Sunday, December 22, 2013


Netflix's War On Mass Culture
(By Tim Wu, New Republic, 04 December 2013)

Given all the faces you see glued to computers, tablets, and cell phones, you might think that people watch much less television than they used to. You would be wrong. According to Nielsen, Americans on average consume nearly five hours of TV every day, a number that has actually gone up since the 1990s. That works out to about 34 hours a week and almost 1,800 hours per year, more than the average French person spends working. The vast majority of that time is still spent in front of a standard television, watching live or prescheduled programming. Two decades into the Internet revolution, despite economic challenges and cosmetic upgrades, the ancient regime survives, remaining both the nation’s dominant medium and one of its most immutable.

And that’s why what Netflix is trying to do is so audacious. For the past two years, the Silicon Valley company has been making a major push into original programming, putting out an ambitious slate of shows that have cost Netflix, which had profits of $17 million in 2012, hundreds of millions of dollars. Because of the relative quality of some of those series, such as “House of Cards” (a multiple Emmy winner) and “Orange Is the New Black,” they’ve been widely interpreted as part of an attempt to become another HBO. Because every episode of every show is made available to watch right away, they’re also seen as simply a new twist in on-demand viewing. But in fact the company has embarked upon a venture more radical than any before it. It may even be more radical than Netflix itself realizes.

History has shown that minor changes in viewing patterns can have enormous cultural spillovers. CNN can average as few as 400,000 viewers at any given moment—but imagine what the country might be like if cable news had never come along. Netflix’s gambit, aped by Amazon Studios and other imitators, is to replace the traditional TV model with one dictated by the behaviors and values of the Internet generation. Instead of feeding a collective identity with broadly appealing content, the streamers imagine a culture united by shared tastes rather than arbitrary time slots. Pursuing a strategy that runs counter to many of Hollywood’s most deep-seated hierarchies and norms, Netflix seeks nothing less than to reprogram Americans themselves. What will happen to our mass culture if it succeeds?  Vladimir Nabokov believed that humanity’s highest yearning ought to be to leave behind any desire to be up-to-date, to be unconcerned with what is happening now. As he put it in his notes to Pale Fire: “Time without consciousness—lower animal world; time with consciousness—man; consciousness without time—some still higher state.”

The business of entertainment has not generally shared Nabokov’s view. It values timeliness above all, creating a hierarchy so fundamental that it resembles natural law: New is better than old, live trumps prerecorded, original episodes always beat reruns. That’s overwhelmingly obvious in sports and news, and accounts for the manufactured ephemerality of reality and talent shows. Yet it is also implicit in dramas and sitcoms, with their premieres, finite seasons, and finales. The rule holds fast for film as well. From its opening weekend in major theaters, through nearly two years of “release windows,” a movie drifts downward through airlines, hotels, DVDs, cable and network television, and the Internet, decaying in perceived worth.

The desire to be current is in some sense human nature. But when it comes to viewing choices, it also arises from the specific history and revenue model of the entertainment business. In its early years, television was necessarily live, for the technology of broadcasting preceded effective and cheap recording technologies. The first popular shows, like “Amos ‘n’ Andy,” were short serial dramas designed to keep audiences on a fixed daily schedule, each episode ending with some aspect of the plot unresolved. If you missed an installment, you missed it forever and might lose the big story in the bargain.

In normal markets, the most popular products aren’t necessarily the most profitable (think Louis Vuitton). But on network television, where the prices charged for advertising depend on ratings, comparative popularity matters a lot. If some sense of newness or urgency can get viewers from the desired demographic to tune in to one channel rather than another, that can make the difference between success or failure. The upshot is a business whose highest ambition is to get enormous groups of people watching the same thing at the same time: “event television.”

Atop this eventocracy are productions like the Super Bowl or the Oscars, which by managing to grab much of the nation therefore command the highest ad rates, about $4 million and $2 million, respectively. That compares with the $77,000 per spot that “30 Rock,” a smart but under-watched series, commanded at the end of its run. The premium on audience size orients creative decisions toward an ideal embodied by a Jay Leno monologue, avoidant of controversy or anything too weird or challenging. TV shows, in the words of economist Harold Vogel, are “scheduled interruptions of marketing bulletins.” And television itself, as Walter Lippmann, a founder of this magazine, put it, has long been “the creature, the servant, and indeed the prostitute, of merchandising.”

