Some observations in the Comcast / Netflix debate

by Ivar Slavenburg

As you might have heard, two major US internet companies, Netflix and Comcast, have announced this weekend that they will connect their networks together. Before this deal, an other provider, Cogent Communications, connected the Netflix servers with the network of Comcast. By no longer using the other provider, Netflix expects to be able to provide better services, in their case streaming video, to their customers that have Comcast as their ISP. For them this should sounds like a great deal. For many months they have seen the quality of Netflix decreasing.

Fast degradation of service

A quick look at the figures published by Netflix show a degradation of bandwidth of roughly 72% in the last 5 months. This means their customers could hardly still use the service if they had Comcast as their ISP. Directly after the agreement was announced on Sunday, measurements of the bandwidth between Comcast and Netflix were showing it was getting better. So fingers crossed for the many customers on the Comcast network that this deal is indeed improving the quality of the service much.

Netflix streaming performance on the Comcast network

Netflix streaming performance on the Comcast network (Source: Netflx)

Bad for competition?

So, sounds like a good deal for Netflix customers on the Comcast Network, right? Well, less enthusiastic about the deal are a lot off journalists and bloggers (many of which are Comcast customers). In their view, the deal will be the beginning of the end of a „free” internet. ISP’s will start charging all kinds of fees to big companies to make sure they get a good connection, leaving the smaller content provider with limited resources to work with. If that is the case, competition is getting diminished.

Funny enough, this explanation is causing outrage of other journalists, claiming that people who believed this explanation simply don’t understand how the internet works. The internet is and has always been a series of networks connected together. How Netflix is connected to Comcast is not really a serious issue, therefore.

Even established economists like Tyler Cowen start to get involved, indicating the importance of the debate. He suggests that the cooperation between the two companies can end up to be good for customers, e.g. if it means that interconnection costs are split by the two companies that want to interconnect with each other. „To put this more concretely, the two parties will deal so that the marginal cost of the input to the monopolist is lowered, the monopolist expands output (and profit), and those gains are shared between the two institutions with market power”. That argument isn’t valid though, as interconnection costs are already split, each party taking its own costs. These kind of deals are no change therefore.

ISP’s are have ruined their brand years ago

Anyway, nothing to worry about then. Comcast customers are getting a better Netflix service, maybe resulting in more customers for Netflix. This might be a reason for other people that want to use Netflix to go to Comcast as well, so they will get more subscribers too. And interconnection costs might be going down a little. Everybody wins! Unfortunately, a company like Comcast, or in fact, most ISP’s are among the most hated and distrusted companies in the world. This is the result of years of advertising with bandwidths that are never reached, regular price increases and pushing al kinds of package deals with services customers don’t want. This is often combined with network instabilities, all kinds of flawed hardware and software on outdated Set Top Boxes that are need to be connected to your TV before you can even access anything and are terrible to use. Finally, if you want some service this is hidden behind expensive telephone numbers, it takes ages to get someone on the phone, let alone you get to speak to someone who is either capable, willing or even allowed to solve your problem.

So it’s not so strange that as soon as it becomes clear that Netflix is paying Comcast for this connection critical bloggers and journalists start to question the good intentions of Comcast. When another large ISP, Verizon, indicates it also want to get paid by Netflix, nobody can seriously believe anymore that this deal is just about delivering a better service to customers or even about cutting costs. It is not about the way the internet has always been managed either. It’s about making more money, lots of money.

Most ISP’s are no pure network providers

Where articles, like those of e.g. Dan Rayburn, are completely missing the point is that, though companies like Comcast are operating a network, and thus can be categorized as a Network Operator, their main business is selling content packages. They are a content aggregator and sometimes even a content operator. You know, those people that have told everybody for years that „content is king”. Without this content, their network hasn’t got any value. With the demise of analog linear video, their golden egg, they invested billions in new content services. They even want to move upward in the value chain, to make sure good quality content is available on their networks always, so services like Video on Demand and all kinds of others are developed. Just watch their homepage, nothing about their network, everything is about content, services and, yes, internet access. I think that Comcast is considering it an insult if you describe them as „just a network operator”.

So how are all these billions financed? Almost all major ISP’s are public companies, financed with other peoples money. To get that money, they have made bold financial statements to their shareholders, primarily based on the premiss that they have a critical advantage over any other company in the digital services business: they have already a paying relationship with their customers. Surely, for some services this seem to be true. E.g. many customers from incumbent telephony companies have come to the ISP’s and buy internet and telephony services from them.

Unfortunately, more and more it becomes clear that this win in telephony is a bit of marketing trickery, as most internet connections are sold with telephony combined and customers don’t care much about the latter (and thus hardly use it). However, these companies think they also can sell TV services. They have invested billions in hardware and software to deliver these services. The idea is to put a Set Top Box in every home to create a deeper relationship with the customer and sell premium content packages and video on demand to them. The average consumer will thus start to spend much more money than they do today. The way this hardware is „sold” is the same way as with telephony, it is sold with the one thing the customer really wants, internet connectivity.

Then along come companies like Netflix, Apple and Google all with a completely different business models and ever since the beautiful plans of the ISP’s are in trouble. Traditional television take up is decreasing rapidly and the great new TV services are not compensating for that loss, both not in revenues as in customer numbers. These revenues are more and more flowing away to the new guys and girls on the block. Not to mention the desire of many content owners to cut out the middle man (aka the ISP’s) to start delivering straight to their customers (e.g. Disney, Warner). The biggest nightmare of all ISP’s, that they become a dumb pipe, just delivering some connectivity and billing services, is starting to become a reality. Yes, content is still king, but the ISP’s have no control over it anymore.

So lets get one thing very clear: Comcast isn’t just an ISP providing a connection to the Netflix service in whatever way, it is a direct competitor of it as well. They are not a neutral party, and thus have every interest (and obligation to their shareholders!) to test the limits of customer experience, the law and regulation to keep these competitors away from „their” customers.

In the coming days I’ll try to publish more observations, including some updates on the above. In the mean time don’t hesitate to comment on this article or write one of your own (or together if you want). It’s a very interesting development that potentially has impact for everybody. So if you have anything to add, do so. I leave you for now with this highly entertaining video of real customers talking about the deal and their concerns. Take notice, ISP’s!

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Why such an industry froth about this type of payment? Why is it such a radical concept to everyone in this industry? Why in fact is it significantly different in character from the toll extracted by a cable operator for carriage of any content aggregators channel(s) today? When I pay Comcast for access to HBO, part of that fee is routed back to HBO, but part stays with Comcast for access to their subscriber base. The carriage fee principle is in place no matter who actually dings my credit card. And I’m sure under these terms Comcast is happy to deliver every OTT players content - alongside its own - just like it does today in a concept called pay-TV.

How long do you think it will take everyone to figure out that Comcast can do the same type of proxy charging for Netflix and offer a TV Everywhere type authentication back to them? In fact, is this one of the potential end games of the whole fundamentally unstable TV Everywhere model?