channels would suffer adverse impacts from any loss of advertising revenue. Furthermore, it is clear that further losses will occur because the latest published data do not reflect the significant downturn in the economy since the beginning of the 2008/09 broadcasting year. The economic downturn, as the Commission knows, has already led to major lay-offs at television stations across the country.

23. Notwithstanding the hypothesis suggested by BDUs that the sale of US specialty inventory would create new revenue, there is absolutely no evidence to suggest this assertion is correct. There is substantial evidence to the contrary. While there is no question that advertising agencies would love to obtain access to US avails, additional inventory in the ad marketplace can serve only to drive down the value of Canadian inventory even further. This is because, as the Commission knows, advertising rates are determined by supply and demand.

24. While FRIENDS will leave the specific calculations to experts at the Commission and the broadcasters themselves, we note the various ranges of dollar impact that were discussed in CRTC 2005-88,⁶ summarized in the following chart:

25. The Commission's impact estimate represents five times the present private television PBIT. This would have a severe impact on every aspect of existing broadcasting operations, including Canadian programming and employment.

26. While FRIENDS does not represent itself as an expert in advertising sales, common sense suggests that the availability of more that 315,000⁷ 30 second commercials on popular US specialty channels would have a significant impact. This number is calculated based only on the 12 services⁸ that the Commission identified in Broadcasting Public Notice CRTC 2005-88. It fails to consider two very significant factors. First, the list of US channels in which BDUs hold local rights has probably increased with the addition of several new US services in recent years. Second, these calculations are based on the existing two minutes per hour, currently designated as local avails, which could change.

27. It is important to note that US channels such as A&E do not derive any incremental advertising revenue from distribution in Canada. It would therefore be reasonable to suggest that once BDUs sell out the two minutes of advertising that they already possess there is no reason to expect that they will not enter into agreements to share revenues from the balance of the inventory by replacing the existing US spots with additional Canadian commercials. As BDUs now routinely substitute their own commercials and promotional spots into the two minutes for which they have rights, there would be minimal if any incremental cost to substituting all advertising contained in US specialty channels.

28. This analysis of new inventory does not begin to take into consideration the fact that several BDUs are in the process of upgrading the capacity of their electronic programming guide interface to enable the sale of advertising within the guide itself. Since the sale of guide advertising is already permitted by the Commission, FRIENDS' strong recommendation is that this new source of revenue be carefully considered before determining whether BDUs should also have access to the mainstream advertising that has been the lifeblood of Canadian OTA broadcasters and specialty services.

29. Owing to Bill C-58, many Canadian advertising agencies buy limited amounts of advertising on US stations, especially for large national clients. The effectiveness of C-58 would be severely compromised if Canadian advertising agencies gained direct access to US specialty channel inventory directly through BDUs – surely not what the legislation intended.

Impact on Canadian content

30. In 2008 conventional television stations spent $ 616M, or 29% of their total revenue, on Canadian programming. In 2007, specialty television channels spent $863M, or 39.7% of total revenue, on Canadian programming.

31. While the CCTA submission the Commission reviewed in CRTC 2005-88 proposed that 25% of the revenue generated by the sale of local avails would go to the Canadian Television Fund, the most recent BDU proposal would see just 6% of revenue go towards Canadian programming through the CTF. While this is advanced as an incremental contribution to the system, that would be the case only if the proposal generated entirely new revenues to the system. However, the BDUs have provided no evidence to support that interpretation.

32. The total advertising pie does not increase exponentially because of a new media opportunity; rather revenues shift from one medium to another. For example, Internet advertising has increased substantially over the past ten years. In July, 2008 the Interactive Advertising Bureau of Canada (IAB) announced that Canadian online advertising had passed $1.2B, a 38% increase since 2006. In 2008, online revenues are expected to exceed $1.6B. Clearly the Internet represents a significant new advertising medium. But what is equally clear is that Internet advertising growth has come at the expense of reductions in the share of spending on other media, including newspapers.

33. To illustrate this point, the following chart shows total advertising spending in Canada for all media (the year-over-year increase as well as the percentage year-over year-increase). During this period Internet advertising went from $25M in 1998 to $1.2B. in 2007. Yet, as the chart clearly indicates, not much better than year-over-year inflationary increases accrued to total advertising expenditures in most years.

FRIENDS contends, therefore, that any advertising dollars that flow to local avails in US programming will come at the direct expense of conventional and specialty television services. Services owned by the CBC that rely on advertising as a key revenue source will be also sustain proportionate impacts.

Impact on the viability of new Canadian services

34. In CRTC 2005-88, the Commission also expressed concern regarding the impact of the CCTA proposal on the 290 Category 2 services that had then been launched:⁹

35. "The Commission has authorized over 290 Category 2 services to date, approximately 60of which have launched. Each of these newly launched Canadian services is competing to sell the audience targeted by its niche programming to Canadian advertisers. Approval of the CCTA's proposal would provide Canadian advertisers seeking specific demographics with access to the local availabilities contained in the schedules of several popular U.S. satellite programming services. The Commission is concerned that this expansion of advertising inventory within the Canadian broadcasting industry could hamper the ability of these newly launched Category 2 services to establish themselves and could discourage other Category 2 services from launching."

