210.  So far we have only referred to regulation of content. However, the BBC Governors and Ofcom currently also have a role in regulating the BBC's impact on the wider media market.

211.  The BBC's activities can be divided into those which are publicly funded and those which are funded commercially. While it is only the commercial activities which are designed to compete with other companies for money, the existence of the BBC as a provider of diverse and high quality public services has a direct impact on the success of other broadcasters and thus on the diversity of services available.

212.  The Office of Fair Trading (OFT) recognised this in its response to the Green Paper. It stated that the BBC can "produce outcomes that are uniquely damaging to effective competition and to commercially funded innovation on media markets, due to the BBC's unique scale, scope, status and ambition." The OFT went on to conclude that it is "crucial to ensure that all activities of the BBC, whether public or commercial are appropriately regulated, by objective and expert bodies, in a manner that takes account of its unique position".[77]

Public service activities

213.  During the course of our inquiry witnesses cited several examples where they believed the presence of publicly funded BBC activities crowded out commercial providers and discouraged diversity. For example Mark Wood, Chief Executive of ITN, suggested that the BBC's publicly funded online news presence had such a weight of resources at its disposal that no other provider had been able to compete. He stated that the BBC had discouraged entry to online news and consequently had inhibited innovation in online news provision and that, in spite of the quality of the BBC's provision, this had a negative impact on the consumer (Q 1365).

214.  Adam Boulton, the political editor of Sky News, told us that effective competition was valuable to the BBC. He explained that if the BBC was not subject to effective competition its services might be of inferior range and quality: "the significant advances in television news so far as serving the public have not been driven by the BBC; they have been driven by competition… If you look back at the launch of breakfast television, for example, the BBC could have done that at any time… ITV decided to licence it and, lo and behold, the BBC suddenly decided they were going to do it" (Q 1212).

215.  The fact that the launch of a BBC service might affect other providers in the market does not mean the BBC should not provide such a service. If the public will benefit then there may well be a good case for launching it. However, it is important that a set of checks and balances are in place to ensure that the BBC considers its impact on the broadcasting sector and adjusts its behaviour where appropriate.

216.  In its response to the Green Paper the BBC acknowledged that in the past it had "been insufficiently sensitive to its potential negative impact on the wider market place".[78] In Building Public Value the BBC stated that "The public, the government, the broadcast industry as a whole and the BBC's many other stakeholders have a right to expect that public value should mean just that, and that the benefits of any existing or proposed new service should outweigh any disbenefits there may be".[79] To this end the BBC proposes to introduce a Public Value Test which will be applied to all proposals for new services and also to significant changes in existing services. It also proposes that each new BBC service will be given a clearly defined remit set out in a service licence.[80] It is important to note that there are no plans to extend the Public Value Test to established BBC services and the Public Value Test will therefore not address any problems which arise either from established BBC services or from new ventures launched before the Public Value Test is implemented.

217.  Evidence to us shows widespread support for the Public Value Test and for service licences providing they are administered fairly (Channel 4 Q 315, ITV p 116, ITN p 366). We consider them an important and encouraging step towards a BBC that considers the wider broadcasting market. Nevertheless we have some concerns about the way the BBC, and the Government, propose to implement the Public Value Test.

The Public Value Test

218.  In Building Public Value the BBC states that the Public Value Test will evaluate three different types of value: the individual value (the benefit people will derive as individuals from a BBC service), the citizen value (the benefit that people derive from a BBC service as citizens, such as its contribution to a better informed democracy, higher educational standards or a more inclusive society) and the net economic value (the net benefit that the wider economy may derive from the BBC's services). The Government welcome the BBC's proposal to develop the Public Value Test. They state that "Only if the public value added by the service outweighs any negative market impact should the proposal be given further consideration".[81]

219.  The BBC has proposed a range of methods for measuring each type of value. It proposes to measure net economic value using market impact analysis and industry modelling. The Government state that the market impact assessment should be conducted according to a standard formula agreed between Ofcom and the BBC Trust and should be conducted by Ofcom "in the case of a new service".[82] However, when the proposal is to extend an existing service the Government suggest that the BBC Trust could carry out the market impact assessment.