The Internet—while it has its own desires for attention—has always been a different animal. One way or another, it tends to thwart efforts to gather lots of users at the same time and same virtual place. The first “YouTube Music Awards,” stuffed with celebrities, attracted 220,000 live viewers, compared with more than ten million for MTV’s version. During the men’s 100-meter-dash final at the London Olympics, Web viewers groaned as NBC’s Web video lapsed into “buffer mode.”

Online, people are far more loyal to their interests and obsessions than an externally imposed schedule. While they may end up seeing the same stuff as other viewers, it happens incrementally, through recommendation algorithms and personal endorsements relayed over Twitter feeds, Facebook posts, and e-mails. New content is like snowfall, some of it melting away, some of it sticking and gradually accumulating. The YouTube Music Awards may have been a bust as a live show, but within two weeks, the production had racked up 3.5 million views.

When I spoke with Netflix CEO Reed Hastings in August, I noticed a subtle but significant shift in nomenclature: He had begun to refer to the company not as a tech start-up or a new media venture, but instead as a “network.” To claim that mantle is not a trivial thing. The National Broadcasting Corporation (NBC) pioneered our understanding of what the concept means back in 1926, when it partnered with AT&T to create the first lasting national broadcast network. Until then, American home entertainment had been necessarily local—radio stations, technologically, only reached their host city or community. The founding idea of NBC was to offer a single, higher-quality product to the whole country. It was an idea of a piece with the late 1920s and 1930s, before fascism became unfashionable and nationalism was all the rage. A mighty and unifying medium fit with an era during which Fortune would praise Benito Mussolini as presenting “the virtue of force and centralized government acting without conflict for the whole nation at once.” The national network was an effective way to put people on a common daily cultural diet.

Claiming network status was also a bold move for Netflix just based on its track record alone; not so long ago, it was a struggling DVD rental company whose cachet came from its distinctive red envelopes and pretty good website. One wonders how much the shift really was planned, a question on which Hastings and chief content officer Ted Sarandos disagree. “When I met Reed in 1999,” Sarandos told me, “part of our first conversations were about the potential for original programming.” Hastings demurs, calling that “generous.” “What was planned all along was really just the evolution to streaming,” he says, “and thus the name of the company: Netflix, not”

Netflix’s transition from delivering movies and TV shows through the U.S. Postal Service to beaming them over high-speed connections began in 2007 and is a well-known story. Less known is how Netflix found its way into the content business, a risky move that has embarrassed many tech firms. In the ’90s, Panasonic, a capable-enough maker of camcorders, acquired a precursor to Universal, only to have to jettison the entertainment studio a few year later. Around the same time, Microsoft, then at its most flush, blew billions creating content that for the most part vanished so fast that not even a Bing search could find it today.

But Netflix, without grabbing many headlines, had actually spent a long time preparing for its current chapter. While it is headquartered in Silicon Valley, the company opened an office in Beverly Hills in 2002, a bid to achieve a certain California bilingualism. Sarandos, who has overseen that southern outpost, spent his formative years working in a strip-mall video-rental shop and is upbeat and easy to talk to. He is a fluent Southern Californian, unlike Hastings, who’s known for his impatience with slow or muddy thinkers.  Throughout the early 2000s, Sarandos experimented with small content deals. Once, while attending a software convention, he ran into a guy named Stu Pollard who had self-financed a romantic comedy named Nice Guys Sleep Alone, the many extra copies of which he now had stored in his garage.  “He gave me his movie, and he said, ‘I’ve got ten thousand of these if you’re interested,’ ” Sarandos recalls. He watched the film, decided it wasn’t terrible, or at least “on par with a lot of the romantic comedies we were distributing.” Sarandos agreed to take 500 discs, pursuant to a revenue share, creating what might be called the first Netflix semi-exclusive.

