BBC Commercial Activity inquiry

Delivering commercial success in a dynamic market undergoing significant change will necessarily entail the BBC taking commercial risks, not all of which will pay off. The BBC is facing changes in how audiences access its content and increased competition from well–financed companies such as Netflix. In response, the BBC has undertaken new commercial ventures. At least one of these, the BBC Store, which allowed people to pay to download digital content to own, failed soon after opening as demand for purchasing programmes from the BBC archives was lower than expected. The BBC intends to continue trying new ventures to secure future audiences and revenue. With the limited capital at the commercial subsidiaries’ disposal, they cannot afford to be slow in exiting unsuccessful investments, as the BBC now accepts happened after its unsuccessful purchase of the Lonely Planet travel business. Recommendation: The Committee recognises that the BBC needs to take risks to be commercially successful, but it should learn appropriate lessons from past failings, including the BBC Store, and should establish in advance fixed points at which it will assess whether all new ventures are paying off.

The BBC is increasingly dependent on working with partners in joint ventures and co-productions to deliver its commercial goals, but partners may have different ideas about how the relationship should develop. In order to address the strategic challenges the BBC is facing, its commercial activities have been changing the ways they do business; for example, entering into increasing numbers of partnerships and co-productions. As a result, dependence on the revenue and returns from these partnerships has increased. For example, Worldwide’s share of the profits made by joint venture and associate companies made up 31% of its own total headline profits in 2016–17, compared to 17% in 2012–13. Also, about two-thirds of the BBC’s TV drama is funded by commercial deals. As a result, the potential impact on the BBC’s commercial activities has grown should partners’ strategic interests diverge from the BBC’s. The BBC says that it is very clear about shared editorial values and editorial alignment when choosing its partners in order to mitigate against subsequent divergence in interests, but the market is nonetheless constantly, and often rapidly, evolving. Recommendation: The BBC should monitor its partnerships for signs of divergence between its and its partners’ interests, and should make contingency plans for when these relationships end in order to minimise unexpected hits to its bottom line.

The BBC’s failure to provide its Board with appropriate benchmarking data means that the Board is not well–placed to judge whether the broadly flat level of performance of the commercial activities in recent years is acceptable. The BBC’s total revenue from its commercial subsidiaries remained broadly unchanged at around £1.2 billion in each of the five years from 2012–13 to 2016–17. In this period only Worldwide made profits, and its profit after tax was 68% lower in 2016–17 than in 2012–13, although this was mainly due to two large one–off costs. According to the BBC, this represents a good level of performance given the changes its commercial activities have gone through in recent years and market conditions. 6 BBC commercial activities The BBC has undertaken benchmarking of its commercial activities, but has not, as a matter of course, shared the results with its Board, making it difficult for the Board to gauge whether the reported level of performance was acceptable. The BBC intends to include more benchmarking information in Board reports in future, and the Board itself is likely to commission more benchmarking soon as part of a review of the commercial operations that it must complete by the end of 2018. Recommendation: The BBC should set out how it will provide the Board with better information in future, so Board members can understand how the BBC’s commercial performance compares to market norms. The Board should also publish the results of the commercial review it must undertake by the end of 2018, including high–level information about any benchmarking this generates.

Understanding of the BBC’s commercial performance has been undermined by inconsistent metrics and a confusing target for “financial returns”. The BBC Board acts as the shareholder for the BBC’s commercial companies, and, in this role, is the proxy for licence fee payers, safeguarding their interests. However, we cannot see how the Board could have scrutinised the performance of the subsidiaries effectively while the BBC, in reports to the Board, was using different profit metrics for different subsidiaries. The BBC says that, since 1 April 2018, it has rectified the situation. However, the BBC also now needs to look at how it measures the financial returns delivered by its commercial activities. Its measure of these returns is unique and consists of a complicated combination of up–front investment in BBC programmes and dividends from profits. The measure is further undermined now that Studios and Worldwide have merged, as some of Worldwide’s programme investment has simply become a transfer within the new merged subsidiary, from its distribution to its production arm. Recommendation: The BBC Board should assess whether the unique “financial returns” target is fit for purpose. It should also, as a minimum, set sub–targets in future to distinguish between dividends and up–front contributions to programme costs, and should monitor delivery against these.

