Netflix (NASDAQ:NFLX) has had a problem lately. Despite working toward more HD offerings and experimenting with 4K resolutions, the company's streaming service has been seeing slower transfer speeds and customers receiving SD streams despite having broadband capable of receiving HD.
Part of the problem is that Netflix uses a middleman to connect to major carriers such as Verizon (NYSE:VZ) and Comcast (NASDAQ:CMCSA). This allows Netflix to minimize its delivery pipeline, letting the company that it purchased the transit bandwidth from actually do the delivery to different providers.
This is where the problem comes in -- the digital transit middleman Cogent Communications (which delivers Netflix content to the larger carriers) is currently having problems delivering that data at full speed. The company's connections to the Verizon network are in need of upgrading, and both Cogent and Verizon want the other company to pay for those upgrades.
In an effort to circumvent these problems, Netflix has made a long-term deal with Comcast to access its network directly instead of using a third party. This eliminates problems like it's experiencing with Cogent, but it might also be opening the door for additional problems down the road.
Under the terms of the Comcast-Netflix deal, Netflix will pay an undisclosed amount to Comcast in exchange for a direct connection to the Comcast network. The agreement is a multi-year collaboration, though according to a joint statement issued by the companies it will not grant any preferential treatment to Netflix content. The deal has been in the works for several months, with the companies reporting that some Netflix customers have already been enjoying the benefits of this direct connection.
While the specifics of the deal and the amount that Netflix is paying have been kept under wraps, the end result is pretty straightforward -- Netflix is skipping the middleman and connecting directly to Comcast's network to eliminate dropped data packets and inconsistent transmission speeds. If this agreement is successful, the company may try to reach similar agreements with other networks it's having issues with, such as Verizon and AT&T (NYSE:T).
For Netflix subscribers who use Comcast, the deal between the two companies might provide better quality for streaming video from Netflix. If similar deals crop up elsewhere, it could have a similar effect for AT&T and Verizon customers. There are a few potential problems that could arise in the longer term, however.
The first of these is the cost of these deals. If they end up costing Netflix less than it's currently paying to Cogent and any other companies that these deals would replace, Netflix will benefit from cost savings in addition to improved quality for its streaming customers.
If the deals cost more, though, that cost increase could be passed on to customers. Netflix is a business, after all, and with plans to spend $3 billion on new content this year and $6.2 billion in the next three years, it will likely want to recoup any new losses somewhere.
Another potential side effect of these deals involves data caps. While not all ISPs currently feature data caps -- and those that do don't always actively enforce them -- it's likely that data caps will become much more common in the future as digital distribution and 4K streaming become more prevalent.
Comcast has been testing data caps and overage fees in several markets, and while it doesn't currently enforce caps that were previously established in non-test markets, the expanded testing makes it seem likely that data caps will come back in a big way in the future. This could set up a case where either Netflix users would once again face slowdowns or lower-quality streaming, or in a worst-case scenario the Netflix-Comcast agreement would be modified to allow for data cap exemptions (at which point Netflix traffic would be receiving preferential treatment).
One other potential problem that could arise is that it could make it more difficult for other companies to compete against Netflix online. With a direct connection to Comcast's network, Netflix could develop a bandwidth advantage over competing services that still used middlemen to connect. This could eventually lead to increased regulation of the industry if it's perceived that Netflix has an unfair advantage over its peers.
A Foolish conclusion
At the moment, there's nothing inherently "bad" about the Comcast-Netflix deal. It solves Netflix's most immediate problem with its streaming quality and may open the door for further 4K expansion.
Where it positions the company and the Internet in general for the future is a different matter. If the deal eventually evolves to the point where Netflix gains an unfair advantage over its peers that don't have expensive connection deals or the company begins receiving preferential treatment regarding data caps, it could deal a very serious blow to both competitors and the Net Neutrality movement.
John Casteele owns shares of AT&T. The Motley Fool recommends Netflix. The Motley Fool owns shares of 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.