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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 In one analogy I saw on Twitter that appears to have been withdrawn, it was compared to UPS opening up packages and delaying them based on the contents.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.

BuzzFeed Master Quiz: A proposal

15 Feb 2014

Everyone is buzzing about BuzzFeed quizzes. What font are you? Billionaire tycoon? Parks and Recreation character? Which US state do you belong in?

These quizzes ask you a bunch of sillyrelevant questions and ostensibly give you an answer based on them. Some of the questions are repetitive and are potentially relevant to multiple quizzes (assuming that they are relevant to any).

BuzzFeed should devise a Master Quiz that’s kept on file for each user. Whenever the geniuses at BuzzFeed come up with a new quiz, it might ask a few extra questions that are specific to that quiz, but will take into account the answers to the master quiz and all previous quizzes the user has taken.

As users take more and more quizzes, BuzzFeed will have a huge number of answers in its database, which they can use to improve the accuracy of quizzes. They could also send out email alerts telling users whether they are a hipster or what arbitrary thing they are without them answering a single additional question.

Bitcoin and stock clearing

07 Feb 2014

Quoth Felix:

A large part of the technology underpinning stock exchanges is the way in which they have to ensure that once you sell a share, you no longer own it, and you can’t sell it a second time. That’s also the technology which underpins bitcoin, except bitcoin transactions take many orders of magnitude more time to clear than stock transactions do.

There are two claims here. One is that stock exchanges enforce rules against “double selling” of stock. Others will be more qualified to comment on this, but my impression is that they don’t actually do this. Brokers do. That’s why brokers can some times lose track and let customers do things that aren’t really allowed. And that’s part of the reason why we have failures to deliver in the stock market.

The second claim is that Bitcoin transactions take much longer to clear than stock transactions. How long Bitcoin transactions take depends on how many confirmations (blocks in which the transaction appears) you wait for, and how much time passes between blocks. Bitcoin blocks come every 10 minutes. The convention used to be 6 confirmations for most transactions, but these days I think it’s closer to 3. With 3 confirmations, Bitcoin transactions will an average of 25 minutes to clear, after which the transaction is irrevocable.

In the United States, stock transactions take 3 business days to settle, which is when you hand over your cash and receive stock (or vice versa), and you can withdraw that cash or buy other stock with it. I know that “clearing” can technically mean something else—the netting of multilateral obligations between brokers—but I don’t think that happens much sooner than 3 business days after the trade.

Goldman DONG

28 Jan 2014

Everyone in Denmark is talking about the sale of a stake worth 11 billion kroner* in the government owned energy company DONG to a consortium of a Goldman Sachs controlled luxembourgeois company and two Danish pension funds. This will most likely be approved tomorrow and be moot anyway, but DONG!

My friend Niels-Jakob Harbo Hansen and I calculated some of the financial aspects of the deal, and they don’t look that good. The bidders are offering about 107.25 kroner per share, supposedly valuing the company at 31.5 billion kroner before the investment. In addition to a healthy package of minority rights, they also get a put option for 60% of the shares: if DONG doesn’t go public within 4 years or so (and Goldman can veto that), the investors can sell 60% of their shares at a strike price equal to the purchase price of 107.25 kr per share, plus a healthy return of about 3% per year.

That’s like an insurance policy that covers not only your loss, but also the insurance premium you originally paid, plus interest.

Once you account for the put option, the deal values the shares at 24.5 billion kr., around 47% of book value. Maybe that’s fair because DONG just had a big loss and will be constrained by its business plan to invest in windmills and such, but it still seems awfully low. On the other hand, the investment bankers have deemed it Fair™, so who am I to question that.

The main thing we did was to compare the deal to the most obvious alternative: the Danish government (AAA rating, 26% debt/GDP, 45% including local government) could borrow at an interest rate of about 1%, and make the investment itself. The expected loss from the deal compared to a government investment is about 2.5 billion kroner.

Should a government make equity investments on this scale? By all accounts an investment is necessary right now for DONG to eventually go public. You could question why DONG Energy exists in the first place. The company was formed by the merger of the former state oil company DONG (you can probably guess what the acronym means now) and various electricity companies, probably to prepare for an IPO. They did something similar with the former regional phone companies in 1990, and Danish phone and internet customers have rued that decision ever since.

The rule against perpetuities

20 Jan 2014

The SPDR S&P 500 ETF, better known under its ticker symbol SPY, is one of the largest investment vehicles in the world, with $172 billion under management. You can trade it in a regular brokerage account.

What owners actually get is a share in the SPDR S&P 500 ETF Trust (or SPDR® S&P 500® ETF Trust), a trust organized under Massachusetts law. There is a trust agreement laying out the rules of the trust and the circumstances under which it can be terminated, with the assets presumably being returned to investors.

A number of events can trigger the termination of the trust. If none of those events happen, according to the prospectus:

The Trust is scheduled to terminate on the first to occur of (a) January 22, 2118 or (b) the date 20 years after the death of the last survivor of eleven persons named in the Trust Agreement, the oldest of whom was born in 1990 and the youngest of whom was born in 1993.

Terminating SPY could be quite disruptive. The tax consequences could potentially be bad; at the very least, it would involve a lot of legal fees to sort everything out so nothing bad happens. And it will happen 20 years after the last of those 11 kids dies.

The oldest of the SPY 11 is now 23 years old. He or she may have graduated college last year.

Who are SPY 11? Are they all still alive? Do they know that their lives are inextricably linked to the fate of billions of dollars worth of savings? Does this weigh on them? Has anyone taken out life insurance on them? Do they know each other? Do they celebrate birthdays together? Does someone from the trust check in on them from time to time? Are they allowed to travel on the same flight? Do they have savings invested in SPY? Have they formed a tontine?