In the wake of news that Netflix added 7.7 million subscribers in 2010 and the fact that Netflix is counting on shifting their DVD mailer business to a video on demand broadband streaming model that is 20 times cheaper than postage, it is baffling that Netflix has decided kill the broadband golden goose that saves them hundreds of millions of dollars a year.  Netflix CEO Reed Hastings has taken the side its Content Deliver Network (CDN) partner Level 3 Communications in its peering dispute against Comcast (see video explanation).  Hastings told Gigaom that ISPs were overcharging content providers like Netflix and consumers alike, but his analysis is flawed, hypocritical, and short sighted.  Hastings stated:

“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.”

Hastings misleading us on the division of labor

Reed Hastings’ analysis is grossly flawed because it does not accurately estimate the division of labor between broadband provider and the content provider.  When Hastings says that the content provider delivers the long distance bits to the regional exchanges and that the broadband provider only has to carry the remaining “last mile”, it’s wrong on two fronts.  First , delivering to 10 regional exchanges to Comcast means that the remaining distance is more like 100 miles.  More importantly, Hastings leaves out the fact that he’s not just handing the single copy of the video he delivered to the regional exchanges, but handing thousands of replicas to the broadband provider.  As I explained last month in a more detailed analysis on the division of labor:

“Imagine the cost of shipping 10 DVDs to ten distribution centers in North America.  Even though that costs a lot per shipment, it’s only 10 shipments.  But once the DVDs reach the distribution center, 1000 copies are made and each copy has to be delivered to nearby cities and towns.  The cost of delivering each copy regionally is less, but there are 1000 times more deliveries.”

Hastings is paying for the 10 long distance Internet deliveries of master copies to the regional exchanges (distribution centers), but he’s asking the broadband provider to deliver 10,000 copies over their broadband infrastructure.  That broadband infrastructure costs broadband providers like AT&T and Verizon billions of dollars in capital expenditures a year to upgrade and each of those broadband providers employ nearly 300,000 employees to keep their networks operational.  Netflix based on their last estimate pays $700 million to the US Postal service while they paid $35 million to deliver the same content to their customers over broadband networks, and Netflix also plans on spending $1.2 billion on content streaming licenses in 2011.  Yet despite the massive deal they’re getting on broadband delivered streaming, they’ve decided that they want the media and the government to pressure and force the ISPs to offer free delivery in place of what little they pay now.  Netflix is asking for thousands of Gigabits per second (Gbps) per month of free bandwidth from broadband providers while consumers have to pay for their few Mbps of service while subsidizing Netflix’s bandwidth costs.

Hastings also seems to be confusing his bits or byte talking points or he’s trying to mislead us when he says:

“Moreover, at $1 per gigabyte over wired networks, it would be grossly overpriced.”

There’s no way broadband providers charge $1 per gigabyte for paid peering.  Paid peering is always cheaper than generic Internet transit service and at the quantities that Netflix buys, it is probably around $1 per Mbps/month which works out to $1 per 324 GB.  Each of Netflix’s movies is a little over 1 GB so it means that $1 will deliver ~300 movies over broadband and even the heaviest user will have a hard time reaching 300 movies a month on Netflix.  By contrast, Netflix spends $1 on postage per DVD mailed.

Hypocrisy on broadband usage caps

Netflix is firmly siding with their CDN partner by insisting that broadband providers must not charge Netflix or its CDN partners.  But when Level 3 complained to the FCC that they shouldn’t have to pay Comcast for 200+ Gbps of private peering capacity, they argued that broadband providers should just lower their consumer broadband usage caps or charge more for broadband usage to cover the increasing infrastructure costs associated with Netflix streaming.  In their press release, Level 3 argued:

“Comcast can either lower the cap or charge more for higher usage as many other broadband access providers have already done”

So on the one hand they’re telling the media and the government that consumers should bear the costs of higher broadband infrastructure costs associated with Netflix video on demand, but Reed Hastings is trying to make Netflix look like the good guy by arguing against usage caps.  He tells Gigaom:

“An independent negative issue for Netflix and other Internet video providers would be a move by wired ISPs to shift consumers to pay-per-gigabyte models instead of the current unlimited-up-to-a-large-cap approach. We hope this doesn’t happen, and will do what we can to promote the unlimited-up-to-a- large-cap model.“

Promote large caps?  But Netflix’s CDN partners are lobbying for the exact opposite.  Netflix and their partners are talking from both sides of their mouth to mask the fact that they’re the ones asking the government to force broadband consumers to subsidize all of their bandwidth costs with higher monthly service fees.

