How Netflix Is Transforming the Economics of the Web

This week, the company announced it has reached an agreement with Verizon to connect its service directly to the ISP's network, a deal similar to the one Netflix reached with Comcast in February. In the past, Netflix delivered its service into Comcast and Verizon through middlemen networks -- "transit networks" that provide the backbone for the internet. But in order to ensure that its video streams arrive in homes without too many hiccups, it's following in the footsteps of Google and Facebook, building a straighter path into ISPs.
Image Getty
The network of the city buildingImage: Getty

Netflix is now paying two major internet providers for a more direct path into the homes of all those people watching movies and TV shows on its popular video streaming service.

This week, the company announced it has reached an agreement with Verizon to connect its service directly to the ISP's network, a deal similar to the one Netflix reached with Comcast in February. In the past, Netflix delivered its service into Comcast and Verizon through middlemen networks -- "transit networks" that provide the backbone for the internet. But in order to ensure that its video streams arrive in homes without too many hiccups, it's following in the footsteps of Google and Facebook, building a straighter path into ISPs.

>In order to ensure that its video streams arrive in homes without too many hiccups, Netflix is following in the footsteps of Google and Facebook, building a straighter path into ISPs

The rub is that Netflix doesn't want to pay. Netflix has been loudly complaining about this sort of deal, saying that Comcast unfairly forced the agreement after allowing transmit network links to "clog up." Comcast, Netflix says, is setting itself up as a gatekeeper that can charge whatever it likes for access to American homes.

As Comcast looks to acquire another large ISP, Time Warner, the situation has fueled much controversy. The worry is that after the merger, Comcast will have even more gatekeeping power, and this becomes even more of an issue when you consider that, as a cable TV provider and the owner of NBCUniversal, Comcast is also a Netflix competitor.

But the situation with Netflix is even more complicated than many people realize. The problem is that we don't really know what the company's deals with Comcast and Verizon look like, and we don't know how Comcast will handle such deals in the future. Netflix may actually be paying less for delivery than it was in the past, and various economic forces may continue to keep the cost of such deals down.

But what we do know is that, now that companies like Netflix and Google are pushing such enormous amounts of video across the network, the economics of the internet are changing.

Equal Pay for Equal Play

In the past, a transit networks like Level 3 would trade traffic with home ISPs like Comcast without either party paying a fee. This is called "settlement free peering." These arrangements worked because both parties were sending and receiving similar amounts of traffic. But that changed when networks like Level 3 started carrying Netflix's streaming video, and they were delivering more traffic than they were receiving. This led to what's called "paid peering," where the transit network must pay for the delivery of its extra traffic.

Some, such as policy analyst Rudolph van der Berg, who now works for the Organisation for Economic Co-operation and Development, argue that all or most peering should be settlement free since it almost always saves both parties money in the long term. That may be the case, but paid peering has become more common over the past few years. And now, Netflix is paying for access too. In past years, Google and Facebook have also set up direct connections to ISPs like Comcast, and though its unclear whether they are paying for the privilege, they very well may be.

As long as an ISP charges everyone the same rates, regardless of the content being delivered, it's not really an issue. But we don't know how much Comcast and other companies charge.

Streaming video industry analyst Dan Rayburn tells us that this lack of transparency isn't a big deal. He believes that market forces ensure that Netflix isn't paying more than they were paying to the transit networks, and certainly, Netflix hasn't said that it's paying more. In fact, Netflix could be paying less than the market rate -- which would certainly give it an advantage over smaller competitors. That said, Netflix argues that it shouldn't have to pay Comcast as much as it pays a Level 3, because Level 3 provides additional services, including moving its content across long distances.

Competition Is Key

It would be far better if the terms of these deals were made public, so we wouldn't have to rely on rumor, speculation and estimation to determine whether everyone is getting unfair treatment. But the bigger issue is that, as more and more companies are must go directly to Comcast, it will wield more economic power. Things may be fair today, but not tomorrow.

The fact of the matter is that everyone who wants to reach Comcast users must go through Comcast, whether that's through direct paid peering or through a transit network that has a peering arrangement with the company. And with the Time Warner merger, that collection of users will grow. "Comcast charged market transit prices for Paid Peering," William B. Norton wrote in the 2014 The Internet Peering Playbook. "But what prevents them from charging a higher price?"

Meanwhile, multiple sources report that the FCC is considering allowing ISPs to charge different rates for different types of traffic. That would give Comcast, Verizon, and other companies even more leverage in negotiations with content providers. In other words, Netflix may have gotten the last good deal any content provider is going to get.

Correction 7:55 EST 04/30/14: An earlier version of this story identified Rudolph van der Berg as a writer for Ars Technica. He is a policy analyst for the Organisation for Economic Co-operation and Development.