With net neutrality dead, will Netflix go cable?

With the FCC “driving a stake” through net neutrality, it’s no longer a question of HBO going online-only but rather the opposite.

President Barack Obama and FCC head Tom Wheeler in happier times.

President Barack Obama and FCC head Tom Wheeler in happier times.

Everyone keeps waiting for HBO to “pull a Netflix,” where the channel would decouple itself from traditional television service providers and go online only. Given the nonsense that’s going on with net neutrality and regulators in the United States, at this point it’s more likely the reverse will happen. It wouldn’t be surprising to see Netflix give up on online and “pull an HBO,” whereby it becomes just another channel in an overpriced monthly TV package.

On Wednesday, news broke that the Federal Communications Commission is planning to introduce “pay-to-play” rulesĀ for internet companies, whereby cable and phone companies will be allowed to charge them extra for better connectivity. This would essentially enshrine the recent controversial Netflix-Comcast deal within actual rules. It was controversial because Comcast degraded Netflix’s quality to the point where the streaming company was forced to pony up. Comcast and other big ISPs have long complained about such services supposedly getting a “free ride” on their networks.

The news set the internet alight, with various voices proclaiming that FCC head Tom Wheeler – a former cable industry lobbyist who was recently appointed to the job by President Barack Obama – had just driven a stake through the heart of net neutrality. It is, of course, that ephemeral principle that all internet traffic should be treated more or less equally so that the guy sitting in his basement with an idea for a startup has the same chance at succeeding as a giant company like Netflix or Google does.

Netflix itself made news just the other day by announcing price hikes of $1 or $2 thanks to its increasing costs, such as the Comcast blackmail job. If the FCC goes ahead with its proposed rules, every major ISP in the U.S. will be lining up with its figurative cap in hand. Moreover, ISPs in other countries will certainly jump on the opportunity too. Here in Canada, we have net neutrality laws that theoretically prevent such things, but our big network owners – all of whom resent Netflix just as much as Comcast – will waste no time in trying to re-open that discussion, or to circumvent the rules as well.

All told, that means the increasing costs Netflix has been seeing on the network side of its business might be chicken scratch compared to what’s coming. And who’s going to shoulder those inevitable extra costs? Yup: subscribers.

Consumers are already getting a pretty raw deal by paying three times to get a service like Netflix: once for an internet subscription, twice for the service itself and a third time for their monthly usage. Extra fast-lane privileges like the FCC is proposing will effectively add a fourth layer of cost onto that.

At what point does this stop becoming worth it for the consumer, or perhaps more pointedly, for Netflix? HBO generally gets to keep about half of the $16 that cable providers charge consumers for the channel, according to the Wall Street Journal, which means it earns the same revenue – $8 per subscriber – as Netflix currently does. However, cable companies handle all of HBO’s billing, which takes one cost away from the channel that Netflix still has to shoulder.

HBO also has none of the network costs or (growing) headaches that the streaming company does, all of which contributes to it being immensely more profitable. HBO is a much more mature business, but still, it pulled in $1.8 billion in operating profit in 2013, compared to just $228 million for Netflix despite both companies having roughly the same revenue of $4-billion or so. How long do Netflix investors or management have the stomach for such under-performance, and for the prospect of never-ending nickel-and-diming by ISPs?

The first casualty in the death of net neutrality may in fact be Netflix, or at least the online version of it that most of its subscribers have come to love. The company is quickly learning that when regulators are not interested in doing their jobs to protect the interests of the people and therefore innovative new efforts, there’s only one option left: if you can’t beat ’em, join ’em.

And if (or when) that does happen, will it even make sense to call the company – or channel – Netflix anymore?

UPDATE (APR. 29): In the week since I wrote this post, Netflix has signed a similar interconnection deal with Verizon and announced that it will be included on the cable boxes of three smaller U.S. TV providers, effectively as another “channel.” Yup. It isn’t surprising that it’s happening, but rather how fast it’s happening.

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7 Comments on With net neutrality dead, will Netflix go cable?

  1. Given the value of NetFlix is the on-demand aspect, and not the original content (as good as it may be), I think this is a matter of being online or going under — not becoming a “channel” on cable.

    If I get “NetFlix Original” content I’m still interested in on DVD like I do HBO, they will still get far less money from me than they do now. As to the cable companies, I won’t go back considering they are the source of the problem. Sometimes it is just not worth paying protection money. Sad that the Competition Bureau isn’t being enabled by this anti-consumer Harper Government to deal with this problem.

    Note: I say anti-consumer given, despite their misdirections claiming they are consumer friendly, their actual legislation tends to be more like the recent rewrite of historical consumer protection law like Trademarks http://www.michaelgeist.ca/content/view/7112/135/ to become anti-consumer.

  2. Good article Peter. But net neutrality is not “ephemeral” but grounded in law (at least in Canada) in common carriage duties as expressed in the Telecom Act. Any aspersions cast on that law weakens net neutrality in Canada and opens the door to this stuff in Canada.

  3. Peter, by generalizing you are missing critical issues. First, Netflix has optimized the video delivery model, such that it’s costs for storage and delivery (AWS and CDN/transport) is 4-5 cents per 1 hour or gig of video consumed. That’s because WAN costs per minute of voice today is $0.0000004 (extrapolated from nearly 2 year old OECD data).

