Netflix's double-standard
The video streaming company wants new rules to protect its own interests.

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Article Highlights

  • Netflix prioritized DVD traffic to certain customers but now says ISPs shouldn't be allowed to

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  • There is no market failure in the Netflix-Comcast deal that needs remedy

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  • It is in the best interest of innovation and consumers that everywhere be governed by the same laws

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Recent skirmishes involving Netflix over interconnection congestion have brought calls for broadband providers to be regulated like utilities with price controls. To date, Netflix has paid third parties for transit.  Now it wants the service to be regulated to be free for content providers.  It’s interesting that Netflix would make this assertion given its own experience with the law when managing congestion in its DVD by mail business.

In 2004 a class action lawsuit was brought against Netflix on behalf of 6 million customers for “falsely and misleadingly" promising “unlimited DVD rentals for a flat-monthly fee ... via one-day delivery.” The case, Chavez v. Netflix alleged that Netflix breached its contract with customers, committed fraud, and engaged in false advertising. It also alleged that Netflix used a sophisticated algorithm to “prioritize” popular movies to new and infrequent users. Netflix settled the suit and disclosed its prioritization policy on its website.

Netflix has 6-7 million DVD by mail customers, and prioritization (smoothing as Netflix calls it) is used to manage higher costs incurred by high volume renters. Under Netflix’s flat monthly rate ($17.99 at the time), only those who rent only a few films a month are profitable. As it can cost up to $1 for shipping a single DVD, Netflix does not recover shipping costs, let alone break even, on the the small set of users who rent many films per month.  Thus limiting the availability of movies helps Netflix manage its operational costs and increase profitability. 

Netflix defended the practice, saying that its overall consumer satisfaction is high while account cancellation is low. Indeed, Netflix does not practice prioritization out of spite for certain users but to optimize the experience for all the subscribers in its network.  In any case high volume customers still get value for money with Netflix’s offer, even if they don’t get every film they want.

Netflix was also the subject of a case brought by video game provider GameFly which complained that the US Postal Service gave Netflix, its largest DVD by mail customer, priority treatment by hand sorting its DVDs for free. GameFly’s parcels, consigned to the automated stream, were frequently damaged, costing the company millions of dollars in lost merchandise and workarounds. A commission appointed by the court concluded that the postal service must eliminate the undue discrimination.

Because of America’s ubiquitous and high-speed broadband networks, Netflix has been able to transform itself from a DVD by mail business into a full-fledged streaming video on demand service with over 30 million customers in the U.S. alone. By putting films online, it has reduced its delivery costs to just a few pennies per movie.

Part of Netflix’s success relies on externalizing costs to other parties, first the Postal Service, now broadband providers. Not only does Netflix account for 30% of traffic on last mile broadband networks, but it is a leading source of congestion at interconnection points between networks.  This is the reason why a number of Netflix subscribers 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.  As it turns out, Netflix was in the midst of negotiating a new transit agreement to eliminate third party transit and connect directly with Comcast. 

The exchange of traffic between networks is a different market from end user broadband access. With an efficient series of norms and agreements, parties exchange traffic for free, as long as the amounts are roughly the same. When the amounts are out of balance, the party with the greater traffic pays a fee to offset the costs. In addition third parties offer content delivery services and transit for a fee, enabling content providers to reach broadband networks.  Dan Rayburn, a leading industry analyst, notes that the agreement with Comcast was 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 Netflix concluded its agreement with Comcast, it announced that a regulatory price control should be imposed, mandating that transit be free for content providers.  It’s not clear what this would mean for the dozens if not hundreds of transit companies engaged in this business today, but if transit was price-controlled at zero, then these companies would likely go out of business.

Netflix justifies its assertion under net neutrality, the notion that all traffic should be treated equally regardless of the costs it imposes on networks. Essentially, Netflix wants broadband providers to eat the cost of network upgrades, even though its traffic is a leading source of the congestion. To be sure, Netflix does not want its customers, a minority of subscribers on any broadband network, to be singled out for higher broadband fees. Netflix wants the upgrade costs to be spread across all the users in the network, even if they don’t subscribe to Netflix.

The postal service has a variety of business models, where either the sender or receiver pays. However it ensures that when packages exceed certain limits, whether in weight, distance, or time, there is a surcharge.  That Netflix says all packets are equal is just opportunism to win favorable conditions. Applying what Netflix wants to the postal system would mean 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.

Funny enough, only Netflix is calling for free transit.  Google, Facebook and video providers such as Hulu and Vimeo, invest in their own transit arrangements and content delivery solutions.  Amazon even charges publishers a fee to deliver ebooks.  Different companies find the business models that make sense for their needs and customers.  Government price controls and regulation would upset this valuable exchange.

With the Comcast agreement, Netflix was able to get better transit conditions, lower costs, and improved quality for its customers, as its own speed index reports. These two large parties resolved their dispute. There is no market failure here that needs remedy.

It is disturbing that Netflix, a profitable, growing company, should direct its energies into lobbying for preferential treatment and price controls. That Netflix should get to prioritize and broadband providers don’t is itself a form of discrimination.  An Internet heavyweight in its own right, Netflix is effectively governed by competition law, and parties invoke the courts and the Federal Trade Commission when necessary.  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.

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