What Does Netflix’s Decision to Block Internet Content Tell Us About Internet Policy?

Posted by | January 23, 2013 | Broadband Internet | 2 Comments

I posted an analysis of Netflix’s new Internet blocking strategy last week. I concluded that Netflix is attempting to leverage net neutrality regulations to gain an anticompetitive price advantage in the marketplace. In my view, this harm is an unintended consequence of the FCC’s decision to abandon its free market approach to the Internet and adopt net neutrality rules that enhance the market power of so-called “edge” companies. As Neil Stevens said in his Tech at Night column: “Told you so.”

Harold Feld apparently agrees that Netflix is threatening competition, and he has is own case of Cassandrafreude (“told you so,” but with a smile). In his view, however, the problem is that the FCC didn’t go far enough. He believes this situation could have been avoided if the FCC had applied common carrier regulation to the Internet (also known as Title II), which would regulate the Internet using statutes written for the old monopoly telephone network.

Though Harold Feld and I disagree on the appropriate level of Internet regulation (I would prefer less rather than more), it appears we do agree on several issues raised by Netflix’s decision to block access to its Super HD service. The unintended consequence of Netflix’s decision is that the ensuing debate has clarified some important Internet policy issues.

Netflix Cannot Invoke the Net Neutrality Rules to Force “Open Connect”

One issue on which there is an emerging consensus is that Netflix cannot invoke the FCC’s net neutrality rules to force ISPs into agreeing to the terms of its “Open Connect” content delivery network (CDN). The FCC’s net neutrality rules apply only to providers of “broadband Internet access service,” a category that does not include the provision of “virtual private network services, content delivery network services, multichannel video programming services, hosting or data storage services, or Internet backbone services” that are separate from the Internet access service. When asked by Congress whether the FCC’s net neutrality rules apply to peering and backbone arrangements, Chairman Genachowski wrote that the rules make it clear that they apply to Internet access only. As a result, the refusal of ISPs to accede to the private peering and CDN demands of Netflix isn’t covered by the FCC’s rules.

Even if the rules did apply, the ISPs are not blocking Netflix’s new service. Netflix could provide all consumers with access to its new service immediately through its existing CDN providers. Netflix itself has instead chosen to block access to its Super HD service because it doesn’t want to pay its existing CDN providers for delivery of the new service. Netflix would prefer that the ISPs pay for its delivery, which would give Netflix a competitive advantage by imposing the costs of delivering its new service on all Internet consumers.

Others that have engaged in Internet CDN and peering debates, including Netflix, support the view that net neutrality rules don’t apply to the Netflix dispute.

 

Harold Feld’s blog post implies that Netflix cannot invoke the FCC’s net neutrality rules to force ISPs to accept its demands, though he argues that regulations should apply to CDN and peering disputes.

Of course, I don’t expect Netflix to allege that the ISPs are violating net neutrality by refusing to use its “Open Connect” CDN. During the peering dispute between Comcast and Level 3, Netflix acknowledged that the FCC’s net neutrality rules don’t govern CDN and peering disputes. In a letter to House Energy and Commerce Committee Chairman Fred Upton and Subcommittee Chairman Greg Walden, Netflix CEO Reed Hastings said the FCC “did not expressly deal with entry into an ISP’s network.”

Consumers Cannot Invoke the Net Neutrality Rules to Access Super HD

The Netflix debate also clarifies an important net neutrality issue: The FCC’s net neutrality rules were never intended to ensure consumers could access the content of their choice. They were intended only to ensure that content providers could access every consumer.

The net neutrality principles adopted by the agency in 2005 were focused on consumers. The principles provided that “consumers are entitled to access the lawful Internet content of their choice,” “run applications and use services of their choice,” “connect their choice of legal devices,” and that “consumers are entitled to competition among network providers, application and service providers, and content providers.” When the FCC adopted net neutrality rules in 2010, it claimed they would “empower and protect consumers” and ensure “consumers can make their own choices about what applications and services to use” on a “level playing field.”

The initial principles and the FCC’s assertions have led many to believe its net neutrality rules are intended to promote consumer choice. Prominent net neutrality proponents “believe consumers, not corporations, should be in the driver’s seat to pick the content they view . . . over the Internet.” I expect they would be surprised to learn that the FCC’s net neutrality rules eliminated the consumer focus of the net neutrality principles as well as the stated right to competition among application, service, and content providers. The FCC decided that, “insofar as these rules translate existing [FCC] principles into codified rules, it is appropriate to limit the application of the rules to broadband Internet access service.”

Despite the FCC’s dramatic claims to the contrary, the net neutrality rules weren’t intended to allow consumers to access the Internet content of their choice. No matter how many times I choose to click on Netflix’s Super HD service, Netflix won’t deliver that content to me, and it has no legal obligation to do so.

To my surprise, knowledgeable public interest advocates (with limited exceptions, e.g., Harold Feld) have been largely silent on the asymmetrical application of net neutrality principles. When I suggested on Twitter that the FCC’s rules had failed to prevent the leveraging of market power on the Internet, I was told that wasn’t the purpose of net neutrality.

 

When I remembered that the FCC relied on a novel “gatekeeper” theory to support its net neutrality rules rather than a finding that ISPs have market power, Timothy B. Lee argued that Netflix isn’t a “gatekeeper” because other content providers don’t have to rely on Netflix to reach consumers.

 

 

This Twitter discussion clarified that the “point” of net neutrality is maximizing the access of content providers to consumers, not maximizing consumer access to content.

 

To the extent net neutrality promotes consumer choice it is a byproduct of the rules rather than their point.

Netflix Can Invoke the Net Neutrality Rules as Leverage in Its Negotiations

If, as my recent Twitter conversation suggests, the purpose of the net neutrality rules was to give content providers (not consumers) an advantage in their negotiations with ISPs, the net neutrality rules are working. As I noted in my original post, the FCC’s rules enhance Netflix’s leverage in its dispute with the ISPs by limiting ISPs’ available responses. In the absence of net neutrality rules, ISPs could accede to Netflix’s demands and recover the additional cost of delivering its new service by raising Internet access prices only for Netflix subscribers. This option would promote competition by ensuring the additional costs of Netflix’s Super HD service are transparent to consumers.

In reality, the asymmetric application of net neutrality increases the possibility that Netflix will be able to conceal the costs of its new service from consumers by requiring ISPs to incorporate it into their pricing structure. The result: Netflix wins! – consumers, ISPs, and Netflix competitors lose.

Eliminating net neutrality is the best remedy

There has been some confusion about the intent of my first blog post regarding Netflix. I am not suggesting that the solution to the asymmetry in the FCC’s net neutrality rules is to include within their scope Netflix and other content providers (i.e., to regulate “up”). In my view, the best remedy would be the elimination of prophylactic net neutrality rules altogether.

The Internet marketplace is still very dynamic, and the relative market power of its participants is rapidly changing. As Chris Yoo predicted in 2006, there is no reason to assume that “payments will necessarily flow from the content providers to the last-mile providers instead of the other way around.” In a two-sided market, the potential for anticompetitive behavior depends on the relative bargaining power of each party. Netflix obviously believes its international scale and exclusive content arrangements give it sufficient leverage to dictate terms to regional ISPs in the United States. Yet the law presumes that even the smallest ISPs can exercise “gatekeeper” power against Netflix.

This illogical favoritism is beginning to threaten the open Internet more than ISPs ever have. It is harming consumers, distorting investment decisions, and strengthening international calls for regulation of the Internet. If we learn nothing else from Netflix, we should all agree that it’s time to start having a more nuanced discussion of Internet policy.

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