Netflix and Comcast

Netflix just agreed to pay Comcast an undisclosed amount to ensure that the video rental company’s customers can access subscription content rapidly through the Comcast network.  In doing so, Netflix belatedly joins high internet traffic-generating firms like Google, Yahoo and Amazon in paying ISPs to get enough bandwidth that their offerings function correctly on subscribers’ computers or tablets.

Terms have not been disclosed.

why now?

Three factors are likely at work:

–a Federal appeals court recently ruled that the rules for net neutrality laid down by the FCC in 2010 exceed that agency’s authority, meaning it’s not clear what obligation, if any, Comcast has to make sure Netflix works right.

–inability of Netflix subscribers (like me) to access “House of Cards” when it first came out led to numerous customer complaints.

–Comcast has bid for Time Warner Cable.  If the deal survives Federal anti-trust scrutiny, Comcast will have considerably more market clout than it has today.  If so, terms would probably be better today than after the merger closes.  Also, in the meantime, Comcast presumably doesn’t want Netflix arguing against the combination.

what changes?

My guess is that in terms of profits the deal makes little difference to either Netflix or Comcast.  Before, Netflix didn’t pay Comcast and Comcast didn’t allocate capital to improving its ability to transmit Netflix.  Now, Comcast gets money, but will have to spend on equipment to support Netflix.  Presumably some people who had avoided Netflix previously will become customers.

I’m not sure whether I’d bet the farm that this is so, but given that as outsiders we have very little information, I think the safest assumption is that the deal doesn’t move the profit needle much for either party.

What I find interesting, though, is the way that Comcast wants its relationship with Netflix to evolve.  Until now, Netflix has been using third parties to route traffic.  They also attempt to smooth traffic’s flow as they connect Netflix to “last mile” ISPs like Comcast.  According to press reports, both Netflix and Comcast want to stop using such intermediaries.   Although the precise form of, and rationale for, the new working arrangement isn’t clear (to me, at least), the gist is that money formerly paid to middlemen will now go into Comcast’s pockets.

Maybe the structure of the new deal will unfuzzy itself after the government rules on the proposed Time Warner Cable merger.  Maybe not.  But the main investment conclusion I see is that Comcast is true “owner” of its internet customers and will continue to use that power to shift money away from middlemen and toward itself.

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