Netflix’s Lost Battle Sets up a Nice Victory in the Longer-Term War

Netflix is forced to pay to provide customers with uninterrupted service, but over the long term this will only be a bump in the road.

Aug 24, 2014 at 11:00AM

Netflix (NASDAQ:NFLX) was recently forced into a peering deal with Time Warner (NYSE:TWC), following similar agreements with Comcast, Verizon, and AT&T to pay a fee to these service providers for streaming Netflix's content. Essentially, these deals ensure that Netflix customers won't encounter problems with streaming content by providing the company direct access to a network, which Netflix CEO Reed Hastings believes should be a standard service. Thankfully for Hastings, major industry changes, along with the growth of his company, suggest that Netflix will ultimately win this war.

Four deals to serve common customers
Video streaming requires lots of data, so much that when Netflix customers watch a movie or show, buffering and slow download speeds often occur in the absence of a direct connection from Netflix's servers to the Internet provider's network. As a result, Netflix has agreed to these deals, with undisclosed terms, to gain direct feeds that should enable more consistent downloads and a better viewing experience for subscribers who receive Internet service from these companies.

Orange

Source: wikipedia.

First, Netflix signed a peering deal with Comcast, then Verizon and AT&T, and now Time Warner. Clearly, a better viewing experience is a big win for consumers, especially for the millions who have abandoned cable and satellite in favor of the much cheaper Netflix. However, Netflix's CEO is far from enthusiastic.

Reed Hastings not happy, but has no choice
Reportedly, Netflix is responsible for nearly one-third of all Internet traffic. Given this information, it is no surprise that the company's services are putting a major strain on Internet providers, and that those providers would want a little extra incentive. Still, Hastings insists that such deals are complete opposite of net neutrality, arguing in a blog post: "To ensure the Internet remains humanity's most important platform for progress, net neutrality must be defended and strengthened. The essence of net neutrality is that ISPs such as AT&T and Comcast don't restrict, influence or otherwise meddle with the choices consumers make."

Hastings offered a strong case against the reasoning for Netflix having to share the costs it creates through such high Internet activity: "ISPs sometimes point to data showing that Netflix members account for about 30% of peak residential Internet traffic, so the ISPs want us to share in their costs. But they don't also offer for Netflix or similar services to share in the ISPs revenue, so cost-sharing makes no sense."

The CEO concluded the posting with this thought: "Some big ISPs are extracting a toll because they can -- they effectively control access to millions of consumers and are willing to sacrifice the interests of their own customers to press Netflix and others to pay." Essentially, Hastings argued that big Internet providers are forcing Netflix into this position because they can, and because they hold all the leverage, not realizing that their customers also want to enjoy the Netflix experience.

Don't worry Hastings, leverage is coming soon
Netflix has more than 50 million global users, meaning that it has likely hurt growth of cable and satellite, and perhaps suggesting why Internet service providers, who often offer TV packages, are content with its slower download speeds and a less than favorable experience. However, Netflix now has expectations for faster speeds as a result of these deals, and isn't afraid to point the finger when service providers don't meet their end of the deal -- thereby making Hastings' company look superior to the public eye. But its greatest asset, and perhaps the consumer's best friend, is a new business from Google (NASDAQ:GOOG) (NASDAQ:GOOGL).

Goog Fiber Expansion Plan

Source: fiber.Google.com.

Google Fiber is a transcendent Internet service with download speeds that are up to 100 times faster than the average broadband Internet; it can download 100 photos in just a few seconds, or an HD movie in minutes. Already, the launch of Google Fiber in three cities and rollout into 34 additional areas has created widespread panic and action by Internet service providers, along with incredible consumer demand. In an industry that has refused to upgrade speeds for many years while technology demands more capacity and performance, Google Fiber might be Netflix's greatest advantage against these Internet providers.

Foolish thoughts
With Fiber taking the U.S. by storm, investors and consumers should feel secure that its network is more than capable of handling Netflix's demand, and that Internet providers as an industry will be forced to either upgrade their networks or become irrelevant within this space. So Netflix might appear vulnerable right now, being forced into unnecessary peering deals. But, with all of its macro advantages, its growing base of users, and the rise of Google Fiber, Netflix's lost battle against service providers will only set up a much more rewarding victory in this war.

Your cable company is scared, but you can get rich
You know cable's going away. But do you know how to profit? There's $2.2 trillion out there to be had. Currently, cable grabs a big piece of it. That won't last. And when cable falters, three companies are poised to benefit. Click here for their names. Hint: They're not Netflix, Google, and Apple. 

 

 

Brian Nichols owns shares of Apple and Verizon Communications. The Motley Fool recommends Apple, Google (A shares), Google (C shares), and Netflix. The Motley Fool owns shares of Apple, Google (A shares), 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.

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