Netflix Just Changed the Digital-Delivery Game

Netflix (Nasdaq: NFLX  ) pushes a lot of data bits out to broadband-connected consumers. At times, the digital-movie service consumes about one-third of all consumer bandwidth in America. By using content-delivery services from Akamai Technologies (Nasdaq: AKAM  ) , Limelight Networks (Nasdaq: LLNW  ) , and Level 3 Communications (Nasdaq: LVLT  ) , the company reduces the strain on the Internet backbone -- your movie rarely comes straight from a Netflix server, but more likely from an Akamai or Level 3 cache closer to you.

But that's still not good enough for Netflix. The company just launched its own content-delivery network, or CDN, service that will put its movie library right in your service provider's data centers. That's the digital equivalent of hooking up a fire hose to your kitchen sink.

Free for you, cheap for them
So you run a broadband service provider and are getting fed up with the huge amounts of data that Netflix pushes across your network borders? Some ISPs have to pay their network partners for that privilege, after all.

Fear not -- Netflix will now be happy to set up a couple of special cache servers in your central network, sucking down each movie from Netflix only once and serving it up to consumers on demand. Or you can connect to the nearest Netflix-owned Internet exchange station, a common industry practice known as peering. Either way, Netflix provides the solution your ISP wants at no cost. There's even a stick to go with that carrot: "For ISPs who do not choose to peer with the Netflix network, content will be filled from any of several CDN and transit networks, and Netflix will not be responsible for any costs associated with appliance fill traffic."

These boxes have actually been quietly available for a while and already serve up about 5% of all Netflix movies. But in the long run, it's pretty much bye-bye to Akamai, Level 3, and Limelight: "Eventually most of our data will be served by Open Connect," Netflix says.

This spring, Netflix CEO Reed Hastings sparred with Comcast (Nasdaq: CMCSA  ) over Netflix streams counting against the cable giant's data caps while Comcast's own Internet video services didn't. These cache servers could do an end-around run to gain the same cap-free status. I love trick plays.

But won't all this hardware be too expensive for Netflix?
Digital-video guru Dan Rayburn notes that Netflix should save a lot of money on the lower bandwidth costs this network will bring. That should offset the costs of shipping out hardware and then become a direct cost-saving when the buildout is complete.

And don't cry for Akamai, Rayburn says. The CDN specialists get a lot of revenue from their Netflix contracts, but at very low margins. Limelight and friends will be able to relax their capital expenses a bit now that Netflix shoulders some of the growing data-handling needs itself.

So Netflix customers get faster and more reliable connections, Netflix saves money, your service provider cuts costs, and the other CDN providers refocus on more profitable contracts. Overall, Netflix reduces the strain it places on the public Internet. It's a win-win-win-win-win in my book.

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Fool contributor Anders Bylund owns shares of Netflix and has created a bull call spread on the stock, but he holds no other position in any of the companies mentioned. Check out Anders' holdings and bio, or follow him on Twitter and Google+. The Motley Fool owns shares of Netflix. Motley Fool newsletter services have recommended buying shares of Netflix. The Motley Fool has a disclosure policy. We Fools don't all hold the same opinion, but we all believe that considering a diverse range of insights makes us better investors. Try any of our Foolish newsletter services free for 30 days.


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  • Report this Comment On June 05, 2012, at 11:39 PM, newageinvestor wrote:

    Netflix is down 72 percent since I finally took your advice to buy it. I'm so on the fence as to whether to wait for it to back up a little and then dump it, because at the rate it's going in the past 6 months, it's going to take 10 years to get back up over the 200 mark. I'm permanently disgusted with the whole thing

  • Report this Comment On June 06, 2012, at 8:40 AM, TMFZahrim wrote:

    @newageinvestor, patience young grasshopper. The Street currently hates NFLX with a passion because it will invest in international growth rather than cultivating earnings. On top of that, there's a short-term overreaction to seasonality here in the summer months. Netflix is building a long-term cash machine, but this is the investment phase. If this stock doesn't hit $120 in 2012, I'll buy a hat just to eat it. $200 and beyond will come, and not in a decade as you fear.

    Anders

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