Comcast/Netflix: Unwinding the Latest Traffic Jam, but at What Cost?

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Depending on whom you ask, Comcast’s deal with Netflix to provide improved speeds for streaming by the latter’s subscribers is either a bargaining chip in the cable giant’s bid to merge with Time Warner Cable, or simply a fix for an issue that has long been a source of complaints from subscribers to both services.

The two companies announced Sunday that Netflix will pay Comcast an undisclosed amount to have the cable provider ensure that subscribers can stream its movies and television shows more quickly. The agreement comes on the heels of a January federal appeals court ruling saying that the Federal Communications Commission does not have the authority to prevent companies like Netflix from paying Internet service providers to prioritize its content. Comcast said in its statement announcing the deal that Netflix receives no preferential network treatment under the multi-year agreement.

Meanwhile, Comcast is expected to face significant federal scrutiny of a deal announced 10 days earlier to buy Time Warner Cable for $45 billion. The deal would create a cable and Internet behemoth that would provide television services for nearly one-third of American households and Internet for about 40% of homes.

Some consumer advocates worry that the Netflix deal may force the company to increase its subscriber rates and trigger a wider trend among similar services. Critics also note that if Comcast expands via the merger with Time Warner, it could exert unfair leverage over smaller video providers that may not have Netflix’s deep pockets.

Gerald R. Faulhaber, a Wharton emeritus professor of business economics and public policy, Lawrence G. Hrebiniak, a Wharton emeritus professor of management, and Kevin Werbach, Wharton professor of legal studies and business ethics, hold divergent views on the strategy behind the Netflix deal and how it would impact both customers and competing streaming video providers.

While Hrebiniak suggests that the Netflix deal is Comcast’s way of showing federal regulators that it “plays fair” and that the Time Warner merger does not warrant extra oversight or antitrust action, Faulhaber says the Netflix-Comcast agreement is merely an example of business as usual for the two firms. Werbach points to legitimate concerns about broadband providers enjoying too much power, and he wants the FCC to examine relationships between carriers like Netflix and Comcast.

Below, the three professors offer their views on this latest deal.

Kevin Werbach:

“We don’t know the details of the deal…. [What we do know is that] Netflix is paying Comcast for direct interconnection of traffic, instead of paying transit providers to deliver traffic to Comcast. As a matter of principle, Netflix had been arguing it shouldn’t have to pay for direct interconnection, but it’s possible the new deal costs it less than its prior arrangement. It seems unlikely that Netflix would have caved at precisely the moment when it had the most leverage, due to Comcast’s proposed acquisition of Time Warner Cable.

“There are legitimate concerns about whether Comcast and the other large broadband access providers have too much power, but simply being big or having a substantial market share isn’t by itself a cause for regulation. The FCC’s network neutrality rules explicitly excluded interconnection relationships between carriers, which is what the Comcast-Netflix deal involved. I’ve been arguing at least since 2007 in my research that the government needs to examine interconnection, because that will ultimately be the key issue for openness and innovation in Internet infrastructure.

“At a minimum, we need transparency. The terms of interconnection deals like this one between Comcast and Netflix are generally confidential, which makes it impossible to assess whether they reflect a competitive market or anti-competitive bullying by one provider.

“In addition to concerns about Netflix, there are two other reasons to worry about potential implications of this deal. Netflix may have the leverage and resources to negotiate a reasonable interconnection deal, but what about smaller and newer players in the online services market?

“Second, what we’ve seen in the video market is that consumers may lose even when the providers on both sides are satisfied. The costs of cable TV keep going up, in part because programming costs are spiraling upward. That reflects a series of agreements between content providers and cable operators, which ultimately pass on the costs to consumers. The FCC hasn’t intervened in these “retransmission” negotiations, partly because its authority is severely limited by Congress. In the case of the Internet, the DC Circuit Court of Appeals recently acknowledged that that it had significant authority under Section 706 of the Communications Act.”

Lawrence Hrebiniak:

“Comcast is flexing its muscles with Netflix and using its power to create a positive deal for itself. The 800-pound gorilla is acting out, and its power is obvious. Netflix has no or few other choices if it wishes to free itself of the problems subscribers have complained about of late.

“Interestingly, however, Comcast may try to come across as the benevolent giant and not show off its power. It can easily and quickly raise prices for [unimpeded streaming of content from] Netflix, [and those costs will] clearly be passed on to [the consumer].

“But Comcast managers are smart and calculating, and they might have a ploy in mind. They might play things softly and slowly and try to show that Comcast indeed can work nicely with other companies like Netflix and that no regulatory oversight or intervention is needed.

