What the FCC's Net Neutrality Proposal Could Cost Consumers

New rules would likely force more streaming content companies to pay internet service providers for better access with consumers ultimately footing the bill.

Apr 28, 2014 at 11:41AM

Until fairly recently Internet service providers operated under the principal of net neutrality -- the idea that all content would be treated equally by Internet service providers. 

In January a federal court overturned the Federal Communication Commission's rules that maintained net neutrality. Under the new rules -- or at least under the common interpretation of what the ruling means -- ISPs are still letting all content through, but they now have the right to slow down delivery speeds. This gives the ISPs enormous power over consumers and it forced Netflix (NASDAQ:NFLX) to make a deal with Comcast (NASDAQ:CMCSA) to ensure its customers who get Internet through the cable giant have a good experience.

Now the FCC wants to end the confusion and has proposed making it law that internet service providers could charge streaming content providers, such as Netflix and Amazon (NASDAQ: AMZN), more for preferential treatment as long as the same deals are available to others on "commercially reasonable" terms. The potential new rules are likely to be voted on at the FCC's May 15 meeting, and would give the FCC the authority to review these arrangements to ensure that they don't harm consumers and competition.

That's probably not a lot of comfort for consumers. The FCC has always been highly political and its decisions tend not to put the general public first. It's hard to imagine that a government agency that supports a law that will increase costs for streaming video services -- and almost certainly consumers -- will also be the public's watchdog to make sure all companies can purchase the same preferential treatment.

Netflix has already paid

Netflix and Comcast made a deal in February in which Netflix will pay Comcast for faster and more reliable access to Comcast's subscribers. The two companies clearly had very different takes on the deal with the cable company trumpeting it as a victory for consumers and Netflix making it's distaste in having to make the deal very clear. No financial details of the deal were disclosed but a person close to the companies said it involved annual payments of several million dollars, The New York Times reported.

"This is the water in the basement for the Internet industry," Tim Wu, a Columbia Law School professor and advocate for net neutrality told the Times, the first in what could be a flood of such arrangements. "I think it is going to be bad for consumers because such costs are often passed through to the customer."

Netflix Vice President of Content Delivery Ken Florance argued on a company blog that these types of deals are bad for consumers and it made its deal with Comcast only because it had to. "Netflix agreed to pay Comcast for direct interconnection to reverse an unacceptable decline in our members' video experience on the Comcast network," he wrote. "These members were experiencing poor streaming quality because Comcast allowed its links to Internet transit providers like Level3, XO, Cogent, and Tata to clog up, slowing delivery of movies and TV shows to Netflix users." 

Florance explained that Comcast does not carry Netflix data over long distances. Usually that is done by companies called transit providers, but Netflix has decided to be its own transit provider and carries the expense of moving its data around. Comcast and other ISPs however control the so-called "last mile," the actual gateway to customers. Florance believes that what Comcast is doing is wrong. 

"Comcast is not charging Netflix for transit service. It is charging Netflix for access to its subscribers," Florance wrote. "Comcast also charges its subscribers for access to Internet content providers like Netflix. In this way, Comcast is double dipping by getting both its subscribers and Internet content providers to pay for access to each other. 

However you look at it consumers are the ones being squeezed as most people have limited choice when it comes to ISPs. In my house I can choose between cable company Internet and phone company Internet -- if both choose to ransom Netflix and other streaming services by holding my level of service hostage, it's not like I'm going to move just to have a better choice in ISPs.

The FCC is not looking out for consumers

If ISPs can charge streaming (and other) services for preferential treatment, it's likely those costs will eventually be passed onto consumers. And while the proposed law will make it so the ISPs have to offer any content provider a similar deal, the cost of such a deal could be a huge barrier to entry for new streaming content companies, depending upon how the FCC interprets "commercially reasonable" terms. 

Let's say the Netflix/Comcast deal is a flat-rate deal not dependent upon how much data flows and Netflix is paying $5 million a year. If Netflix makes similar deals with other major ISPs, perhaps the company would have $15 million to $20 million a year in costs. That's an unpleasant but relatively minor expense for a company that spent $2 billion in content in 2013.

But for a potential new player in the field it's a company killer. Even if the ISPs offered some level of metered deal based on volume it's an added expense that will be passed onto consumers.

Under the proposed rules the ISPs are making out on both ends of the transaction and customers are getting the short end of the stick. It's not like Comcast, with its new source of revenue, plans to lower rates for its customers. Instead the cable company is using its customers as a wedge to force Netflix and others into these deal.

The FCC should be protecting the American public but it seems like protecting giant cable and telephone companies comes first. 

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Daniel Kline has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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