220.  We question why the Government propose to treat applications for new services and applications for changes to existing services differently. In its response to the Green Paper Ofcom noted that "significant changes or repeated changes to existing services are not different in nature to new services, as to their impact on the market(s), competition and on predictability/certainty in the market… if they are treated differently, there is a risk that the objectives of the market impact assessment regime—namely ensuring that the BBC's market impact is limited to an acceptable level—could be circumvented by simply reclassifying a new service as a change to an existing service".[83]

221.  In its response to the Green Paper the BBC expressed serious concerns about Ofcom undertaking the market impact assessment, because "Ofcom may have a conflict of interest, or be perceived to have, in relation to the sectors it regulates." The BBC therefore proposes that Ofcom and the BBC Trust should jointly commission market impact assessments from a third party.[84]

222.  We believe that the BBC's concerns about Ofcom conducting the market impact assessment will prove to be groundless. Ofcom is the industry regulator not an interested party. Moreover, Ofcom already has regulatory responsibilities in respect of public service broadcasters (including some responsibilities for the BBC) and is responsible for reporting on public service broadcasters' performance.

223.  Nevertheless, if our recommendation in para 227 is adopted, a different problem will arise should Ofcom conduct market impact assessments. In para 227 we will argue that an aggrieved party should have the right to appeal to Ofcom if it believes that the BBC Board has not paid due regard to evidence (or there have been procedural irregularities) when conducting the Public Value Test. If this recommendation is adopted then it would be inappropriate for Ofcom to conduct a market impact assessment which forms part of the Public Value Test. For this reason, and this reason alone, we do not think that Ofcom should be responsible for carrying-out market impact assessments of new and extended BBC services.

224.  We therefore recommend that all proposals for new BBC services, and significant changes to existing services, should be subjected to a Public Value Test. This must always include a market impact assessment commissioned from an independent third party. Where significant and well reasoned concerns about existing BBC services are raised, these services should also be subjected to a Public Value Test.

APPEALING THE RESULT OF THE PUBLIC VALUE TEST

225.  The Green Paper states that the Secretary of State will only be able to veto the Trust's recommendation for new and extended services if due process has not been observed. There will therefore be no option of appealing against a recommendation of the BBC Trust on substantive grounds—the only ground for appeal would be if the BBC had not observed due process in carrying out the Public Value Test.

226.  Some witnesses objected to this. In its written evidence the Newspaper Society stated "the BBC Trust will decide whether new services should be permitted, even if found to have adverse effect upon competition. Ministerial approval and oversight are seemingly downgraded to 'process' observation" (p 510). In its response to the Green Paper the OFT stated "there will still be considerable scope for the exercise of discretion by the Trust when deciding whether to allow the BBC to launch a new service, and under what conditions, given the inherently subjective nature of the task. While this is to some degree inevitable, we would suggest that the exercise of this discretion should be subject to some form of external oversight, to enable third parties who may be unsatisfied by a decision by the Trust to seek redress".[85]

227.  We believe there should be a right of appeal for an aggrieved party to Ofcom on matters of substance and/or procedure if it is considered that the BBC has not paid due regard to the evidence obtained through the Public Value Test. We also believe that the BBC Board should have a duty to publish its reasons for approving or rejecting a proposal by the BBC management. If the BBC has to make its reasoning public, its decision is likely to be more strongly evidence-based and the nature of the costs and benefits taken into account in the Public Value Test will be plain. This would also answer calls by some witnesses for approval of BBC services to be "a much more public process than now" (e.g. Charles Allen, ITV, Q 495).

A THRESHOLD FOR THE PUBLIC VALUE TEST?