“Comcast is [also] arguing that net neutrality is alive and well with good prospects for the future. [The company argues that] Netflix is receiving no preferential treatment, so the deal with Netflix — and implicitly with Time Warner — only goes to show that Comcast is committed to an open Internet. Again, the message to regulators and critics is that it is not necessary to create hurdles for Comcast as it is proving it is a good neighbor and fair company. Coupled with Comcast’s strong political connections in Washington, a host of people might be seduced by this logic.

“Will someone actually be hurt some day [by the deals]? Yes. Customers of Netflix eventually will pay more.” –Lawrence Hrebiniak

“Will someone actually be hurt someday [by the deals]? Yes. Customers of Netflix eventually will pay more. A combined Comcast-Time Warner will be able to control Internet traffic and raise prices for customers. Some small companies without the ability to pay won’t be able to secure a Netflix type of arrangement and will suffer for it. And what will happen to net neutrality in the future? Watch a combined Comcast-Time Warner, if the acquisition is approved, and let’s see what happens. You can probably guess that I’m a bit nervous about the outcome.”

Gerald Faulhaber:

“Since the very first days of the Internet in the early 1980s, networks had financial arrangements for exchanging traffic. They had two forms of arrangements. One was between Network A and Network B, where if they had roughly the same amount of traffic, they did unpaid ‘peering,’ so they didn’t charge each other. [The second form] had smaller networks with ‘unbalanced traffic,’ where they sent more traffic out than they received back. They were called ‘transit networks’ and were charged because the traffic was unbalanced.

“Fast forward to today when the situation is a lot more complicated, and there are all kinds of different networks. Netflix is a classic content provider, and it had deals with Level 3 Communications [of Broomfield, Colo.] and Cogent Communications [of Washington, D.C.] to deliver traffic to end-users. In particular, Netflix used Cogent’s network to send streaming video to Comcast customers. Netflix paid Cogent, and Cogent paid Comcast. That was always the way these networks worked — it is called paid peering.

“The principal problem, apparently, was that Cogent had limited capacity, and Netflix and Comcast were aware of it. [Therefore,] Netflix wanted to interchange its traffic directly with Comcast. Netflix for years tried to get the Internet service providers to peer with them for free, but it did not succeed. All that has changed is Netflix, which was paying Cogent [previously], will now pay Comcast for its video traffic.

“The speed and the latency with which video content gets delivered depend on every link in the market — it depends on Netflix, it depends on Cogent and it depends on Comcast. But who do you call [to improve it]? You call Comcast.

“It is also very clear that any other video provider is going to be able to go to Comcast and connect their content delivery network directly with it. Comcast will negotiate a deal with them, and that will be that. We don’t know if Netflix is going to be paying more. We won’t know because these are typically confidential agreements. But when you step back and you see both parties are happy with it, that tells you something right there. I don’t see this as a problem at all.

“Any other video provider is going to be able to go to Comcast and connect their content delivery network directly with it.” –Gerald Faulhaber

“Comcast is a tough negotiator. But you will find very few people that will say [the company is] not fair. Every time there is a breakdown in communications between a content provider and a cable company, it takes the content off cable. These disputes hurt subscribers. Comcast, as far as I understand, has never had one of these. The FCC has shown zero interest in regulating the interexchange of information on the Internet — and it is quite sensible [for not doing so].

“Another issue that comes up is that Netflix would like Comcast to do ‘caching’ for it. With caching, Netflix would send Comcast content before it is actually requested by subscribers. Then, when the request comes, the content pops up right away. Comcast has said it doesn’t want to do caching for Netflix. The main reason is that once they do caching for Netflix, they have to do caching for everybody.

“According to the terms of Comcast’s agreement with the FCC when it merged with NBCUniversal [in 2011], whatever Comcast offered one, it would have to offer to all. [At the time of the merger with NBC, Comcast agreed to abide by the principle of net neutrality, where it would not give preference to its own content and treat all traffic equally; that agreement runs through 2017.]

“Incidentally I am much less concerned now than earlier that Comcast is going to be able to exercise some ‘monopsony power.’ I just don’t see it [happening]. The merger [with Time Warner Cable] gives Comcast a little stronger leverage upstream with content providers. But with the new competitive market, the content providers have been getting a lot more money recently. They can sell to Hulu, Netflix, AT&T U-Verse and Verizon, and prices for content have been going up. If Comcast-Time Warner [gains] more power over content providers, I am not going to object to that — the [content providers] have been raising their prices for the last year. A little payback wouldn’t be a bad idea.

“The future of Comcast and Time Warner Cable is going to be about how it deals with the likes of Netflix. This is not a merger based on strength. It is a merger based on the fact that there is a new video market out there, and they have to figure out how to deal with that.”

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