On Wednesday the Senate Committee on Commerce, Science, and Transportation will hold a hearing on the future of the video marketplace and discuss the impact of the growth of online video. Recent skirmishes involving Netflix congestion at interconnection points will likely be mentioned.
To date, Netflix, like thousands of other Internet companies, pays third parties for transit. Now it wants to get the service for free through regulated price controls and a reclassification of broadband providers as common carriers. It has even invoked net neutrality, a concept that applies to managing traffic on last-mile networks, to justify its claim. It’s interesting that Netflix would make this assertion given its own experience with the law censuring its DVD by mail business and that Netflix has received wrist slapping for failing to disclose how it manages congestion on its own network.
In 2004, a class action lawsuit was brought against Netflix for false advertising of unlimited DVDs for a flat monthly fee. It also alleged that Netflix employed “prioritization” by making popular movies available to new and infrequent users but not heavy users. Netflix settled the suit and disclosed its DVD allocation policy.
Netflix maintains that limiting the availability of DVDs to high volume users ensures the optimal experience for all subscribers in its network, characterized by high consumer satisfaction and low cancellation.
Due to Netflix’s flat rate, only users who rent a few films a month are profitable. As it costs about $1 to ship a single DVD, Netflix does not recover shipping costs, let alone break even, on the the small set of users who rent many DVDs per month.
By offering content online rather than by post, Netflix has reduced delivery costs to just a few pennies per movie. Because of America’s ubiquitous and high-speed broadband networks, Netflix has transformed itself to an online video streaming service with over 30 million customers in the U.S. alone.
Part of Netflix’s success has been to externalize the cost of its operation to other parties, first the postal system (handsorting its DVDs for free) and now broadband networks. Not only does Netflix account for 30 percent of traffic on last mile broadband networks, but it is a leading source of congestion at interconnection points between networks across the Internet. This is the reason why a number of Netflix customers recently complained of poor experience.
An independent study from the Massachusetts Institute of Technology for the time period suggests that though congestion is not widespread, it was frequently related to Netflix. It turns out that for the period in question, Netflix was negotiating a new transit agreement to eliminate third party transit and connect directly with Comcast. This is different than Netflix finding a new vendor for a printing service. The deal is designed to improve Netflix’s quality and decrease its transit costs. Comcast cannot and does not offer to prioritize Netflix in its last-mile networks.
But as soon as the agreement was settled, Netflix piggybacked on the net neutrality debate and announced that transit should be free for content providers. It argued that all traffic should be treated the same, regardless of the costs it imposes on networks. The shift to high definition video from ordinary web browsing is a fundamental shift for the Internet, and it requires significant investment to be realized. Netflix wants to ensure that someone else pays for the infrastructure it needs to realize its business, even though its traffic is the leading source of the congestion. Not wanting its own customers to be adversely impacted, Netflix calls for the socialization of upgrade costs to all the users in the network, even if they don’t subscribe to Netflix. If applied to the postal system, this would mean that those sending heavy packages would not need to pay, but everyone else would have higher postal rates regardless of whether they sent or received packages. Interestingly, Netflix is the only content provider calling for free transit. Facebook, Google, and other video providers cover their own costs to bring video to broadband networks.
With the Comcast agreement, Netflix was able to get better transit conditions, lower costs, and improved quality, as Netflix’s speed index reports. These two large parties resolved their dispute. There is no market failure here that needs remedy or utility style, monopoly era regulation. It is exactly through these type of agreements that the internet has evolved to date, efficiently, with decreasing cost, and with a minimum of government involvement. It is not justified to discard a model that works well because one company wants a preferable business condition.
Netflix is governed by competition law, which means that there has to be evidence of wrongdoing in order to prosecute. Netflix customers had complaints, and they used the courts and Federal Trade Commission for redress. This arrangement can work for broadband providers too. A level playing field where all players are governed by the same laws is in the best interest of innovation and consumers.