Sarandos’s acquisitions budget, originally $100,000 a year, swelled as Netflix became a regular at Sundance and other film festivals. Under the name Red Envelope Entertainment, Netflix bought the rights to independent films such as Born into Brothels, a 2004 documentary about the children of Calcutta prostitutes (it won an Academy Award), and Super High Me, a documentary about the effects of smoking weed heavily for a month (sperm count and verbal SAT scores both went up; math scores suffered). When it acquired these films, Netflix added them to its own catalogue but did not keep the content entirely for itself, instead trying to distribute it as widely as possible. For Super High Me, that included sponsoring viewing parties for stoners.  In 2008, after acquiring about 115 films, Netflix folded Red Envelope and let go of several employees. Sarandos, at the time, gave good reasons for Netflix’s retreat. “The best role we play,” he said, “is connecting the film to the audience, not as a financier, not as a producer, not as an outside distributor or marketer.” It was the statement of a tech company sobering up.

Yet just a few years later, Netflix abruptly reversed course again. The company had finally passed 20 million subscribers. To thrive over the long term, it would need many more. At the same time, it now had enough scale to try a different way of using new content to lure them. “When a big company does a little bit of music, or a little bit of video, and it’s not essential to their future, it’s almost assured that they won’t do it well,” says Hastings. “It’s a dabble.” To make its first major original series, Netflix shelled out $100 million. It would not be dabbling.

In 2011, when independent studio Media Rights Capital shopped the American remake of a modestly successful British political drama named “House of Cards,” Netflix didn’t bother to attend its presentation to the networks. Instead, Sarandos got in touch with David Fincher, the Oscar-winning director of The Social Network, who’d been tapped to make the show. “We want the series,” Sarandos told him, “and I’m going to pitch you on why you should sell it to us.” Aware of the challenge of convincing a famous auteur to bring his talents to a medium more commonly known for cat videos, Netflix promised a lot: Fincher, though he’d never directed a TV series before, would enjoy enormous creative control. And rather than putting the show through the normal pilot process, the company would commit to two 13-episode seasons up front. It was nearly as aggressive with “Orange Is the New Black,” ordering a second season of the show—a subversive drama set in a women’s prison, featuring a notably motley cast—before the first was even available.

If those were big gambles, they were also calculated ones. Whatever it calls itself, Netflix still has tech-company DNA; its game, in part, is data. Much more so than a network that reaches viewers through a third-party cable operator like Comcast or Time Warner, it knows what its customers actually like and how they behave. To the consternation of entertainment reporters, Netflix never reveals just what its numbers say (or anything resembling ratings), but Sarandos says its process for “House of Cards” worked roughly like this: “We read lots of data to figure out how popular Kevin Spacey was over his entire output of movies. How many people actually highly rate four or five of them?” Then his team did the same for David Fincher. If you liked The Social Network, The Curious Case of Benjamin Button, and Fight Club, “you’re probably a Fincher fan—you probably don’t know it, but you are,” he says. Once the company has a sense of how many fans are out there, it can “more accurately predict the absolute market size for a show.” And when you can do that, you don’t have to worry about pandering to, or offending, the masses.

Right now, American viewers are averaging only about 45 minutes of Internet-streaming video per week, a blip in comparison with total television intake. Given that audiences trained for decades to respond to event-driven television, how realistic is it to expect more viewers to shift from traditional TV? John Steinbeck offered one answer: “It’s a hard thing to leave any deeply routined life, even if you hate it.” Any historian of consumer technology would add that machines change much faster than people.  Television in particular moves so slowly that the last time the concept of the network really came up for grabs was the late ’70s. That’s when Ted Turner (the Turner Broadcasting System), Pat Robertson (the Christian Broadcast Network), and the founders of HBO successfully used satellites to begin to beam programming to cable subscribers. The ensuing frenzy resulted in the launch of a dozen networks, including ESPN, MTV, CNN, Discovery, and Bravo. Most of those channels are still around, not necessarily because of the strength of their programming, but because the reigning content hierarchy has been so entrenched.

