Here's Why It's a Bad Time to Be an Internet Service Provider

Here's how a recent push for transparency by Google and Netflix could lead to weakened margins for internet service providers.

Jun 11, 2014 at 11:30PM

How many times have you struggled streaming a video on Netflix (NASDAQ:NFLX) or YouTube? Probably too many to count. It can be a maddening experience. Especially because you probably don't know who to blame for the bad quality. 

Up until recently, consumers have been in the dark about the causes of their erratic service quality while streaming videos. But Netflix and Google (NASDAQ:GOOG) aim to change this. 

Recently, the two companies have attempted to increase transparency about the quality of their customer's Internet connections. In a sense, Netflix and Google have placed the blame on Internet service providers for the poor service quality received by their customers. This has outraged companies such as Verizon (NYSE:VZ) and AT&T (NYSE:T). With good reason: If the push for transparency gains steam, ISP's may be forced to invest massive amounts of money into revamping their technical infrastructure which could severely drop their profit margins. 

Google's push for transparency & how it could affect the margins of ISP's 
Google has created a tool called "Video Quality Report" for its video streaming website YouTube. The site provides data obtained from billions of YouTube videos watched across thousands of ISPs.The tool educates users on the role Internet service providers play in the quality of YouTube videos. People can also use the tool to determine which ISP will provide them with the best Internet in their area. 

Google Tool

Source: Google

Netflix's fight against Internet service providers
On its U.S. and Canada blog, Netflix regularly posts an "ISP Speed Index." The post is meant to inform customers about how their Internet service provider ranks against others when it comes to speed. 

In March of this year, Netflix made its most controversial post titled "Internet Tolls and the Case for Net Neutrality." The post vouched for consumers and promoted net-neutrality. 

The post from March also discussed ISP Interconnection Fees. Reed Hastings, CEO of Netflix, talked about the slippery slope ISP Interconnection Fees may create. "If this kind of leverage is effective against Netflix, which is pretty large, imagine the plight of smaller services today and in the future."

In response to the post, Jim Cicconi of AT&T created his own post titled "Who Should Pay for Netflix." Mr. Cicconi believes Netflix should pay for the increased Internet demand it has created. 

In its most recent attack on Internet service providers, Netflix created a memo that pops up for Verizon users when their streaming is interrupted by poor connectivity:

Netflix Burn

Source: Yuri Victor's Twitter post

Verizon fights back
Verizon threatened Netflix with a cease and desist letter demanding that it removes the Verizon-blaming caption from its website. 

Netflix quickly responded with this message: "This is about consumers not getting what they paid for from their broadband provider. We are trying to provide more transparency, just like we do with ISP Speed Index, and Verizon is trying to shut down that discussion."

Who will win and who will lose
It's very difficult to say what net-neutrality laws will look like in the future. Both sides of the debate seem valid.

As for the push for better Internet service quality, the unveiling of what goes into our Internet speed and connectivity could be a great thing for consumers and companies such as Netflix and Google. 

If Netflix' and Google's efforts change consumers' Internet service provider preferences, the consequences could be monumental. Consumers may begin ditching their current provider for a better service. This could cause a much-needed boost in the level of competition in the ISP industry. To retain customers, companies may be forced to invest in their technical infrastructure to improve the quality of their services. 

What it could mean for investors
For Google and Netflix, all-around better Internet connectivity would probably mean happier customers. 

For Internet service providers such as Verizon and AT&T, a race for better connectivity in the ISP industry could be harmful to their bottom lines. If they were forced to spend money on their networks, this would diminish their robust profit margins of 20% and 10% respectively.

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Michael Nielsen owns shares of Netflix. The Motley Fool recommends Google (C shares) and Netflix. The Motley Fool owns shares of Google (C shares) and Netflix. 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.

4 in 5 Americans Are Ignoring Buffett's Warning

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Jun 12, 2015 at 5:01PM

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David Hanson owns shares of Berkshire Hathaway and American Express. The Motley Fool recommends and owns shares of Berkshire Hathaway, Google, and Coca-Cola.We Fools don't 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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