Netflix CEO Warns of Possible Grim Future, Post-Net Neutrality

Netflix CEO on Net-Neutrality

Another great post on in the world of Net-Neutrality that I just had to re-post.  To see the original article click here.

He says that he doesn’t believe it will happen, but that there’s a small chance an ISP could embrace such tacticsIn its quarterly earnings report, Netflix, Inc. (NFLX) CEO Reed Hastings paints a cautionary tale of what could happen if Congress does not clarify and strongly protect net neutrality.I. The WarningHe writes:

Unfortunately, Verizon successfully challenged the U.S. net neutrality rules. In principle, a domestic ISP now can legally impede the video streams that members request from Netflix, degrading the experience we jointly provide. The motivation could be to get Netflix to pay fees to stop this degradation. Were this draconian scenario to unfold with some ISP, we would vigorously protest and encourage our members to demand the open Internet they are paying their ISP to deliver.The most likely case, however, is that ISPs will avoid this consumer-unfriendly path of discrimination.  ISPs are generally aware of the broad public support for net neutrality and don’t want to galvanize government action.  Moreover, ISPs have very profitable broadband businesses they want to expand. Consumers purchase higher bandwidth packages mostly for one reason: high-quality streaming video. ISPs appear to recognize this and many of them are working closely with us and other streaming video services to enable the ISPs subscribers to more consistently get the high-quality streaming video consumers desire.In the long-term, we think Netflix and consumers are best served by strong network neutrality across all networks, including wireless. To the degree that ISPs adhere to a meaningful voluntary code of conduct, less regulation is warranted. To the degree that some aggressive ISPs start impeding specific data flows, more regulation would clearly be needed.
Reed Hastings
Netflix CEO Reed Hastings is fearful of what the death of net neutrality could bring.
[Image Source: Social News Daily]

In other words, Verizon, Inc. (VZ) and AT&T, Inc. (T) — the two largest wireless operators in the U.S. market — plus Time Warner Cable Inc. (TWC) and Comcast Corp. (CMCSA), have all pledged to not discriminate against “legal” content to some extent.

But Mr. Hastings is aptly pointing out that such promises are nebulously defined at best, and there’s a lack of momentum to commit to a single industry-wide standard that would prevent abuse without government intervention.

The problem is somewhat of a catch-22 as unequal taxation and other government handouts have helped to consolidate the U.S. wired and wireless industry into just a handful of dominant powers.

The issue extends all the way down to the states, where cable internet operators like TWC and Comcast pay large sums of cash to state officials to hinder efforts by potential competitors to enter “their turf” and to stymie public-private partnerships, another alternative.  As a result, in many regions a single provider retains a monopoly on high-speed service in a region, or at best two large powers control local service.

Given the at times collusive behavior of these top players, “two can be as bad as one” as the band Three Dog Night once sang.

Friendly bribe
Lots of bribes — or as the Supreme Court defines it “free speech” — has winnowed the cable and wireless markets down to just a few dominant entities. [Image Source: Haberrus]

In other words, in a healthy, competitive market, service providers might be forced to bow to customers and not stymie popular content providers (or even small newer content providers).  But in the U.S.’s artificially controlled market where the government has doted on a few favored companies, growing them to monstrous proportions, there may not be enough competition to rely solely on competition to enforce net neutrality in the absence of regulation.

II. Will Service Providers Throttle More Than Just Filesharing?

So far, throttling efforts have largely been focused on populist file-sharing movement — whether it be of the legal or illegal kind.  But some fear similar tactics could be applied to high bandwidth content such as internet video or radio.  Such a move could help promote a service provider’s rival offering (which streams at full speed), be aimed at squeezing at “toll” out of the content providers, or simply be aimed at reducing network usage to increase profit.

The internet is inherently an interstate affair, hence it might seem to fall clearly under the commerce cause of the Constitution.  Yet Congress has done a very poor job of giving the U.S. Federal Communications Commission (FCC) direction and the power to enforce its rules.  As a result, the FCC tends to put forth policies such as net neutrality, only to have them later killed in embarrassing court defeats.

