On Sunday, Netflix Inc. (Nasdaq: NFLX) announced a massive deal with Comcast Corp. (Nasdaq: CMCSA). The agreement would pay the country's largest cable provider a premium to ensure reliable, high-quality streaming services to Netflix subscribers.
For an undisclosed figure, Comcast will connect directly to Netflix's servers, a move expected to dramatically improve Netflix's streaming quality.
Many believe this is just the first of many deals between Internet service providers and online content distributors. Hulu Plus, Amazon Prime, Apple Inc. (Nasdaq: AAPL), and Netflix will all require greater access to necessary infrastructure and high-capacity networks in order to provide the best in-home content experience.
That's why opponents of the deal are hailing it as the latest deathblow to Federal Communications Commission rules that guaranteed free and equal access to online bandwidth - or net neutrality.
Despite such claims, here's why this deal actually has little to do with recent net neutrality developments...
Netflix (Nasdaq: NFLX) Deal Prioritizes High Quality
The Netflix deal is really about Comcast's ability to deliver content to its subscribers.
Since November, stream performance of Netflix content has dropped significantly for Comcast customers, from 2.1 megabits per second (mbps) to 1.5, according to its ISP Speed Index. This was the fourth-lowest performance out of the top 17 service providers.
As a result, Comcast customers have complained of grainy, low-resolution video that doesn't meet the standard of past viewing experiences.
The problem stemmed from the sheer bandwidth demand of Netflix customers. Netflix's 33 million U.S. customers swallow a little more than 30% of the nation's entire peak Internet traffic.
Since 2012, Netflix has sent the bulk of its traffic through third-party companies that no longer can handle the traffic.
Given that Comcast's purchase of Time Warner Cable (NYSE: TWC) will easily make it the largest Internet provider in the United States (with 32 million households), Netflix's decision to pay for improved quality and connect its pipes directly to Comcast is a no-brainer. Comcast, after the Time Warner deal, could end up with 60% of U.S. broadband subscribers under its belt (before any divesting).
The streaming problems faced by Netflix were actually taking place at a third-party provider's servers. Netflix has been using a company called Cogent Communications to connect its network to Comcast and other service providers. However, this connection had been running at capacity for some time, thus affecting the quality of content.
Time Warner and several other ISPs had refused to hook up to Netflix's exchanges without payment to prioritize the bandwidth. Critics argued that Netflix's surge in online demand could affect the online performance of non-streaming households. But the reality is that these companies simply wanted to be paid money for the time and convenience.
Though the sum was undisclosed, it is fair to expect the amount was significant. However, Netflix will see future revenue opportunities through this agreement.
This deal changes the dynamics of the online streaming debate...
Not only is it likely that Comcast and Time Warner cable boxes will come pre-installed with Netflix software, but cable companies will likely have to begin to explore similar deals in order to stay competitive against rivals with improved streaming capacity.
That favors the content providers, particularly those like Netflix that have extremely successful original programming like "House of Cards" and "Orange Is the New Black."
Meanwhile, in Washington, regulators are attempting to reboot net neutrality rules and create new disincentives to discourage Internet service providers from charging companies to stream digital content through fiber-optic express lanes.
The Comcast deal for Time Warner creates a system with immense providers and higher barriers to entry for new competition. This has driven calls for increased regulation of service providers like the old days of Pacific Bell telephone.
Net neutrality rules set by the FCC would reduce a service provider's ability to offer preferential treatment to content providers by allowing bids for preferential treatment and faster online access. Regulators fear that companies like Comcast could end up blocking legal content in favor of other websites and content - like Netflix.
But just last month, a Federal Appeals Court argued that the FCC had overstepped its authority and overturned net neutrality rules in a lawsuit against Verizon Communications Inc. (NYSE: VZ).
Many are hailing both the court ruling and Netflix's agreement as fatal blows to Washington.
However, the Netflix agreement doesn't apply.
Net neutrality rules require equal treatment of trafficked content flowing through the last mile to customers. This deal centers on the connectivity of the content provider and the service provider at the network level. No longer will Netflix need its third-party providers to ensure delivery of content.
The Netflix-Comcast deal is just the beginning of a bigger battle that will include regulators, content providers, and online content distributors. Moving forward, the bigger question will center on the infrastructure needed to meet booming demand for content, which is set to explode in the coming years.
For now, the net neutrality debate is still in its infancy...
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