Why Netflix paying ISPs is bad

23 Feb 2014

A few days ago we received the apparent good news that Comcast and Netflix are now exchanging traffic directly. Today, the Wall Street Journal reports that Netflix is paying Comcast for peering. This sets a disastrous precedent for the future of the Internet.

I’ve seen several attempts to explain why it’s bad that Netflix pays for Internet access. Some of them have been a bit unsatisfying. In one analogy I saw on Twitter that appears to have been withdrawn, it was compared to UPS opening up packages and delaying them based on the contents. But that’s not quite right: UPS already charges shippers extra for faster shipping, and they certainly won’t ship anything for free.

In the Netflix–Comcast deal, Netflix and Comcast entered into a peering arrangement. The way this works for high bandwidth content providers, Netflix is basically shipping streaming bits directly to the customer’s doorstep at multiple locations throughout the United States. A Comcast customer who watches House of Cards in Philadelphia will receive the stream from Netflix through a Comcast facility somewhere in the Northeast. (Comcast could, reasonably, require the stream to be delivered to a facility in Philadelphia.) Netflix has already paid to bring the video from their servers all the way to the nearest Comcast peering point.

The analogy I would use is that your apartment building charges Netflix to bring their red envelopes through the door. This is unfair because you’ve already paid for your mailbox and lobby (and maybe even a doorman) through your rent. Netflix should pay to bring the DVD to your doorstep, and they do. (I won’t consider the special case where USPS is your landlord.)

Your building should not get to charge shippers and delivery people extra: you don’t really have a choice of an alternative mailbox/lobby provider if you think their terms are unfair. And you already paid for this service.

You could always move to a different building. But guess what: every building in the neighborhood (or if you’re in a smaller town, the whole town) is owned by the same company.

Getting back to my earlier post on net neutrality, the problem isn’t so much that Netflix has to pay a little extra. It’ll add a bit to their costs, in the longer run they have to charge you a bit more, but a Netflix subscription is already cheap. The problem is that we lose a culture of permissionless innovation:

Anyone can buy Facebook ads (maybe BuzzFeed gets a better deal?), but the kind of access that Netflix can get by paying is only available to big, established companies who can get ISPs on the phone and get them to take meetings. Or who have the wherewithal to meet with every major residential ISP in the country (or the world, if they want to be global).

And who knows if Netflix could ever have become a big, established content provider if established players had been allowed to veto their growth at every stage. (This would be a lot more tolerable if the cable companies got out of the content business and become pure ISPs.)

There’s a growing trend of mood affiliation in favor of high and increasing monopoly rents in as many markets as possible. It’s true that in contestable markets, monopoly rents can provide an incentive to invest and to actually contest the market.

However, I see very few attempts to ask “how much?” and “how?” There are potential benefits to the existence of rents. There are costs too, in the form of reduced consumer surplus (you have to pay more), less innovation, and in the case of the Internet, the loss of permissionless innovation. Some methods of collecting rents are more harmful than others.

In the US, patent terms are 20 years from priority date; why not make it 30 years, or 40 years, or 120 years? I think the reason is obvious, but nobody ever thinks this way about ISP rents. Until the Netflix–Comcast deal, a limiting principle for rents accruing to an ISP was “you can screw the customer as much as you want, but you can’t screw the content provider”. No more.

Update: Changed the title to reflect the fact that this post is not written from Netflix’s point of view. Also, I should add that my description of peering reflects what Netflix is now paying Comcast to do, and what they do with other providers such as Cablevision on a settlement free basis, but does not describe how peering generally works. In particular, what I describe is the opposite of the “hot potato” routing in most peering agreements.