Netflix believes it has a powerful factor in its favor as it tries to change viewers’ habits. “Human beings like control,” says Sarandos. “To make all of America do the same thing at the same time is enormously inefficient, ridiculously expensive, and most of the time, not a very satisfying experience.” There is a freedom achieved when your options extend beyond that night’s offerings and the limited selection of past episodes that networks make available on demand. Specifically, it’s the freedom to only watch television you really enjoy. The crude novelty factor that compels people to try “Whitney” or “Smash” ultimately yields a lot of disappointed and frustrated viewers. An old episode of “Freaks and Geeks” or “The West Wing” might in fact be more worth your time—a message Netflix has pressed in a recent ad campaign promoting its collections of classic series and cult hits. Eventually—or so goes the strategy—people won’t be able to imagine having their options defined by a programming grid. Not coincidentally, Netflix has been vying with Amazon to become the premiere source of streaming series for young children, for whom having to wait for new episodes of their favorite shows to air is unfathomable.

While Netflix’s first few original series have been aimed at connoisseurs of high- or at least upper-middle-brow fare, its philosophy might be best captured by its co-production of “Derek,” a show that skews toward less sophisticated sensibilities. “Derek”is a Ricky Gervais sitcom revolving around the staff and residents of a small nursing home in England. The show, to put it mildly, does not have the usual indicia of widespread appeal. It might be described as the opposite of “Baywatch”—the setting is bleak, the stars ugly and often annoying, the dialogue sometimes incomprehensible to American ears.

And then there’s Gervais himself. He did serve for three years as the host of the Golden Globes, a paragon of event programming and water-cooler culture. Yet in that role, he was deemed a failure, his humor too edgy and offensive. Selling the masses on a series featuring Gervais playing the part of a weird man with greasy hair who likes hamster videos would be a losing proposition—but that’s not what Netflix is doing. To the company, it doesn’t matter if you’ve never heard of the show, or even know anyone who has. All that matters is that it wins the approval of Gervais loyalists, whom, the data must show, are a large enough Netflix population to justify the investment. Similarly, the names Luke Cage and Jessica Jones may mean nothing to you, but they do to comic-book fans, which is why Netflix just worked out a deal to create series based on them and two other Marvel superheroes.

Netflix’s transformation would of course be impossible without the path blazed by premium cable. HBO pioneered the subscription-fee model (though it collects from cable companies rather than directly from consumers) and its success made possible the specialized programming on other premium networks, like AMC and the rest. The DVD box set gave hard-core enthusiasts the first taste of the binge-viewing that is a Netflix trademark. The company’s achievement is to bring it all together and target the entire TV-watching population—not just a few selected die-hards, but every individual based on his or her own interests and obsessions.

And from that a picture of the not-too-distant TV future emerges. What remains of live programming is reserved for sports programming, breaking news stories, talent contests, and the big awards shows. Nearly all scripted shows become streaming shows, whether they are produced or aggregated by Netflix or Amazon, CBS or a (finally unbundled) HBO—or even an unexpected entrant such as Target, which recently launched a Netflix competitor. The new networks compete based on their ability to make the right original programming decisions and secure the best old shows, as well as the prescience of their recommendation engines. But ultimately they’re all just selling access to piles of content to be perused at the viewer’s desire. Oddly enough, it’s a vision that actually makes television a lot more like the rest of retail. Or, more specifically, not unlike the old-style video-rental stores where Sarandos started his career, but super-sized for a new era.

Through the sheer number of hours watched and the dictation of evening routines—not to mention the way people orient entire rooms around the shiny screens placed at the center of their homes—network television played a singular role in creating American mass culture over the last 60 years. It now does the same in sustaining its vestiges. In the absence of a generation-defining genre—the rock of the 1960s, the rap of the 1990s—today’s pop hits flit through radio dials and iTunes playlists, catchy but ephemeral. Blockbuster movies and books are few these days, and the windows during which they command widespread attention brief. But television, despite the fragmenting influence of the Web and proliferating cable channels, continues to bind us more than any other medium. That’s why, should Netflix and the other streamers even partially succeed at redefining the network as we know it, the effects will be so profound.