228.  The Government state that they want to consider whether the Public Value Test should set a threshold beyond which the market impact of a service might be deemed completely unacceptable—for instance if it risked foreclosing a new market or significantly lessening competition. In its response to the Green Paper the BBC noted this suggestion and undertook to consider it further but also stated that "the BBC is not yet convinced that it is either possible or desirable to introduce a hard and fast formula".[86] We believe that unless there is a clearly defined threshold, beyond which the market impact of a service would be deemed unacceptable, then the market impact assessment could become a pointless exercise the results of which could easily be ignored. We therefore recommend that if a market impact assessment indicates that the launch of a new BBC service will risk stifling a new market then the new service should not be launched.

Cross-promotion

229.  Several of our witnesses objected to the BBC cross-promoting its publicly funded services. For example ITN was concerned that "the BBC could use its cost-free cross-promotional power from television, radio and websites to promote short-code access numbers of its mobile services and thereby achieve an enormous marketing advantage over commercial competitors" (ITN/05-06/29).

230.  In the Green Paper the Government state that they are aware of the concerns of the commercial sector and will commission research to assess the value to audiences of cross-promoting publicly funded services against the potential adverse market impact of such activity. However, the Government also state that there is a clear value to users in the BBC making known the range of programmes and services available.[87] We believe that there is value to the licence fee payer in being informed of services provided by the licence fee. However we agree with the Government that research on the value of cross promoting BBC publicly funded services should be commissioned and we recommend that the findings of that research should be made public. The BBC should take the research findings into account.

Commercial activities

231.  The Green Paper quotes research showing public support for the BBC making money to supplement the licence fee. 90 per cent of people surveyed agreed that "the BBC should raise as much money as it can from selling its programmes and other products".[88] We too believe that it is desirable to realise commercial, as well as public value from the BBC's assets.

232.  However, the BBC is not like any other company in the market—it is a hybrid public/commercial organisation. The BBC's commercial operations are on a large scale. Moreover, the BBC's commercial activities may enjoy advantages not enjoyed by rivals such as lower profit targets, cross-promotion, and preferential access to BBC assets funded by the licence fee. The commercial activities of the BBC may therefore have adverse consequences for competition and a well functioning market. We are reminded of Isaiah Berlin's aphorism: "Freedom for the pike is death for the minnow". What may be good for the BBC's bottom line may also be lethal for its competitors with unfortunate consequences for media diversity.

233.  In the Green Paper the Government assert that the BBC should be encouraged to generate income through commercial activity. However, the Government also acknowledge that the BBC's commercial operations are frequently criticised on three grounds. First that the commercial operations are not adequately aligned to the BBC's PSB remit. Second, that there is too much cross-promotion of commercial services by public services. And third, that the BBC's commercial businesses are not profitable by industry standards and might make more money for licence fee payers if they were sold or licensed to other operators.[89]

234.  To address these criticisms the Government propose four criteria against which each BBC commercial service should be assessed to establish whether or not they are appropriate:

• Fit with PSB purposes—does the activity either support or relate to PSB purposes?
• Commercial efficiency—is BBC ownership the most efficient economic exploitation of the assets involved or might sale or licensing of assets provide better value for money for the licence fee payer?
• BBC brand protection—is there a positive or negative implication for the BBC's brand or values?
• Market distortion—are BBC commercial services being sold or structured in a way that might give them unfair advantage over the competition?

235.  In its response to the Green Paper the BBC agrees with the Government that these are the right criteria and that for the sake of transparency and certainty it should ensure that all its commercial activities meet these four criteria.[90]

236.  We support the introduction of these four criteria against which BBC commercial services be tested. They constitute a set of principles to govern the BBC's commercial activity. Together with attempts to define the principles underpinning the BBC's public service activities (see chapter six) they represent a move towards a clearer distinction between the BBC's two separate incarnations as a public service broadcaster and as a commercial company.