Shameless lobbying from Netflix and Level 3

Reed Hastings has decided that broadband providers should not charge Netflix the commercial peering rates they’ve always charged and they want peering prices set to zero.  There’s nothing wrong with a desire for lower prices from suppliers and negotiating rates, but Netflix and their CDN partners want’s the government (the FCC in particular) to declare this peering negotiation as a Net Neutrality violation and force broadband providers to give away thousands of Gbps of broadband capacity for free.  They want the government to force all broadband consumers, whether they use Netflix or not, to subsidize Netflix and it is utterly shameful.

I guess it’s good money if you can get it, but this is a horrible deal for the Internet and consumers.  The Internet has always been comprised of private commercial agreements around private property networks, and content providers have always paid for their usage of someone else’s network just like the consumers.  If Netflix gets their way, it will force consumers to subsidize content distributors who already have billions of dollars in revenue.  If Netflix and Level 3 are successful, they will bring about the “dead hand of regulation” to the Internet which will reward companies with the best lawyers, the best lobbying, and the highest political donations at the expense of the free market innovation that has given us the dynamic growth of the Internet.

Killing the broadband golden goose

Ultimately, Netflix will likely harm themselves in the process of harming consumers if they successfully lobby for a consumer subsidy of their bandwidth costs.  If the government outlaws broadband providers like Comcast from charging for private peering bandwidth, which is what Net Neutrality extremists have been lobbying for and almost got from the FCC and we know that consumers aren’t willing to pay more, where is the broadband provider’s incentive to provide another thousand Gbps of private exclusive peering capacity?  Comcast was already giving Level 3 CDN 200 Gbps of free peering capacity and wanted money for an additional 200+ Gbps of peering capacity.  If it’s illegal to charge for peering bandwidth, can the Government step in and demand that Comcast install an additional 200 Gbps of peering capacity for Level 3 and Netflix at no charge and simply absorb the costs?  The FCC can try to outlaw charges on existing peering connections (and get sued), but I can’t see how they can force a broadband providers to install additional free capacity.

This is a classic example of greed killing the goose that laid the golden egg.  Netflix stands to save hundreds of millions of dollars in postage charges with a successful transition to a video on demand over broadband.  Netflix currently pays broadband providers directly or indirectly via CDN for bandwidth yet it still costs them 20 times less than DVD postage.  In their greed to force that cost to zero, they might just get what they’re wishing for and the extra capacity they were counting on will never materialize.  They might lobby their way to a thousand Gbps of subsidized capacity, but good luck asking for another thousand Gbps and they’ll need it sooner than later.

Given the economic realities, Broadband is a shared network designed to be used concurrently by a very small percentage of its subscribers.  When we put a persistent high bandwidth video on demand load on that network, the network will simply fail to deliver all the traffic and Netflix streaming bitrates and quality will decline noticeably unless more capacity is installed.  That won’t happen without a lot of capital and it won’t come from price sensitive broadband consumers who won’t pay much more than they’re paying today.  The content providers have always paid their usage of the network and if they think a government ban on paid peering is going to help them, it might help them in the short term but they’ll come to regret it soon enough.

I might even see some rationale behind Level 3′s financial desperation after they underbid on Netflix video delivery thinking that they can avoid paying Comcast for peering capacity, but Netflix is a booming company with fast rising revenues and a rapidly declining online delivery cost structure.  Why Netflix would even humor this shameless lobbying game and endanger the viability of broadband delivery is beyond comprehension.

[Cross-posted at Digital Society]