Netflix Wants All the Advantages of the Internet, But None of the Cost
Netflix CEO Reed Hastings doesn't like paying for Internet connectivity. He has a new idea, which he calls "strong net neutrality," that could significantly reduce one of his big input costs. For decades, content providers, websites, ISPs, and consumers have paid fees to connect to the next level of the network. Call it Internet access, or call it "transit" or "paid peering." The business of network firms is transporting bits in exchange for money. But Hastings has a better idea. "Instead," Hastings demands in a new blog, "they must provide sufficient access to their network without charge."
Why didn't General Motors think of that? Steel without charge!
Hastings' novel proposal caps a series of recent disputes over Internet "interconnection." The first high-profile row came in 2010 when Level 3 (with Netflix at its side) wrangled, and then came to an agreement, with Comcast. Then a few months ago Netflix, having changed its network architecture, once again began complaining about Comcast. That dispute was settled in late February when Netflix agreed to pay Comcast to connect directly to the broadband service provider's network.
At the time, Columbia law professor Tim Wu, a chief advocate of "net neutrality" and coiner of the term, erupted, demanding such agreements be blocked. "This is the first-ever direct interconnection deal between a broadband provider, like Comcast, and a content company, like Netflix or Google," Wu insisted. But he was flat out wrong. Firms like Google, Amazon, and Microsoft have connected directly to broadband providers for years.
Hastings is back, however, perhaps angling for Washington's support in his negotiations with other broadband providers. The FCC net neutrality rules, twice thrown out by courts, only covered last-mile transmissions and explicitly did not cover interconnection and peering. Thus Hastings' invention of super duper strong net neutrality.
His proposal is odd for a number of reasons. From the beginning, interconnection has been a competitive and cooperative arena. Unlike the highly regulated old telecom world, with its government-set tariffs and tolls, the interconnection market is unregulated and "just works." Consumers and websites pay ISPs for access, who, in turn, pay even larger ISPs for access to the global Internet. As networks grow, new technical and business arrangements evolve to accommodate the new technology and economics. Like any industry, companies haggle, but serious disputes are rare. In this unregulated interconnect arena, moreover, bandwidth supply has boomed and prices have plummeted. Now, however, Netflix and Level 3 want new government rules to change the way network firms interact with each other. If there's one thing in our economy that emphatically is working, it's the Internet. And the last thing we need is Congress or the Federal Communications Commission posing as network architect. (Our recent report "How the Net Works" is a primer and brief history on interconnection.)
If you are confused by the uproar over the fact that Netflix (and others) used to pay an Internet backbone provider for an arguably inferior connection to the network but now pay broadband providers for a better, more direct connection to the network, you are not alone. This is part of the natural evolution of the network. It's precisely what allows this industry to grow so fast. As I like to say, the dynamism of the Internet is its chief virtue.
Netflix appears to want consumers to pay for both their own connections and Netflix's connections. Moreover, depending on the pricing plans of the broadband providers, lots of consumers who are not Netflix subscribers will be subsidizing its business. Shouldn't Netflix subscribers pay Netflix's costs?
But Hastings proposal is even more radical than that. He seems to be saying that all network firms connect to all content firms via "settlement free peering." He's talking about the practice whereby networks of roughly similar size who exchange roughly equal amounts of data ("peers") trade traffic at no charge ("settlement free"). Some relationships on the Internet do use this form of barter - but only when it makes sense for both parties. Hastings apparently wants the law to mandate a zero price for interconnection no matter how big or small the parties, no matter how much value each side is bringing to the table.
Hastings says he's willing to accept equal amounts of traffic from the broadband providers. But that is a silly notion. Netflix is essentially a one-way service. Nobody would have any need to send exabytes of data to Netflix. It's not just the direction of the traffic but the value the other network provides in its reach to other points on the Internet.
At a zero price, demand would explode. The supply of interconnection bandwidth would shrink. Every website and content provider on the planet would insist on being inside the broadband providers' networks - for free! But if every website and content provider demands premium connectivity, then no one will actually get premium connectivity.
Prices are a way that we rationally allocate resources - not excepting bandwidth, interconnect capacity, data center space, and all the other costs of network transport and content. For some content providers, like high-end video streaming services, capacity, latency, and reach are important. And they have always been willing and able to pay to improve performance. YouTube has done so for years. So has Netflix. For other services, like my little website, it doesn't make sense to pay for high throughput or CDN services or paid peering. All I'm doing is delivering vanilla webpages. But if a law or regulation mandated that my little website (and a million like it) get the same access as Netflix to every network service, with no ability to differentiate how much interconnection capacity or CDN service we or they can buy, then Netflix, which is much larger and more sensitive to network constraints than I am, could suffer in quality.
Hastings' rhetorical expansion of net neutrality to "strong" net neutrality is one of many reasons we opposed the regulation from the beginning. As we wrote in The Wall Street Journal in 2009, "This regulation could expand bureaucratic oversight to every bit, switch and business plan on the Internet."
Netflix wants all the advantages of high capacity and low latency but none of the cost. Hastings' proposed rule, if fully implemented, however, could actually degrade his own service. The Internet is changing many things in our economy, but not the most basic laws of supply and demand.