BBC teams up with Murdoch in bid for digital terrestrial television licences

ITV and Channel 4 include a pay-TV element as they put together rival bid to the BBC

The BBC has taken a massive gamble and broken ranks with the other terrestrial broadcasters in the contest for the digital terrestrial television licences now up for grabs. It has teamed up with Rupert Murdoch's BSkyB in an audacious alliance of the two big would-be monopolists. The duo would turn the licences vacated by the failed ITV Digital into a free-to-air proposition, requiring consumers to buy only a basic set-top box to receive the signal.

The BBC has been unable to agree a joint bid with ITV and Channel 4 and has now left them out in the cold. ITV and Channel 4 will now submit their own application for the licences to the regulator, the Independent Television Commission, by the deadline of 5pm today. And it will be the ITV bid that aims to have a pay-TV element, being put together by David Chance, a former Sky executive and now a non-executive director at Granada.

So we now have an extraordinary face-off, with Sky, an aggressive pay-TV operator, backing a free proposition. Furthermore, the regulator has already kicked Sky out of DTT once – before the launch of ITV Digital.

Simon Baker, an analyst at SG, said: "It looks like Sky is trying its luck, having been ejected once and to do this in league with the BBC is really testing the tolerance of the regulator."

The Government has clearly indicated that it wants a pay-TV element in the successor to ITV Digital, although this is not strictly required to bid for the licences. The Government believes that pay-TV is the way to drive take-up of digital TV, which it needs in order to turn off the analogue signal by 2010. Ideally the Government wants a cheaper pay-TV offering than that provided by the two existing pay platforms, Sky and the cable companies, in order to provide a range of price options for consumers, many of whom cannot afford to pay £37 a month for Sky's most popular package. This is what ITV-Channel 4 are proposing.

And, on competition grounds, the BBC-Sky axis, both dominant players in their respective parts of the television market, is bound to be problematic. These considerations may outweigh the influence with New Labour enjoyed by the BBC's director-general, Greg Dyke, and its chairman, Gavyn Davies.

Many believe, then, that the BBC has made a mistake in abandoning the other terrestrial players, or at least that it is taking a very great risk. A united terrestrial bid would have been almost certain to succeed (whoever the victor is will have to show all the main free-to-air channels anyway).

One leading City commentator said: "The ITV proposition is clearly more attractive. There's not enough there with the BBC plan to drive penetration [of digital]. The BBC is pursuing its own selfish agenda but they've cocked-up."

So why has the BBC chosen Sky as its partner? The BBC believes that the failure of ITV Digital demonstrates that DTT cannot work as a pay-TV platform – the technology has also failed in Sweden and Spain.

The number of channels available on DTT will have to be reduced from 36 to about 24, in order to boost the strength of the signal and get away from the reception difficulties that plagued ITV Digital. That does not leave enough room for a pay-TV element, in the BBC's opinion.

Also, a pay proposition complicates matters and the BBC wants to break the link, in consumers' minds, between digital TV and pay-TV.

But the more important reason why the BBC fell out with the other terrestrial broadcasters is that it is terrified of getting involved with any pay platform. This is because it worries that this could, ultimately, endanger the sacred licence fee that provides its income.

Although, Tessa Jowell, the Secretary of State for Culture Media and Sport, recently said the licence fee was safe, it is always possible that a future government could change this policy. The BBC is concerned that if it becomes an instrumental part of a pay-TV platform, this could provide a ready basis for turning the broadcaster into a subscription business.

Sky is not an ideal partner for the BBC, because of the regulatory worries and the fact that the two compete in the news channel market, with BBC News 24 directly pitted against Sky News. But it looks like Sky was all it was left with after the corporation failed to bully ITV and Channel 4 into dropping pay-TV.

And, what's in it for Sky? It is thought that it would get three channels on the BBC plan – Sky News, Sky Sports News and Sky Travel. These channels would be funded by advertising. The more eyeballs that Sky can claim, the more it can charge advertisers.

A source at a rival broadcaster said: "This would be a great shop window for Sky. It's magic for them. It's the next best thing to owning Channel 5. They can promote their brand and give households a taster of what's available on a full Sky subscription."

Sky has never been in the free-to-air game so this bid is a major and surprising departure. Aside from the promotional benefits, Sky's involvement looks very much like a spoiling tactic, aimed at protecting its core Sky Digital satellite business.

David Elstein, the former chief executive of Channel 5, said: "Sky would rather have it free-to-air. It would not be allowed to run a pay operation [on DTT]. So any pay business [on DTT] would be run by someone else and would be a potential competitor.

"This is an extreme safety option [for Sky]. It eliminates any threat from DTT."

Channel 4 clearly wants to be part of a pay-TV bid, so that its E4 and FilmFour channels are available on DTT. ITV agrees with the Government that pay television drives digital take-up. Cynics suggest that ITV is also happy to see a pay operation gobble up spare spectrum.

If ITV had gone in for a free proposition with the BBC, there would have been unused capacity that, ITV feared, would have been grabbed by the corporation for new digital channels. This would only have increased the BBC's competitive edge over ITV. The BBC, under Mr Dyke, has pursued a very commercial strategy and it would dearly love to extend its reach with new digital channels.

There are likely to be a number of other contenders submitting bids to the ITC today, including a proposition put together by the former Mirror Group chief executive, David Montgomery. But the rival BBC-Sky and ITV-Channel 4 camps are by far the strongest bidders.

The ITC may take the view that this extraordinary bickering and pursuit of narrow self-interest by the broadcasters is not what digital television needs and, some suggest, force a compromise between the two main contenders. The ITC will deliver its verdict by 4 July.