Netflix Ponders Life Without Net Neutrality

Netflix CEO Reed Hastings did as much as anyone to shape the Federal Communications Commission’s net neutrality rules. CEO Reed Hastings’ aggressive public lobbying for what he termed “strong” net neutrality, after Comcast and AT&T successfully forced Netflix to pay for access to their last-mile networks, was largely responsible for putting interconnection arrangements between ISPs and edge providers at the center of the debate and helped persuade former FCC chairman Tom Wheeler to push through reclassification of broadband access as a Title II telecommunications service, which gave the commission jurisdiction over those deals.

Yet, as Republicans in Congress and on the commission sharpen their knives to disembowel Wheeler’s hard-won rules Netflix says it no longer needs the protection.

“Weakening of US net neutrality laws, should that occur, is unlikely to materially affect our domestic margins or service quality because we are now popular enough with consumers to keep our relationships with ISPs stable,” Hastings said in his Q4 letter to shareholders this week.

Translation: we’re too big now even for Comcast to push around, a point Comcast itself obliquely acknowledged in November by integrating Netflix into its flagship X1 set-top box.

There could be a lot of pushing and shoving elsewhere, though, if the rules are eliminated (Hastings went on to say in his shareholder letter that Netflix still favors the rules as a matter of public policy).

For one thing, getting rid of net neutrality would remove a major hurdle to further consolidation among telecommunications operators.

It’s probably not a coincidence, for instance, that Verizon CEO Lowell McAdam was reportedly telling friends at CES this month that he’s on the hunt to acquire a cable operator, perhaps even Comcast, just as the prospect of getting rid of the rules (which Verizon had sued to block) was becoming real.

Buying a cable operator would give Verizon the scale, cash flow, and video-delivery architecture to support the build out of its planned 5G wireless network, which Verizon hopes to turn into the mobile-first video-delivery platform of the future. It would also help Verizon counter its rival AT&T, which has already made its big video player by acquiring DirecTV.

Even under a more merger-friendly regime expected by many CEOs under the Art of the Deal presidency of Donald Trump, the FCC’s asserted authority under its Open Internet Order to veto interconnection fees and zero-rating of proprietary data services could hamper that vision.

AT&T’s zero-rated DirecTV Now, in fact, was dinged last month by the FCC’s media bureau for violating the net neutrality rules’ prohibition against operators favoring their own content services over others. The bureau also said it had opened an investigation into Verizon’s existing zero-rated video service go90.

While that might have been a problem six months ago, almost no one expects the new Republican-majority commission to approve any action against the companies, a realization that is no doubt encouraging McAdam’s cable ambitions.

Although net neutrality became something of a populist cause among the tech community and among some consumer advocates, as a practical regulatory matter it was always about refereeing the eternal tug-of-war between content and delivery as it plays out on the internet.

On traditional video platforms, such as cable and satellite pay-TV, content has long held the whip hand. Content owners and broadcasters have been able to extract ever-growing carriage and retransmission fees from pay-TV operators to augment what they earn from advertising. Broadband operators, many with roots in the pay-TV business, have long dreaded the prospect of recreating traditional pay-TV economics on their new platforms, where they enjoy robust margins due in part to the lack of content costs.

Thus far, broadband operators have been able to hold the line. Much of the original impetus for AT&T and Comcast to seek nominal retransmission fees from Netflix, in fact, was simply to make a show of their leverage before content owners started getting ideas.

For their part, content owners have long coveted the fat margins operators earn from their broadband business and have tried to use what leverage they can to get a piece of that action.

Even Netflix will eventually reach a point where subscriber growth alone can no longer sustain its margin. To restore it, Netflix will either have to raise prices amid a highly and increasingly competitive environment, or look for other sources of revenue. Hastings has ruled out advertising as a solution, which could leave Netflix sorely tempted to seek revenue from network operators.

Its vocal support for net neutrality, and in particular its opposition to paying interconnection fees, was in large part an effort to preserve that option for the future.

The net neutrality rules, as implemented, put the FCC’s thumb squarely on the content providers’ side of the scales. Broadband operators, however, see the possibility of a much friendlier playing field ahead under a Republican FCC, Congress, Justice Department and White House, and they’re clearly already making plans to take advantage of it.

Netflix may be big enough now to hold its own. But with the referee off the field, the other side will have a chance to bulk up as well.