The phrase, "there's no such thing as a free lunch" is getting a new application this morning, as Netflix's massively popular streaming service and over-the-top online video delivery in general face their first big reality check in the form of the Level 3-Comcast traffic fee dispute.
In case you aren't fully up to speed yet, yesterday Level 3 issued a press release asserting that Comcast was forcing Level 3 to pay it higher rates in order for its traffic to be passed through to Comcast's network, and by extension its subscribers. On this basis alone, this would be a snoozer dispute; few of us are aware of or care about the behind the scenes Internet plumbing that enables the delivery of online content. And as long as it doesn't affect what we pay, we also generally don't care which provider gets paid what or how much.
That's why Level 3 cleverly decided not to depict this as a commercial dispute, but rather as a violation by Comcast of "net neutrality" regulations. To drive its point home further, it chose to use highly-charged language, accusing Comcast of "putting up a toll booth," "enabling it to unilaterally decide," "threatens the open Internet" and "preventing competing content" among other things. These are exactly the kinds of terms that net neutrality advocates have been using for years to justify new, stricter net neutrality regulations and Level 3's choice of words is a blatant play to transform this into a net neutrality spark. Trying to set the record straight, Comcast replied that in fact this is a commercial dispute, centered around an imbalance of traffic being exchanged (5:1 by its estimate), and that by convention a separate payment from Level 3 is warranted.
One thing Level 3 does not mention in its statement is that Netflix's streaming content is at the center of this issue. That's because Level 3 recently won most of Netflix's video delivery business. And given the size of Netflix's business, Level 3 no doubt competed very aggressively in order to win it. But because Netflix's streaming is so popular (up to 20% of prime time Internet traffic by one recent estimate), it's not unexpected that a large ISP like Comcast, which is on the receiving end of a lot of the traffic, would want to retain a balance by charging Level 3 incrementally. This would obviously erode Level 3's profitability on the Netflix business.
And that's what brings us to the free lunch discussion. Because there are real costs in transmitting large volumes of Internet traffic, somebody is going to be on the hook for them. Level 3 believes this should be Comcast. Comcast believes it should be Level 3. In reality, it should be Netflix, because these online delivery costs are really no different than postage. Though it's certainly possible Comcast is trying to overcharge Level 3 (and to be fair, we don't know the relative level of the fees being assessed), or that it's trying to discriminate. But with its NBCU acquisition in the final approval stages, it's hard to imagine they'd do something inflammatory and stupid at the 11th hour.
Rather, what most likely happened here is that Level 3 bid too aggressively for the Netflix business and is now trying to recover. When it couldn't do so privately in its negotiations with Comcast, it instead went public, wrapping itself in the cloak of net neutrality. My bet is that the FCC will quickly see this as well, and that over time content delivery pricing to Netflix will find its appropriate level. Regardless of what that is, online delivery will still be vastly less expensive to Netflix than postage, so in the long term, streaming is still hugely beneficial to its future.
Updates: Comcast is aggressively trying to set the record straight, today posting a letter to the FCC explaining its position, a "10 facts about peering" primer, and a 7 minute video interview with John Schanz, EVP of National Engineering who does a step-by-step walk-through of how peering works, noting that this is the first time in his experience that 2 companies that had a traffic imbalance have not been able to settle commercially.
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