    The duopoly MAN on the other hand is priced at $0.001. That’s 4 decimals and another 75% in cost differential. My estimate is that Google’s price over its fiber network approaches $0.000001; so much closer to competitive WAN pricing and reflecting the fact that costs decline at a linear, not geometric rate at the edge.

    What everyone is missing is that Net Neutrality was a convenient fiction invented by Lessig, Wu and the internet monopolies to reinvent history and say that the lower layers had nothing to do with the upper layers of the stack. Note that Wu has now official backtracked and wants some form of Title II applied in that info services really ARE 2-way.

    IP, without price signals, was able to “ride into town” in the 1990s because WAN costs and router costs were become so cheap due to scaling of both the data and voice stacks. On top of that the Baby Bells resorted to expanded flat rate local pricing which afforded the dial-up ISPs to come out with flat-rate pricing by the mid 1990s. That’s really where the concept of “free” was developed. But it was supported by the end-to-end (insecure, unmetered) TCP/IP networks, and the autonomous use principle (AUP). All 3 led to the perception of a free and open internet.

    The moment TA96 propagated the myth that info service was different from voice we started rebuilding the walls and reversing course. Only the digital, horizontal forces had already been unleashed and scaled to the above numbers. So this is really a fight in layer 2 about where the WAN/MAN demarc is, since the edge access providers cannot extend their layer 1-2 edge monopolies up through layers 3-4 (the TCP/IP stack; except in wireless, although iOS and Android mitigated that to a large extent).

    Hastings was correct several weeks ago to say that open internet (NN) and interconnect are inherently related. If people visualized the world through the InfoStack framework they would better understand the evolutions and relationships that brought us here. Furthermore, they wouldn’t be arguing over NN and Netflix/Comcast, rather they would be saying, how do we realize a 4K, 2wayHD telepresence, inexpensive mobile BB and IoT if we move the peering points to the core and reverse the process of the cloud moving to the edge? Clearly the latter 3 drivers all require significantly greater upstream capacity, lower latency, higher QoS, and, lastly, balanced settlements.

    • Could you try that again in plain English? Try to avoid words like “stack” and “layer.” ; )

      • Peter, networks are made up of 3 primary layers: transport/access (lower), control (middle) and application (upper) layers. Think of them as vertically integrated or vertically complete stacks. The old (incumbent) access providers continue to think along the lines of integration and therefore spend more on capex and opex. The new (data/internet/content) entrants develop vertically complete solutions across horizontally scaled platforms and exchanges. If you’re going to comment on TMT/ICT companies you’ve got to understand how this vertical vs horizontal structuring.

        Open access and interconnect can occur at any layer or boundary point. But monopoly bottlenecks can form as well; and then spread to other boundary points. Whenever we have open/fluid boundaries we find generative and low cost markets (we’ve seen this in LD voice, then data, then wireless and lastly wifi in the 1980s. Pole attachments and must carry are similar examples in media). When we increase barriers prices rise and growth and generativity slows; until the arbitrage gets too big.

        These layers and boundary points vary across market segments and technologies; and of course shift over time. For instance, the cellphone collapsed the MAN/LAN interface. It was a PBX in your pocket. When we included LD minutes in the voice bundles and went to AYCE, we collapsed the WAN/MAN boundary.

        My point about Netflix and Comcast is that the arbitrage between WAN cost and MAN cost is so large that pretty soon it will be easy for the internet companies (if they could agree to join forces) would easily have the scale to rapidly bypass the incumbents in the last mile. The problem, as I said in my analysis about Google Fiber, is that disrupting the last mile might also disrupt their own silo-ed monopolies. http://bit.ly/1670oOx So they too might fall into the trap of vertical integration if they don’t appreciate the forces that made them what they are. That’s why I call net neutrality a convenient fiction.

      • First paragraph should end, “how this vertical vs horizontal structuring impacts costs and prices; especially ex ante. Neither regulators nor monopolies have been able to accomplish the latter well.”

  4. Their stated price hikes have less to do with the agreement and more an understanding that they will have to pay more for content, because Comcast and broadcasters are increasing their monopolies over video distribution on several fronts simultaneously (Aereo, owning content, sports, and public wifi).

    The Comcast deal actually lowers Netflix’ rates relative to everyone else. But in losing the locomotive that would move information and processing to the edge, the scale effects of the internet slow down dramatically for everyone else; and ultimately Netflix.

    Take the example of 10,000 Netflix subscribers in Springfield MA. Under the new regime they will be served via POPs in Boston or NYC, not Springfield. That means 3 separate transport costs on non-competitive networks vs 1 or 2x on competitive networks (Cogent, Level3, Akamai, etc…). Only Netflix has a perspective on end-user consumption and demand and can therefore trade-off storage and transport efficiently. Now imagine we move to a world of 2-way. The implication is that tromboning and hairpinning will go up dramatically and so will latency and capacity costs. Not smart, even for the incumbents. And of course the economics get worse the farther out from the core one goes, like to Hatfield MA or somewhere in the Berkshires.

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