The fair trading regime

237.  Currently the BBC's commercial services are, like any other commercial enterprise, subject to regulation by Ofcom, the OFT and the EU. In recognition of its special position as a publicly-funded organisation the BBC also voluntarily abides by a fair trading regime underpinned by its Fair Trading Commitment. This fair trading regime is currently approved and overseen by the Board of Governors. It sets out commitments to achieve fair competition, to avoid risking public funds through commercial activity, and to ensure BBC commercial activity is both commensurate with the BBC's PSB remit and reflects BBC values and purposes.

238.  The Green Paper states that the "Fair Trading Commitment has proved controversial".[91] Our evidence certainly supports this statement. One of the most controversial features of the Fair Trading Commitment is its self regulating nature: the BBC Governors both define the Fair Trading Commitment and enforce it.

239.  The Green Paper states that the Government would welcome views on whether the Fair Trading Commitment should continue in its current form, or whether it might be simpler to separate matters of internal BBC housekeeping from those of external regulation that could be left to Ofcom.[92]

240.  This would mean the existence of two regimes. The first would be an internal compliance document governing how BBC staff should comply with the BBC's legal obligations in the field of competition and state aid law. The second would be a set of ex ante rules that Ofcom would be responsible for defining and enforcing. These would ensure that the BBC did not give undue preference to its commercial activities, did not cross-subsidise them from public funds or resources and had a duty to provide Ofcom with information and to give Ofcom prior notice of proposals for new, or significantly changed, activities.

241.  The Advertising Association questioned whether the BBC had the skills to police its Fair Trading Regime. It suggested that if the BBC Trust were to take on the Governors' Fair Trading role some of the Trustees would need specific competition expertise (p 462). Andy Duncan, the Chief Executive of Channel 4 (and formerly a member of the BBC's Executive Committee), told us that even though the current Governors are now performing their fair trading roles quite well "there need to be appropriate mechanisms put in place that do not mean as soon as the Charter is agreed they suddenly go back into expansionist mode over the next ten years" (Q 293).

242.  We received evidence that Ofcom should be given responsibility for the regulation of the fair trading regime. Mr John Hambley, Chairman of the Satellite and Cable Broadcasters Group, told us that "even with current fair trading policy, the BBC is always judge and jury in its own cause and …[based on the past experience of some of his members] the jury always seems to find for the BBC" (Q 889).

243.  Regulation of fair trading should be seen to be carried out effectively by an independent body. We recommend that the BBC Fair Trading Commitment be revised so that matters of internal BBC housekeeping are separated from those of external regulation. Matters of external regulation should be the responsibility of Ofcom. However, in the spirit of light touch regulation, and respecting the BBC's editorial and journalistic independence, Ofcom should seek to work in partnership with the BBC to rectify problems and fair trading infringements. Financial penalties should be imposed only as a last resort.

244.  In the Green Paper the Government also ask whether Ofcom should be required to grant approval to the BBC's internal rules if external regulation were handed to Ofcom. In its written evidence the Music Business Forum told us that Ofcom should scrutinise any internal fair trading rules "to give the necessary confidence to the BBC's competitors as to their probity" (p 506). Channel 4 endorsed this position (p 64). We agree. The internal rules governing the BBC's conduct have an important role to play and must be clear, transparent and have the confidence of the industry. We therefore recommend that the BBC's fair trading rules should be subject to approval by Ofcom as the lead sectoral competition regulator.

245.  In order for both the above recommendations to work we recommend that the BBC should be required to provide information relevant to fair trading and competition matters to Ofcom on request. This should form part of the Fair Trading Commitment.

Separating commercial and public service activities

246.  The BBC's Fair Trading Commitment includes a set of guidelines designed to ensure that the relationship between its commercial and public service activities are conducted at arm's length and that there is fair pricing and transparency in the dealings between the two parts of the BBC. This reflects European Union requirements as set out in the European Commission Communication on State Aid.[93]

247.  If our recommendations on regulation of fair trading are accepted there will be some independent scrutiny of this separation. However, evidence we have received has led us to believe that more should be done within the BBC to ensure that the separation is clear and transparent.