If modern American popular culture was built on a central pillar of mainstream entertainment flanked by smaller subcultures, what stands to replace it is a very different infrastructure, one comprising islands of fandom. With no standard daily cultural diet, we’ll tilt even more from a country united by shows like “I Love Lucy” or “Friends” toward one where people claim more personalized allegiances, such as to the particular bunch of viewers who are obsessed with “Game of Thrones” or who somehow find Ricky Gervais unfailingly hysterical, as opposed to painfully offensive.

The baby-boomer intellectuals who lament the erosion of shared values are right: Something will be lost in the transition. At the water cooler or wedding reception or cocktail party or kid’s soccer game, conversations that were once a venue for mutual experiences will become even more strained as chatter about last night’s overtime thriller or “Seinfeld” shenanigans is replaced by grasping for common ground. (“Have you heard of ‘The Defenders’? Yeah? What episode are you on?”) At a deeper level, a country already polarized by the echo chambers of ideologically driven journalism and social media will find itself with even less to agree on.

But it’s not all cause for dismay. Community lost can be community gained, and as mass culture weakens, it creates openings for the cohorts that can otherwise get crowded out. When you meet someone with the same particular passions and sensibility, the sense of connection can be profound. Smaller communities of fans, forged from shared perspectives, offer a more genuine sense of belonging than a national identity born of geographical happenstance.

Whether a future based fundamentally on fandom is superior in any objective sense is impossible to say. But it’s worth keeping in mind that the whole idea of one great entertainment medium that unites the country isn’t really that old a tradition, particularly American, nor necessarily noble. We may come to remember it as a twentieth-century quirk, born of particular business models and an obsession with national unity indelibly tied to darker projects. The whole ideal of “forging one people” is not entirely benevolent and has always been at odds with a country meant to be the home of the free.  Certainly, a culture where niche supplants mass hews closer to the original vision of the Americas, of a new continent truly open to whatever diverse and eccentric groups showed up. The United States was once, almost by definition, a place without a dominant national identity. As it revolutionizes television, Netflix is merely helping to return us to that past.

Netflix Takes On Hollywood With Original Shows
(By Cecilia Kang, Washington Post, 02 February 2013)
Tech giant Netflix is going Hollywood. As the dominant paid provider of streaming online videos, it now sees making its own videos as the key to its future.  This big bet — and an expensive one — turns the ever-evolving company into a chief rival of HBO and major television networks.  Chief executive Reed Hastings was in Washington last week to promote Netflix’ s $100 million Web-only series “House of Cards,” starring Kevin Spacey. He dropped by The Washington Post to talk about the future of television entertainment and the tensions he’ll have to sort out with his biggest frenemies — networks and the telecom providers that deliver Internet services like his to homes.
The company is regaining steam on Wall Street after a stock freefall last year, following the embarrassing mistake of prematurely canceling its DVD mail-order business. Hastings changed his mind and announced that the company will keep that service for at least a decade, he says now — or as long as the Postal Service survives.  Here’s an edited version of the discussion:

What’s in store for the next couple of years? Will you look more like NBC Universal or YouTube?
We want more members, more content and to serve more countries. The people at YouTube have that space figured out; it’s all ad supported. For us, we will license more movies, television shows and create more original content.
Why do you do original content? For buzz?
For subscriber enjoyment and the buzz. If there is more buzz, more people join.
But it seems awfully high-risk.
That’s how you differentiate. With on-demand, you can have doubles and not a home run. But networks can’t. That’s why they have to do pilots and pay for overhead. We don’t. We have incredible shows for the Hindi community and other audiences. The whole notion of what is a hit is different. We are about figure out what people are passionate about. We aren’t trying to program to the lowest common denominator. Linear TV has had a one-to-many broadcast, whether its NBC or HBO. We have more creative latitude.
What will the the market look like in five years?
Linear TV today will be like landline telephone. You’ll still have it. Many people will pay for it but won’t use it very much. The most communication will go to the mobile phone. Electronics will get better. There will be an iPhone 9 or iPhone 10, and it will be impossibly thin and have amazing resolution, and we’ll have incredible bandwidth.
We’ll have 4K TVs that will be cheap and have large screens. You will control your TV with your smartphone. So the smartphone will be the remote control for your car, give you diagnostics. It will open your house, and it will be your remote control for your life, too. You’ll buy channels like Netflix, Hulu and others on that remote control phone. And whatever screen, whether upstairs, downstairs or in a hotel, will recognize you from your mobile phone-centricity.
Who will own the pipes for Internet connections?
For residential, cable will have their own, fiber will have theirs, too. There will be radio stacks and different providers. The question is how much speed will there be and how much competition.
Do you think we will get detached from the monopoly cable provider?
Billing and bundling will be tricky. I don’t know to what degree the bundle will break up. More likely than not. HBO in the Nordics is competing as a stand-alone [offering]. The question is if the [cable providers] can handle the disruption.

