Sky and Virgin in fight to the death

The failure to reach a settlement means that Sky will be deprived of about £60m in annual carriage fees and ad revenue, while Virgin customers hooked mid-series on shows such as 24 and Lost are left teetering on cliffhangers not written into the scripts. How will the two bloodied but unbowed companies fare without the other - and why did this have to be a fight to the death?

On paper, Virgin is David to Sky's Goliath. But as one Sky insider says: "It's always convenient for Virgin to paint itself as the plucky upstart taking on the big, lumbering corporation. It should be noted that ntl:Telewest is not a small company."

Virgin's weaknesses

However, Virgin does have significant weaknesses. It is relying on video-on-demand to boost its offer, which, according to one ex-Sky executive, offers little scope for revenue growth.

"Virgin Media's strengths are video-on-demand and Virgin Central, which are probably helpful from a technical standpoint," he says. "If you look at more mature pay-TV markets, video-on-demand has never been big business. It's a nice add-on, but it doesn't replace the subscription model."

Nevertheless, as the bitterness of the row indicates, Sky has never had to face a challenge of this scale before. It is clearly rattled and is acting accordingly.

One industry insider says: "To spend a billion pounds (on its 18% stake in ITV) to stop Virgin Media getting hold of ITV is a clear sign Sky sees Virgin as a threat. It has never had to fight a strong brand."

Ernst & Young senior analyst James Healey agrees. "Sky is a little nervous and sees Virgin Media as its only real competitor," he says. "It's a competitive threat. Virgin Media is very definitely number two, but it is a threat."

Sky's range of content, particularly movies and drama, is admittedly a key draw for customers. Yet, the most compelling element of its content is sport, and this is where it is looking over its shoulder.

"The real battleground is in sport. Virgin has to bite the bullet and compete with Sky on sport," says a rival TV executive. "It will possibly look at buying Setanta and then bid through the nose on rights."

Like a petulant elder sibling, Sky is flexing its muscles - but its attitude could end up having the opposite of the desired effect. As one former Sky director points out, it is not just in its spat with Virgin that Sky is coming across as heavy-handed.

"It is only one of the very, very aggressive moves that Sky is making at the moment," he says. "James Murdoch seems to be on a very high protein diet. When you are so powerful in the marketplace and take such an aggressive stance, you reinforce the view that you have a bully-boy mentality. I think Sky has to be careful. It is taking on so many fights with so many people. Terrestrial broadcasters are starting to switch into the anti-Sky camp."

He cites Sky's recently revealed plans to pull Sky News, Sky Sports News and Sky Three off Freeview and replace them with a subscription service on the platform, which has created tension between Sky and its Freeview partners.

Crossing the line

"The danger for Sky is that there is a fine balance between playing up to the line and crossing the line," he adds. "It will start to attract a lot more regulatory attention."

That's not its only worry. Advertisers on Sky channels carried by Virgin until last week have just lost 3.3 million viewers. "We already said we'd have to CRR (Sky) on loss of impact. Going forward, it won't bode well for Sky as an adspend model," says Chris Locke, group investment director of Starcom, which has been in talks with Sky over the loss of advertisers.

Neither party has come out of this row looking good and it is highly unlikely that talks will recommence. Now they must pick themselves up, dust themselves down and each reassure their advertising clients and customers that they can survive the fallout.

SKY v VIRGIN

Sky - 8.4 million subscribers.

Offers broadband and telephone services, including The See, Speak, Surf package, which includes 350 TV channels, broadband up to 8mb and unlimited UK landline calls at £37 per month.

A more basic package includes a couple of hundred TV channels, 2mb broadband and free evening and weekend calls at £26.

Channels include Sky One, Sky Sports and Sky Movies.

It will be offering movies, entertainment shows like Lost, Sky News and 46 pay-TV live Premier League matches per season via Freeview as a pay-TV service

Virgin Media - 3.3 million subscribers.

Offers TV, landline, mobile and broadband, including more than 82 channels, from £40 per month.

Top of the range "Very Impressive Package" includes all four services plus a high definition V+ PVR box, broadband up to 10mb and unlimited UK landline calls for £125 per month.

Channels include all its Flextech channels such as Living, UKTV as well as Sky premium content - Sky Movies and Sky Sports. The latter can be viewed in a cheaper package with Virgin than with Sky.

Replaced Sky One with Virgin Central, its TV-on-demand library, on its electronic programme guide.