36. At the time this latter Public Notice was released, the Commission would have had access to 2004 financial data for all specialty services and would have noticed that in that year, 40 Category 2 services cumulatively lost $34M in PBIT and $47M before taxes. By 2007, 75 Category 2 services reported a PBIT of $ 761K (or 0.5%). It is certainly fair to state that there has been subsequent improvement in Category 2 financial performance. But arguably, profit levels of less that $1M are not indications that that the Commission should abandon its earlier concerns for the well-being of the Category 2 services.

Impact on the availability of promotional opportunities for Canadian services

37. As outlined in PN CRTC 2008-102, under the present rules, BDUs may use 25% of the local availabilities in US specialty programming to promote their own services while 75% of the availabilities are reserved for the promotion of Canadian programming services. However, there is no restriction on a BDU promoting its own programming services within the 75%. In other words, there is no restriction on Rogers, for example, promoting CFTR, CHFI, OMNI, or CITY TV in Toronto as part of the 75%, or Shaw promoting its Corus radio stations in western Canada.

38. The initial commitment from BDUs was to provide free access. However, after the Commission allowed cost recovery, numerous complaints have been filed suggesting that cost recovery has become a ‘profit centre' and access to these spots was anything but fair – or available at a reasonable cost.

39. As there was substantial discussion during the recent BDU hearing about the treatment of the local avails, FRIENDS hoped that the Commission would conduct a review of actual spot usage by a representative group of cable companies in major markets so that firm statistics by which to determine a baseline might now be available.

40. There is no question that the value of these promotional spots is significant. But we expect that if such research had been conducted, it would have revealed that the vast majority of spots showcased either cable services or BDU-owned and operated Canadian programming services. It is entirely possible that the Commission's proposal to preserve 25% of the spots for non-BDU-owned services at no charge would constitute an actual improvement from the current unacceptable situation.

Impact on Commission polices

41. When the Commission first allowed BDUs to own specialty services, it fundamentally changed the function of a BDU from a distributor to a direct competitor of the other non-owned channels that the BDU carried. The Commission then worked to put in place rules such as undue preference to ensure equitable treatment for all channels, but experience has shown that there are very few, if any, BDU-owned specialty services that are not carried, nor BDU-owned programming services that do not have preferential treatment from the BDU. Testimony during the BDU hearing offered further evidence as to why the concept of market forces, noble in concept, could not work between broadcasters and BDUs – because of the dominant position of the BDUs in virtually all negotiations.

42. The sale of advertising is critical to the survival of private conventional television stations. FRIENDS believes that allowing BDUs to encroach on local avails can only aggravate a financial situation which is already dire, create further confusion in the marketplace and exacerbate the blurring of the respective roles of broadcaster and distributor. And since these repercussions would have a direct negative impact on the availability of Canadian content and local programming, this conflict of interest is not in the public interest.

Impact on the structure of the Canadian broadcasting system

43. In CRTC 2005-88 the Commission noted the fundamental difference between broadcasters who generate their revenue from advertising and BDUs that generate income primarily from subscriber fees, and concluded that:¹⁰

"The Commission has determined that permitting cable BDUs to place commercial messages in the local availabilities would represent a fundamental change to this important aspect of the Canadian broadcasting system. It is the Commission's determination that the CCTA has not demonstrated clear and substantial net benefits to the Canadian broadcasting system to justify such a fundamental change."

44. FRIENDS suggests that little has changed since the Commission's 2005/06 determination. There is, of course, one notable exception: the financial picture for the television sector and in particular for conventional broadcasters has materially deteriorated, while that of the BDUs has improved.

Yours sincerely,

Ian Morrison
Spokesperson

*** End of Document ***

¹ Broadcast Distribution-Class 1, 2, and 3 Statistical and Financial Summaries

² It should be noted that not all high-speed Internet or telephone customers are also basic cable subscribers.

³ Broadcasting Public Notice CRTC 2005-88 par. 42

⁴ CRTC Industry Statistics and Financial Data Private Television 2004-2008 (for the broadcast year ending August 31)

⁵ CRTC Statistical and Financial Summaries Pay & Specialty Services 2003-2007

⁶ Broadcasting Public Notice CRTC 2005-88 par. 45

⁷ 4 x (:30 second units per hour) x 12 (channels) x 24 (hours) x 365 (days) x 75% (allowed to be sold) =315,360

⁸ A&E, BET, CNN, CNBC, Court TV, Game Show, Golf, Headline News. The Learning Channel (TLC) Speed Channel, Spike TV, and WTBS-TV

⁹ Broadcasting Public Notice CRTC 2005-88 par. 49

¹⁰ Broadcasting Public Notice CRTC 2005-88 par. 58