The BBC could not explain clearly how it reconciles the notable tensions that can arise between its commercial activities and its Public Purposes. It is inevitable that tensions will sometimes emerge as the BBC looks for programmes and ventures that, on the one hand, can deliver commercial returns and, on the other hand, fit with its mission and contribute to its Public Purposes. We heard two examples. First, if the BBC decides to increase licence fee payers’ access to programmes by extending the period for which they are available on the iPlayer, it may reduce opportunities for the commercial exploitation of these programmes. Second, the Global News subsidiary’s BBC World News TV channel arguably delivers wider benefits for the British taxpayer by boosting the UK’s reputation overseas through its provision of trusted and independent news. However, the market for selling advertising for global news is very difficult, and the future looks challenging, leading the BBC to seek a public subsidy towards Global News operations in Europe and Sub-Saharan Africa. We are not convinced about the extent to which the Board explicitly considers the balance between the delivery of commercial returns and the public benefit when examining both these specific situations and the performance of the commercial activities more broadly. BBC commercial activities 7 Recommendation: The BBC should clarify for itself, Ofcom and Parliament how it will resolve tensions between commercial activities and Public Purposes in future, and should develop its ability to quantify the level of commercial performance it is sacrificing due to the Public Purposes. Specifically, the BBC should quantify the commercial income it will forego if it decides to make more series available for longer to licence fee payers via iPlayer. The BBC should also write to us explaining how Global News could continue as a commercial venture if it were to receive a public subsidy.

The creation of BBC Studios and its merger with BBC Worldwide constitute a high–risk strategy to protect the BBC’s position as a programme maker and owner of intellectual property (IP) in future. The BBC established its in–house production arm as a commercial company in April 2017, and then merged it with its commercial distribution business, BBC Worldwide, in April 2018. Establishing BBC Studios represents the biggest change the BBC has gone through in a generation. The new subsidiary’s success—in delivering content for audiences and creating IP which can be exploited to generate financial returns—is critical to the BBC’s future. The BBC expects that accounts later this year will show that the former BBC Studios made a profit in 2017–18, with Worldwide having seen significant growth in profits. Going forward, the BBC expects both the production and distribution arms of the new, merged business to succeed commercially even as they have to compete more intensively than ever for access to the best programme-making talent. Recommendation: The BBC should set clear expectations for the performance of the merged BBC Studios and should act decisively if the business seriously underperforms. The BBC Board should be kept informed of varying levels of profitability within, and not just between, the subsidiary’s individual lines of business. 8 BBC commercial activities 1 Performance

The BBC disagreed with the suggestion that its Board was light on commercial experience. The BBC said its Board members came from very diverse backgrounds and included directors with experience in retail, the media, and financial and other commercial areas. The BBC felt the capability of its main Board had grown immensely and rapidly since its establishment in April 2017 and that the Board was now actively challenging the BBC to make sure its decisions were made properly and in a well thought through way.11 Similarly, the two non-executive directors on the Commercial Holdings Board had commercial backgrounds. They had previously fulfilled the same role on the BBC’s Executive Board under the old governance structure, where the Executive Board was answerable to the BBC Trust. They therefore brought some experience of the BBC to the new corporate governance arrangements. The BBC assured us that it applied the normal rotation rules to appointments to refresh board membership.12 6 Qq 21, 23, 46 7 Qq 21, 23, 67 8 Qq 37–39, 46 9 C&AG’s Report, para 10 10 Qq 65, 68, 111 11 Qq 81, 88, 100, 101 12 Qq 103–107; BBC (LBA0002) 10 BBC commercial activities Reporting performance

A further area of concern for us was the confusing approach the BBC had taken to reporting on the profitability of commercial subsidiaries to the Board, employing a number of different measures that varied from subsidiary to subsidiary: for example, Profit Before Tax for Studios but Earnings Before Interest, Tax, Depreciation and Acquisition (EBITDA) for Worldwide. The BBC explained that it had done this because its four main subsidiaries were different businesses operating in distinct markets and on different scales. However, from the beginning of this financial year, in response to the NAO report, it said it had been using the same profit measures for all its main subsidiaries in Board reports.13

We asked the BBC about its use of other common measures of commercial performance in its Board reporting, such as Return on Capital Employed and profit margin. The BBC told us that, although it was good to take a shareholder’s perspective from time to time when assessing the performance of its commercial activities, it could not act as a full- blooded commercial company, but instead needed to strike a balance between delivering commercial returns and using the commercial activities to contribute to the wider BBC Public Purposes. Thus, for example, Worldwide had not concerned itself with delivering earnings per share or an increase in asset value with a view to the possible sale of the company. Instead, it sought to deliver cash returns and a supply of programmes and intellectual property (IP) to the BBC, at times choosing to invest more in programming, potentially at the expense of profits.14