Will your move into content push those changes?
I don’t think so. But we are becoming more like HBO faster than they are becoming like us. We were an Internet company, and then we became a content company. Maybe in the long run, there will be two great companies battling it out, and that’s fine. That’s good for everyone.
Talk about your relationship with the telecom ISPs. What are pain points in that business relationship ?
Right now, it’s not really painful at all. The customer experience is great. You click and you watch. In the long term, there is potential conflict because we’re capitalist and they’re capitalist and everyone wants to expand their profit pool.  ESPN and HBO get a percentage of total cable cost. Cable costs 70 bucks and ESPN gets like 6 bucks of that.  So we look at it and say, “Hey, there’s a $60 ISP bill that is hugely profitable for ISPs. Maybe we should get a part of that because [consumers] are getting broadband to get Netflix.”  They say, “One-third of our bits, our costs, are Netflix, and so Netflix should pay part of our costs.”  There will be some battle around there. Our basic view is that there is a safe medium that avoids all the [television] carriage battles that we’ve had over 15 years.
What are you doing to that safe medium?
We have Open Connect, how we connect to their networks. It’s servers that have all our discs. We bring the servers and connect them to their networks. We have to carry the bits to where they want, to each metro area, at our cost. The ISPs carry them. And we don’t charge them, and they don’t charge us.
Are they happy?
Small ISPs are thrilled. But the big guys, they are used to better deals than that and they don’t want smaller guys to have the same deal.  Consumers want a change in their cable relationship. No one is mad at the equipment makers. They don’t say Samsung is doing things wrong. It has nothing to do with the electronics. It has to do with service side. What’s hard is that businesses are interlocked between cable, satellite and long-term contracts [with networks]. They sign up for 10 years for ABC stuff and ESPN.  But we are changing that. We signed a deal with Disney where movies like Pixar and Lucas Films will only be available on the first pay window on Netflix starting in 2016.
Does it make sense to move in Apple’s direction and become a gateway for how users get video content — through a set-top box?
Consumers want a box with multiple services. They want Hulu and YouTube and ESPN. We’re trying to be like Google Maps, on every device.
What’s your relationship like with Amazon?
Great. We are doing great work with Amazon Web services. We compete on the retail side, bidding against each other for NBC and ABC and other networks. Competition is healthy. Different providers will have different content.
Will you every advertise on Netflix?
No. Our position is like HBO, to be a commercial-free network.
Why not? You already have a ton of information about users. You could target ads to them, too.
It depends on what you are trying to attract. Part of our proposition, like HBO, is to differentiate ourselves in a way so that we’re worth paying for. Being commercial-free is part of that proposition.
How much longer will you keep mailing DVDs?
It depends on how quickly the Postal Service has problems. Taxpayers soon will be bailing out the post office to a huge number. So we’ll stay in that business for at least a decade, because people still need the post office to deliver Social Security checks, medicine, etc.
Will you take user-generated content? Sports?
Don’t think so. YouTube is already so good at it, and it’s not part of our brand. Same thing with sports; we don’t think we will do that. Movies, TV shows are the main places we are focusing and adding more content and getting better. Knowing that you are in middle of a series and going home to watch the next episode of “Lost” or “Mad Men”is a good feeling. We want you to feel that all the time.
What do you need from Washington?
There is this ISP battle stuff. In an ideal case, we need nothing at all because it will all be worked out commercially. AT&T and Comcast in particular are very sophisticated with their regulatory mechanism. Yes, we compete with them on the video side. but we are also one of the main reasons people get broadband.
What makes you think you are driving broadband adoption?
In peak traffic on a Friday, 30 percent of it is Netflix.
But ISPs could say you gobble up so much bandwidth because your service is so bandwidth-intensive.
We don’t gobble anything. Their users choose to watch us. They sell a service to their members, and their members are using it.
What has surprised you the most about Washington?
How hard immigration is. In 1998, I worked hard on H-1B visas, and it’s been a long and hard-fought battle. I’m optimistic something will pass this year.

