Media battleground: Murdoch v Branson

For fight fans, the battle between Rupert Murdoch's BSkyB and Sir Richard Branson's Virgin Media has been a classic - as childish as when the big beasts of old Fleet Street traded insults via the columns of their papers. "It seems absurd that we should witness two media tycoons engage in such a hard-nosed standoff at the expense of the customer, who has been trapped in the middle," says Steven Jukes, head of the Media School at Bournemouth University.

When upstart cable king Sir Richard demanded a better deal from James Murdoch, Rupert's second son, for subscribers to his Virgin Media network, analysts assumed the argument was about price. Last month Sky negotiated a cut in what it pays to transmit the Virgin-owned Flextech channels. Virgin seemed to want tit for tat.

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But in the early hours of Thursday morning, after Sky One, Sky Two, Sky Sports News and Sky News disappeared from the screens of 3.35 million Virgin subscribers, it became plain the issue was more fundamental .

The inability of Virgin subscribers to watch shows including Lost, 24, The Simpsons and Battlestar Galactica is not cost-neutral for Sky. The advertising rates for commercials on its channels were agreed on the basis that Sky's basic package would be available to Virgin subscribers as well as Sky's own 8.4 million viewers. One media analyst warns: "If this dispute is not resolved, BSkyB can expect agencies to cut spend in line with the reduced audience for its programmes." A Sky spokesman admits: "The absence of Sky's basic channels from Virgin will cost us £15m to £20m this year."

In the short term it would make sense for Sky to accept the appointment of an arbitrator to decide how much Virgin should pay it for content - as Virgin chief executive Steve Burch suggested in a telephone conversation with James Murdoch last week. But Mr Murdoch may be playing a longer game. "This is more than a battle about a few popular programmes," says Steven Jukes. "It is a battle for control of the multi- media home of the future, with the all-embracing concept of integrated television, radio, broadband and telephony."

"At one level this is a tactical battle over price," says Virgin's chief commercial officer, Ernie Cormier. "But at a deeper level it is a strategic war."

Analysts believe the market for subscription digital services is approaching saturation. Many households seem happy to settle for the one-off cost and limited choice on Freeserve, the BBC and ITV-backed digital terrestrial network, which is already in 3.9 million homes. Households that cannot receive its signal are waiting for the launch of its satellite companion Freesat, which was approved in principle last week by the BBC Trust.

BBC research offers a reason. "There are a significant number of hard-core digital refuseniks," says a source. "They are people who, unfairly, associate paid-for services with pornography and shopping, consider Sky trashy and do not want it in their homes. They fear that if they buy even a basic package, they will be persistently pestered to buy more." Mr Cormier says such prejudice hurts Virgin as well: "There is a base of viewers who are resistant to multi-channel television."

Recent performance reinforces that view. When James Murdoch was appointed chief executive of BSkyB in 2004, he vowed to drive subscriber growth. In 2005-06 the group did well, but the latest figures are less good. Between October and December 2006, the key Christmas season, Sky's overall net customer growth was below analysts' predictions at 183,000. And the churn rate - the proportion of people cancelling subscriptions - was up from 11.8 to 11.9 per cent. Virgin Media lost 37,000 customers in the same period.

The Sky spokesman denies this is evidence of market saturation. "In the last quarter of 2006, Sky recorded its highest sale to new customers in six years [omitting churn]. We are on track for 10 million customers in 2010. This is not a zero-sum game between Virgin and Sky. [Subscriber] digital take-up in the UK is not yet 50 per cent; we believe it can grow to 70 or 80 per cent as it has in the United States. This is a very dynamic market."

Perhaps, but with millions of potential customers unwilling to pay for digital television, it is certainly not ultra-dynamic. Future growth for Sky, Virgin and new competitors - including BT - will clearly involve persuading existing customers to switch service. After all, to sell multimedia add-ons, a provider needs subscribers.

Sky claims some success: it sold a total of one million add-ons - including broadband internet, multi-room television, telephone services and high-definition TV - in the last quarter of 2006. But these were predominantly sales to existing subscribers. Further growth means winning new ones, and the easiest way is to poach from rivals. Hence the war with Virgin.

"Cable is already blighted by its reputation for technical unreliability," says a source responsible for promoting the Government's policy of digital conversion. "By showing that Virgin is no better than its predecessor [the old NTL network], Sky will take customers that Richard Branson can never get back."

On Friday, Sky confirmed its appetite by launching a poster campaign urging its rival's customers to buy a Sky "rescue package", which lets Virgin subscribers switch. One poster declares, "Get Jack Back" - a reference to Kiefer Sutherland's 24 character, Jack Bauer. Another says, "Don't Lose Lost".

Virgin's response is to portray Sky as a bully in the hope that regulators will rein it in. Mr Cormier says: "When the Government switches off the analogue signal in 2012, Sky would like everyone to think that it is the only quality provider of digital television. But what effect would that have on choice? Sky could charge what it likes. With Virgin Media coming together, there is now a branded competitor to Sky. This will be painful for us in the short term, but in the long term we are confident."

Virgin Media claims overseas experience - particularly in the American market - indicates that its cable services can compete with BSkyB. Since rebranding the old NTL network in February, it has certainly found the confidence to risk confrontation.

Sky's reaction suggests it sees Sir Richard's business as a genuine threat. In five years' time, when the Government kills analogue television, every British home will need digital simply to continue watching. Sky and Virgin want those customers to buy their multimedia services, but with plausible free competition from Freeview and Freesat, they know they must fight hard to get them. The danger is obvious: selling digital multimedia subscriptions means persuading consumers that providers are reliable - the battle between Virgin and Sky does not help.

Depriving customers of shows they have paid to receive is an appalling way to generate confidence among existing digital subscribers. At the same time, it reinforces the prejudices of people who regard pay-to-view as wrong in principle. The signs are that Virgin and Sky are beginning to realise it.

On Friday, Sir Richard ordered the removal of the "Sky Snooze" on-screen jibe about the disappearance of Sky News from Virgin Media screens. Meanwhile, the Sky spokesman says: "We have sought at every stage to keep our channels on Virgin. We did not want this outcome."

Both sides need to grow up. Without compromise, the reputation of subscriber digital services will suffer permanent damage.

MEDIA DIARY

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