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As part of Netflix’s letter to shareholders today, including its earnings results, it included a section about some of its challenges going forward.Here, Netflix CEO Reed Hastings and CFO David Wells discuss their thoughts on Internet service providers and “net neutrality,” including what they think is a fair commercial relationship between Netflix and ISPs.
Netflix (obviously) comes out against the idea that ISPs will stop offering unlimited bandwidth access, switching instead to a consumption-based model. Netflix says that it only costs ISPs about a penny per gigabyte of bandwidth, and that charging $1 per GB would be “grossly overpriced.”
Netflix also says that tomorrow, it will publish a blog post identifying which ISPs deliver the best, most consistent high-speed Internet access for streaming Netflix. The highest performing ISP, Netflix says already, is Charter.
Here’s this section of Netflix’s investor note:
The long-term threats to our profit stream haven’t changed much over the past year. There is the substitution threat of better offerings from MVPDs, with free TV Everywhere, in particular, making supplemental services like Netflix and Hulu Plus less desired. There is the threat of growing piracy from websites like Megavideo and others, especially in international markets. There is the threat of direct competition, such as Hulu Plus or perhaps HBO Go or Amazon. There is the content cost threat: that content pricing uniformly rises so sharply that we can afford fewer titles, thus our service becomes less amazing to consumers, and our growth is slowed. Finally, there are various ISP-related threats, which we’ll look at in detail below.
Recently the FCC adopted a version of net neutrality for wired networks in the U.S., and it’s a step in the right direction. The focus is on fair-play within an ISP’s network, but does not explicitly address entry into the ISP’s network.
Delivering Internet video in scale creates costs for both Netflix and for ISPs. We think the cost sharing between Internet video suppliers and ISPs should be that we have to haul the bits to the various regional front-doors that the ISPs operate, and that they then carry the bits the last mile to the consumer who has requested them, with each side paying its own costs. This open, regional, no charges, interchange model is something for which we are advocating. Today, some ISPs charge us, or our CDN partners, to let in the bits their customers have requested from us, and we think this is inappropriate. As long as we pay for getting the bits to the regional interchanges of the ISP’s choosing, we don’t think they should be able to use their exclusive control of their residential customers to force us to pay them to let in the data their customers’ desire. Their customers already pay them to deliver the bits on their network, and requiring us to pay even though we deliver the bits to their network is an inappropriate reflection of their last mile exclusive control of their residential customers. Conversely, this open, regional, no-charges model should disallow content providers like Netflix and ESPN3 from shutting off certain ISPs unless those ISPs pay the content provider. Hopefully, we can get broad voluntary agreement on this open, regional, no-charges, interchange model. Some ISPs already operate by this open, regional, no-charges, interchange model, but without any commitment to maintain it going forward.
Tomorrow, we’ll publish on our blog ongoing performance statistics about ISPs collected from our 20 million subscribers detailing which ISPs provide the best, most-consistent high speed internet for streaming Netflix. We can tell you now, though, that for our subscribers streaming Netflix, Charter is the highest-performance ISP in the United States.
Recently, there was a report that at peak times Netflix subscribers in the U.S. were driving about 20% of peak downstream last-mile Internet traffic. This may or may not be accurate, but it should be noted that because we pay for the data to be delivered to regional ISP front doors, little of this traffic goes over the Internet or ISP backbone networks, thereby minimising ISP costs, avoiding congestion, and improving performance for end-using consumers.
An independent negative issue for Netflix and other Internet video providers would be a move by wired ISPs to shift consumers to pay-per-gigabyte models instead of the current unlimited-up-to-a-large-cap approach. We hope this doesn’t happen, and will do what we can to promote the unlimited-up-to-a large-cap model. Wired ISPs have large fixed costs of building and maintaining their last mile network of residential cable and fibre. The ISPs’ costs, however, to deliver a marginal gigabyte, which is about an hour of viewing, from one of our regional interchange points over their last mile wired network to the consumer is less than a penny, and falling, so there is no reason that pay-per-gigabyte is economically necessary. Moreover, at $1 per gigabyte over wired networks, it would be grossly overpriced.