From 2012–13 to 2016–17, BBC Worldwide delivered financial returns to the BBC of £989 million and it has a target to deliver further returns of £1.2 billion from 2017–18 to 2021–22. The BBC intended the £1.2 billion target to be very stretching, given a tough market with lots of new competitors. However, it acknowledged that it now needed to revisit the figure in light of possible cost synergies and other benefits and changes arising from the merger of Studios and Worldwide.15 In particular, in 2017–18, some of Worldwide’s programme investment took the form of payments to Studios, but such transfers would in future take place entirely within the new Studios subsidiary, potentially making it harder to justify classing them as financial returns.16

More generally, the BBC’s definition of financial returns was an area of focus for us, since it includes both dividends paid by Worldwide and other payments that the company makes to the BBC’s public service broadcasting operations as contributions to programmes and payments for associated rights. The metric is unique to the BBC and therefore is not comparable with measures of financial performance used by other commercial companies.17

The BBC currently has great flexibility over the balance it strikes between dividend payments and programme contributions. The balance varied from year to year, with decisions on dividend levels influenced, for example, by how much future investment was required in the commercial subsidiaries.18 The BBC told us that the Board already approved the proposed returns figure for the year as part of its consideration of the annual 13 Qq 109, 118–119 14 Qq 24, 33, 69, 110 15 C&AG Report, para 16; figure 16; Q 67 16 C&AG Report, paras 19b, 3.8, 3.16; Q 67 17 C&AG’s Report, paras 13, 2.24, 3.17 18 C&AG Report, para 3.17 BBC commercial activities 11 budget. However, the BBC committed in future to giving the Board the opportunity to be more prescriptive about the amount that should be returned through dividends and through investment in programmes respectively.19 Balancing the tensions between commercial and public purpose objectives

We questioned the BBC further on the tensions that can exist between the need to deliver commercial returns and the need to comply with the BBC’s mission and contribute to its public purposes. The BBC acknowledged, among other things, that it would commission different programmes if its only aim was to maximise global returns. However, it considered that the tensions it faced could be overstated, since British content produced for British audiences could also be commercially successful. It pointed, in particular, to ‘Blue Planet’, ‘Sherlock’ and ‘Doctor Who’, and said that “we make most money when we are most BBC”.20

The BBC provided two examples where it seemed to us that the tensions truly were significant. First, it highlighted the balance that it needed to strike between any potential increase in licence fee payers’ access to programmes, by extending the period for which the programmes were available on the iPlayer, and the commercial returns that could be made by selling the right to air these programmes (after their first airing on a BBC channel) to either an advertising- or subscription-funded video on demand service.21

Second, the BBC considered that the World News TV channel, operated by BBC Global News, delivered wider tangible benefits for the British taxpayer by boosting the UK’s reputation overseas through the provision of trusted and independent news. The BBC pointed to surveys showing that, in countries where the BBC was strong through news or other programming, trade with Britain also tended to be strong.22 However, although the BBC expected Global News to be profitable in 2017–18, the advertising market for global weekly news was very difficult, and Global News’ future therefore looked challenging. As a result, the BBC had approached the Department for Digital, Culture, Media & Sport for a subsidy so that it could make some of the content it provided to Europe and Sub- Saharan Africa freely available, instead of placing it behind a paywall as at present. The subsidy would replace the subscription income lost as a result of this change.23

The BBC assured us that all the decisions within its commercial activities took account of the need to balance commercial returns and the public purposes, since all changes had to comply with the BBC’s four commercial criteria. This means they had to: fit with the BBC’s mission and public purposes; deliver a commercial return; be concomitant with the BBC brand; and not distort the market.24 The BBC said it had a rigorous process for reviewing the commercial and public purpose aspects of any new proposal. However, it admitted that the Board was yet to reject any commercial proposal because it conflicted with the public purposes. The BBC said it would have already rejected proposals at a lower 19 Qq 62–64, 67 20 Qq 41, 44 21 Qq 72, 76 22 Qq 48, 49, 52 23 Qq 23, 46, 47, 53 24 Qq 24, 55, 58 12 BBC commercial activities level before this point in the process. Nonetheless, we were not convinced about the extent to which the Board gave explicit consideration to the balance between the delivery of commercial returns and the public benefit.25 25 Qq 58, 70–73 BBC commercial activities 13 2 Future challenges and risks Risk taking

The BBC’s main commercial subsidiaries operate in sectors that are constantly changing, bringing many opportunities, challenges and risks. They face significant risks from changing audience behaviour, as people, particularly the young, spend less time watching “linear” TV channels and buy fewer DVDs. Instead, people are increasingly streaming programmes digitally via subscription video on demand services.26 The subsidiaries also operate in markets that are increasingly dominated by non-traditional media organisations which have entered the market and grown rapidly, including Netflix, Amazon and Google.27

