Asymmetric warfare

Streaming Video In their letter to shareholders included with their Q4 earnings announcement, Netflix CEO Reed Hastings and (new) CFO David Wells confirm something I noted back in December: The FCC’s recent net neutrality ruling did not offer as much protection to Netflix and other online video distributors as it may have appeared.

While the new rules will bar last-mile ISPs from blocking or degrading OVD-generated traffic, that’s not really an issue for a company like Netflix, with its more than 20 million subscribers. As Hastings noted in his unusual public debate with hedge-fund manager and Netflix short, Whitney Tilson, last month, it’s as likely that Netflix would be able to charge ISPs for the right to deliver its highly prized video service as the other way around.

The real network danger facing Netflix lies in the increasingly volatile world of peering agreements among network operators. The scope of the danger became apparent back in November, when a dispute arose between CDN Level 3 Communications and ISP Comcast over asymmetric traffic flows soon after Level 3 landed a big chunk of Netflix’s streaming business. Such disputes, largely out of view of consumers and regulators are only going to grow more common as the amount of video traffic passing between different parts of the Internet surges, disrupting long-standing settlement-free peering arrangements that were based on an assumption of roughly equal levels of traffic back and forth between networks.

The new FCC rules, while protecting broadband customers of Comcast from potential anti-competitive behavior toward Netflix, do nothing to protect Netflix and its CDNs from potential service disruptions and monopoly transit pricing by Comcast and other last-mile ISPs.

As Hastings and Wells put it:

Recently the FCC adopted a version of net neutrality for wired networks in the U.S., and it’s a step in the right direction. The focus is on fair-play within an ISP’s network, but does not explicitly address entry into the ISP’s network.

Delivering Internet video in scale creates costs for both Netflix and for ISPs. We think the cost sharing between Internet video suppliers and ISPs should be that we have to haul the bits to the various regional front-doors that the ISPs operate, and that they then carry the bits the last mile to the consumer who has requested them, with each side paying its own costs. This open, regional, no charges, interchange model is something for which we are advocating. Today, some ISPs charge us, or our CDN partners, to let in the bits their customers have requested from us, and we think this is inappropriate. As long as we pay for getting the bits to the regional interchanges of the ISP’s choosing, we don’t think they should be able to use their exclusive control of their residential customers to force us to pay them to let in the data their customers’ desire. Their customers already pay them to deliver the bits on their network, and requiring us to pay even though we deliver the bits to their network is an inappropriate reflection of their last mile exclusive control of their residential customers. Conversely, this open, regional, no-charges model should disallow content providers like Netflix and ESPN3 from shutting off certain ISPs unless those ISPs pay the content provider. Hopefully, we can get broad voluntary agreement on this open, regional, no-charges, interchange model. Some ISPs already operate by this open, regional, no-charges, interchange model, but without any commitment to maintain it going forward.

Clearly — and correctly — Netflix sees potential for trouble ahead.