248.  Channel 4 told us: "there needs to be clear transparency and separation between the BBC's core public service activities and its commercial activities so that competitors can be confident there is no cross-subsidy"(p 64). In its response to the Green Paper the OFT stated that "the provision of [commercial] services by the BBC raises inevitable questions about whether they enjoy an unfair competitive advantage through their association with the BBC's public service activities and this leads to an ongoing need to police the interface between the public and commercial services to avoid such issues arising".[94]

249.  We recommend that the BBC Board should enforce strict separation between the management of commercial and public service activities within the BBC.

The creative archive

250.  The BBC has a pool of assets created by generations of past public investment in the BBC. One such asset is its programme archive. This is a priceless asset which the BBC holds in trust for future generations of the public. The advent of digital technology has made it possible for this archive to be easily accessible to the public in a cost effective way. In Building Public Value the BBC states that it will launch a Creative Archive with free access for UK licence fee payers through broadband internet access.

251.  The BBC plans to apply the Public Value Test (including a market impact assessment) to the Creative Archive but only after an 18 month trial phase due to start this autumn (i.e. pre-dating the next Charter). We received evidence which cautions against the BBC launching such a trial before a full Public Value Test. ITN, which operate a large video archive business, told us in written evidence that BBC trial services often continue unchecked after the trial has ended and that even the trial itself could have a serious market impact. ITN concluded that "The BBC should not be allowed to develop major new initiatives such as this without a licence, involving both a Public Value Test and market impact assessment" (p 370). ITN also told us that it should be possible to define a form of the Creative Archive project which serves the public and limits adverse commercial impact.

252.  We believe that the Creative Archive project is a real opportunity for the citizen to reap the reward for years of investment in the BBC. In our opinion it is desirable that assets held by the BBC are utilised as fully as possible for non-commercial purposes although we recognise the need to do this in a way that does not unduly affect the market. We also recognize that the BBC is currently able to make money from selling rights to its archive. The more money the BBC makes from this sort of activity the less the licence fee payer has to pay. While we support the proposal to open up the archive for non-commercial purposes we hope the BBC will do this in a way that will preserve the commercial value of the archive.

78   Review of the BBC's Royal Charter: BBC Response to A strong BBC, independent of government, p. 70. Back

79   Building Public Value, Renewing the BBC for a digital world, p. 83. Back

80   Ibid, p. 85. Back

81   Department for Culture, Media and Sport, Review of the BBC's Royal Charter: A strong BBC, independent of government, March 2005, para. 5.42. Back

82   Ibid, para.5.42. Back

83   Ibid, para. 3.21. Back

84   Review of the BBC's Royal Charter: BBC Response to A strong BBC, independent of government, pp. 70-71. Back

85   Office of Fair Trading response to the Department for Culture, Media and Sport, BBC Charter Review Consultation, 2^nd June 2005. Back

86   Review of the BBC's Royal Charter: BBC Response to A strong BBC, independent of government, p. 71 Back

87   Department for Culture, Media and Sport, Review of the BBC's Royal Charter: A strong BBC, independent of government, March 2005, para. 8.47. Back

88   Department for Culture, Media and Sport, Review of the BBC's Royal Charter: A strong BBC, independent of government, March 2005, p. 99. Back

89   Ibid, para. 9.3. Back

90   Review of the BBC's Royal Charter: BBC Response to A strong BBC, independent of government, p. 89. Back

91   Department for Culture, Media and Sport, Review of the BBC's Royal Charter: A strong BBC, independent of government, March 2005, para. 9.17. Back

92   Ibid, para. 9.18. Back

93   Commission Communication on the application of State aid rules to public service broadcasting - OJ C 320/5 15.11.2001, para. 49. Back

94   Office of Fair Trading response to the Department for Culture, Media and Sport, BBC Charter Review Consultation, 2^nd June 2005. Back