All media companies are increasingly emphasising the development and ownership of content, and the related intellectual property (IP), as a means of guaranteeing their commercial future. The BBC told us that it considers that its position as a provider of high-premium, British-driven content will help it succeed in the global market.28 Just as importantly, the BBC also assured us that it had rigorous processes for opening, closing and changing commercial ventures, approving programmes, and managing strategic and operational risks. However, it accepted that some of its investments would win and some would lose, and it therefore looked to have a basket of investments to spread its risk.29

One venture that failed was BBC Store, which had allowed people to pay to download digital content from the BBC’s archives to own themselves. Despite what the BBC considered to be good research, the service had not proved popular as people preferred to access newer content elsewhere. BBC Store had consequently been losing money, and the BBC therefore moved quickly to close it. The relative speed of the closure reflected one of the lessons the BBC learned from its unsuccessful acquisition and ownership of Lonely Planet. The BBC had eventually sold this as it did not fit with the BBC’s mission and purposes and was not delivering value for the licence fee player, but the sale incurred a very large loss.30 Partnerships and joint ventures

The BBC told us that, in order to address the strategic issues it faced, its commercial subsidiaries had been changing how they do business by entering into increasing numbers of partnerships. For example, Worldwide sold part of BBC America to AMC in order to gain a partner that could help it improve its position in the US market. The UKTV partnership was also important in delivering money back to the BBC. As a result, Worldwide’s dependence on the revenue and returns from partnerships has increased. For example, in 2016–17 31% of its headline profits came from joint venture and associate companies, compared to 17% in 2012–13. The BBC also told us that co-productions were phenomenally important to it. About two-thirds of its TV drama was funded by this sort of commercial deal: for example, such deals provided 78% of the funding for “Blue Planet II”.31 26 C&AG’s Report, para 15; Qq 21, 22, 121 27 C&AG’s Report, para 15; Qq 67, 123–124, 126 28 C&AG’s Report, para 3.5; Qq 36, 44 29 Qq 39, 58, 93–96 30 C&AG’s Report, figure 12; Qq 56, 75, 130 31 C&AG Report, figure 20; Qq 21, 22, 32 14 BBC commercial activities

The BBC assured us that it had rigorous processes for considering any prospective partnerships. It told us that it spent a lot of time on the pre-selection of partners in terms of their editorial values, and it would not enter into partnerships with those who wanted to go in an inappropriate direction creatively or were not editorially aligned with where the BBC wanted to take a business. It was only following such considerations that the BBC decided to sell part of BBC America to AMC and selected Sony in India as a partner for its BBC Earth Channel.32

We asked about the recent change in ownership of the BBC’s partner in UKTV, Scripps International. Scripps owned 50% of UKTV but was purchased by Discovery earlier in 2018. While acknowledging that it was still early days, we expressed concern that new partnerships sometimes did not work, and, more generally, we feel it is important that the BBC has contingency plans in place for all its partnerships. The BBC agreed that, when a partnership went wrong, it could go very wrong, but it noted that it had had a good relationship with Discovery in the past and was working with it to consider the future of UKTV.33 Merger of BBC Studios and BBC Worldwide

In April 2017, the BBC established its in-house production arm, BBC Studios, as a commercial company. In April 2018, it then merged this with its commercial distribution business, BBC Worldwide, creating a new BBC Studios.34 The BBC told us that establishing BBC Studios was the biggest change it had been through in a generation requiring, most significantly, a transformation in Studios’ culture as the BBC moved to open up almost all its production to competition by 2027. Ensuring the change worked was of the utmost concern to BBC management as the success of Studios over the next five years in developing content and the related IP was critical to the BBC.35

The BBC told us that BBC Studios was also fundamental in its battle to retain the creative talent it needed to develop the best content. Companies like Netflix had been able to outbid the BBC and lure talent away. Studios’ commercial status might give it greater flexibility over how it worked with talent in future. However, the BBC acknowledged that there was a risk of a “football-style transfer market” developing for talented generators of valuable IP, like natural history content, with a consequent impact on costs.36

Although the BBC acknowledged that there was real jeopardy around Studios’ prospects in the context of the global market and associated challenges, it was confident about the subsidiary’s opportunities for future growth. Studios had succeeded in winning business from both the BBC and other broadcasters in its first commercial year, including making a programme about fatbergs for Channel 4, shown the night before our evidence session. The BBC expected that both the production and distribution arms of the new BBC Studios would perform acceptably in their respective markets, commenting that both parts of the business at least “have to wash their face” in future.37 32 Qq 22, 33–35, 58 33 Qq 25–27, 29, 31, 33 34 C&AG’s Report, paras 2, 3; figure 2 35 Qq 30, 71, 72, 120, 124 36 Qq 124, 126, 128 37 Qq 30, 37–40 BBC commercial activities 15