Net neutrality cutting the wires
Cutting the wires could kill innovations on the net, as well as popular services like Netflix.
[Image Source: CFC Oklahoma]

While Verizon was the latest to kill that policy (which was installed “officially” in Dec. 2012), Comcast had previously successfully shot down a FCC complaint on de facto net neutrality rules.  In the Comcast case the justices seemed to feel it was doubtful that the FCC had authority under laws passed by Congress to enforce such a provision.

With the more codified Dec. 2012 implementation and with the FCC’s formal justification of how it believed net neutrality was within the powers granted it by Congress, the same court (U.S. Court of Appeals for the D.C. Circuit) rethought the April 2010 Comcast ruling, when Verizon sued to block the rules.  But ultimately the FCC still lost under the new rules, as the court ruled that the FCC could not enforce the policy given how it classified large carriers (a classification that it used to unofficially try to give benefits to smaller competitors).


Part of the blame in that latest loss rests on the shoulders of FCC officials, but part of it also rests on Congress for failing to simply pass a law clearly defining the extent of net neutrality, a clear Constitutional justification, and the endowment of strong enough regulatory power for enforcement purposes.

Fiber optic cable
The FCC lacks clear guidelines when it comes to net neutrality, and also lacks the power to carry out significant enforcement. [Image Source: Guardian UK]

As a result, companies like Google Inc. (GOOG) (whose YouTube service could be in the crosshairs of throttling), Pandora Media Inc. (P), and Netflix have to adopt a wary wait-and-see attitude, hoping service providers live up to their nonbinding promises, and that any would-be throttling schemes are stayed for fear of angering customers.  As Mr. Reed suggests, we may arrive a decade from now and be relieved that no major clashes between service providers and content providers occurred.  But sooner or later, it might happen, and that’s a big threat to Netflix.

(Older estimates indicate Netflix may use as much of a third of cable internet bandwidth in the U.S.  Competitors such as, Inc. (AMZN) and Hulu may have cut into that total, though.)

III. For Now Netflix Can Smile at Steady Growth

Otherwise, Netflix posted a strong quarter, with 2.33 million new subscriptions in the U.S. and 1.6 million abroad.  Netflix now has 33.42 million subscribers in the U.S. and 10.93 million abroad.  Of these 31.71 million in the U.S. (95%) and 9.72 million abroad (89%) are paid subscribers.  Netflix pulled in a cool $1.175B USD in subscription revenue, and saw a net profit of $48M USD ($0.79 USD/share), a figure that was sunk somewhat by a net loss of $57M USD.

The customer growth was in the high end of analyst predictions, and was met with much enthusiasm.  The earnings per share beat the average expectation among analysts surveyed by Thomson Reuters I/B/E/S.  Analysts, on average expected only $0.66 USD/share ($40M USD) earnings.

Netflix has faced its fair share of controversies over the years.

While it may now cry foul on data discrimination, it had no problem discriminating against others content less than a decade ago.  Back in 2006 it tried to kill Blockbuster’s internet rental service — an anticompetitive effort that would arguably help to kill Blockbuster in the process, dealing a fatal blow to the video rental service’s recovery and attempt at transitioning to a more modern online business model.  Following a 2008 court battle, Blockbuster did eventually beat back Netflix, winning the rights to launch digital services and cut its late fees, but that wasn’t enough to save itby 2010 it was bankrupt.

While many didn’t care for Blockbuster, some disliked how Netflix used legal actions to freeze Blockbuster’s online efforts, helping to eventually kill the rival firm.

Some customers remain bitter about that.

Netflix also weathered a storm of controversy when it split its DVD rental and streaming services, knocking two dollars (from $9.99 USD/month for the bundled rate to $7.99 USD/month) for streaming only service, but increasing the overall price for customers who want both.  As might be expected the new terms led to some shrinkage in both new subscriptions and overall DVD subscriptions.

Netflix family
Netflix survived controversy over its pricing and legal campaign against Blockbuster.

But Netflix won customers back with a recent price cut down to $6.99 USD/month for single-user streaming video, and grew profits steadily throughout late 2012 through 2013.

Netflix has also is still struggling to get premium content from some sources.  But overall it is growing fast and customers are generally happier with it today than they were during the rocky periods of the Blockbuster wars and the restructuring from DVD-focused with a side of streaming to streaming focused business.


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