Comcast’s Deal With Netflix Makes Network Neutrality Obsolete
By Timothy B. Lee, Washington Post, 23 February 2014)
(Paul Sakuma / AP)(Paul Sakuma / AP)
For the past two decades, the Internet has operated as an unregulated, competitive free market. Given the tendency of networked industries to lapse into monopoly—think of AT&T's 70-year hold over telephone service, for example—that's a minor miracle. But recent developments are putting the Internet's decentralized architecture in danger.  In recent months, the nation's largest residential Internet service providers have been demanding payment to deliver Netflix traffic to their own customers. On Sunday, the Wall Street Journal reported that Netflix has agreed to the demands of the nation's largest broadband provider, Comcast. The change represents a fundamental shift in power in the Internet economy that threatens to undermine the competitive market structure that have served Internet users so well for the past two decades.

The deal will also transform the debate over network neutrality regulation. Officially, Comcast's deal with Netflix is about interconnection, not traffic discrimination. But it's hard to see a practical difference between this deal and the kind of tiered access that network neutrality advocates have long feared. Network neutrality advocates are going to have to go back to the drawing board.
The classic Internet

To understand what's going on, it's helpful to review the structure of the "classic" Internet.  This is is an idealized depiction of how the "classic" Internet of the late 1990s worked.

Backbone Provider B provides Internet service to Yahoo, carrying traffic to users around the world. Provider B connects with other companies, such as Backbone Provider A. The residential ISP on the right is a customer of Backbone provider A, and it, in turn, offers Internet access to individual households. The red arrows indicate who pays whom for service.  Because the two backbone providers are roughly the same size, they engage in what's called "settlement-free peering": They exchange traffic with each other with no money changing hands.  A big advantage of this industry structure is that the backbone market is competitive. If Backbone Provider B overcharges Yahoo for connectivity, Yahoo can switch to another backbone provider. I've only drawn two backbone companies, but in the real world there were a number of them competing with one another. The fact that the largest backbone providers engage in settlement-free peering ensures that every computer on the Internet can reach every other computer. Competition among backbone providers helps keep prices down and service quality up.

This industry structure has another virtue, too: Network neutrality is protected by default. Traffic from Yahoo comes to the residential ISP in a big bundle along with traffic from lots of other Web sites. As I argued in a 2008 paper for the Cato Institute, that makes non-discrimination the default and gives residential ISPs limited leverage over distant Web sites. If the residential ISP wanted to discriminate against Yahoo traffic, it would need to make an explicit decision to block or degrade it, which would likely trigger a customer backlash. That has allowed network neutrality to thrive in the 1990s and 2000s even though there was no formal network neutrality regulations until 2010.

But the Internet is changing. One sign of that change is the just-announced deal between Comcast and Netflix. Another is Ars Technica's recent story about a dispute between the backbone provider Cogent and Verizon. Netflix is a Cogent customer. Surging Netflix traffic has been overwhelming the links between Cogent and Verizon. Cogent has asked for those links to be upgraded, but according to Cogent, Verizon has demanded payment for upgrading the links. (When Ars asked Verizon for comment, a spokesman declined to comment on the specifics of the negotiation.)
We can depict the dispute like this:  In this version of the Internet, two big things have changed. First, Netflix is really big. The video streaming site now accounts for about 30 percent of all traffic on the Internet. Second, Verizon acquired the formerly independent backbone provider MCI in 2006, helping to turn itself into a major backbone provider in its own right.  Those changes matter for Cogent's negotiations with Verizon. In the first chart, Backbone Provider A's leverage was limited by the fact that Backbone Provider B could always connect directly to the residential ISP, potentially costing A a customer. That gave A a strong incentive to keep its network fast and its interconnection terms reasonable.  The negotiation between Cogent and Verizon is different. Verizon plays the role of both backbone provider and residential ISP. That puts Verizon in a much stronger negotiating position, because Cogent doesn't have any practical way to route around Verizon. If Cogent wants to reach Verizon's customers, it needs to cut a deal with Verizon.

The FCC's dilemma
The fact that Netflix agreed to pay Comcast suggests that Cogent will likely lose its fight with Verizon as well. And as Cogent's chief executive Dave Schaeffer told Ars, "once you pay it's like blackmail, they've got you, there's nowhere else to go. They'll just keep raising the price in a market where prices [for transit] are falling."  Indeed, in the long run, this development threatens the survival of independent backbone companies like Cogent. If it becomes industry practice for backbone providers to pay residential ISPs, companies like Cogent will become mere resellers of access to the networks of large broadband companies. Or they may be cut out of the loop altogether, as large customers such as Netflix cut deals directly with broadband providers such as Comcast.

Cutting out the middleman might make the Internet more efficient, but it will also make it less competitive. Cogent has many competitors. Verizon's FiOS service does not. If companies like Cogent are squeezed out of business, it will make these already powerful network owners even more powerful.  It would also transform the network neutrality debate. As I mentioned before, the conventional network neutrality debate implicitly assumes that residential ISPs receive Internet traffic from one big pipe. Network neutrality advocates want rules prohibiting ISPs from divvying this pipe up into fast and slow lanes based on business considerations.  But in a world where Netflix and Yahoo connect directly to residential ISPs, every Internet company will have its own separate pipe. And policing whether different pipes are equally good is a much harder problem than requiring that all of the traffic in a single pipe be treated the same. If it wanted to ensure a level playing field, the FCC would be forced to become intimately involved in interconnection disputes, overseeing who Verizon interconnects with, how fast the connections are and how much they can charge to do it.
At this point, the FCC doesn't have any good options. Regulating the terms of interconnection would be a difficult, error-prone process. Trying to reverse the decade-old mergers that allowed America's broadband market to become so concentrated in the first place would be even more so. But the growing power of residential broadband providers will put growing pressure on the FCC to do something to prevent the abuse of that power.

One clear lesson, though, is that further industry consolidation can only make the situation worse. The more concentrated the broadband market becomes, the more leverage broadband providers like Comcast and Verizon will have over backbone providers like Cogent. That gives the FCC a good reason to be skeptical of Comcast's proposed acquisition of its largest rival, Time Warner Cable. Blocking that transaction could save the agency larger headaches in the future.


Comcast And Netflix Make A Deal To End Traffic Jam
(By Jennifer Saba, Reuters, 23 February 2014)

Comcast Corp customers are about to get improved streaming service from Netflix after the two companies announced on Sunday an agreement to give Netflix a direct connection to the broadband provider.  This agreement means that Netflix will deliver its movies and TV programs to Comcast's broadband network as opposed through third party providers, giving viewers faster streaming speeds for watching movies and TV programs.  The deal could also mean that other broadband providers like Verizon and AT&T will have to strike a similar arrangements, known in the industry as interconnect agreements.

The companies said in a joint statement that they have been "working collaboratively over many months" to strike a multi-year agreement. The terms were not disclosed and Netflix will not receive preferential network treatment, the companies said.  With more than 44 million subscribers throughout the world, Netflix has been making an effort to connect directly with broadband Internet providers. It has struck similar deals with Cablevision and Cox.  The announcement comes as Comcast prepares to acquire Time Warner Cable for $45 billion, a deal that will draw the scrutiny of U.S. antitrust enforcers.  The combined company would have a near 30 percent share of the U.S. pay television market, as well as be the major provider of broadband Internet access.  At the same time, Federal regulators are wrestling with an issue known as "Net neutrality" concerning broadband providers and whether they can slow down traffic to some particular websites or applications, potentially forcing content providers to pay for faster Web service.  The Federal Communications Commission said last week it plans to rewrite the rules after a U.S. court struck down the commission's previous version.




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