Recently, Internet service providers started using "interconnection fees" to charge Netflix (NASDAQ:NFLX) for its colossal use of bandwidth. While the fees are good for ISP's, they have caused some Netflix investors to question its long-term profitability. Over the last month, shares dropped 25%. But, a recent EU Parliament vote has positive implications for Netflix.
ISP Interconnection fees and how they will affect Netflix
As Netflix's subscriber base has grown, so has its network bandwidth consumption. According to Jim Cicconi of AT&T (NYSE:T), increased Netflix user traffic has forced Internet service providers to expand their capacity -- a costly endeavor that, according to Cicconi, should be borne by Netflix consumers.
To offset expenses created by Netflix, AT&T and Comcast (NASDAQ:CMCSA) will begin charging interconnection fees. Netflix will pay the fees in exchange for preferential streaming quality. The size and frequency of the fees has not yet been disclosed, but Netflix has agreed to pay them to guarantee high-quality streaming content.
Netflix has two choices: It can pass the new expenses on to shareholders in the form of lowered profits, or increase the price of its subscriptions.
Why won't Netflix just raise the price of its subscriptions? One word: Qwikster. In September 2011, Netflix announced a plan to restructure its DVD video service as an independent company called Qwikster. Shortly thereafter, Netflix ditched the plan. Although it never reached fruition, the plan caused 800,000 people to cancel their Netflix subscriptions. Needless to say, the company is weary of altering its subscription terms.
The situation looks bleak for Netflix. If global Internet service providers also decide to charge Netflix usage fees, this could wreak havoc on the company's ability to expand and prosper.
EU ruling is a ray of hope for Netflix
On April 3, 2014, the European Union Parliament voted in favor of "Net Neutrality." In a nutshell, Parliament decided that all traffic on the Internet should be treated equally.
The ruling is great news for Netflix. Part of its international strategy is to "expand as quickly as possible while staying profitable on a global basis." Thankfully for Netflix, the parliament's ruling will outlaw ISP Interconnection fees in the European Union, a region where Netflix is planning a substantial expansion later this year.
Now that the company won't have to pay ISP fees in the EU, it has a better shot at successfully executing its global expansion plan.
How the ruling may affect Internet service providers in the long-run
European telecom companies such as Vodafone and Liberty Global won't be able to charge clients for preferential treatment. The ruling will strip European companies of their ability to collect ISP interconnection fees and "roaming charges." Some believe European telecom companies will experience a competitive disadvantage under American telecom companies such as AT&T and Comcast.
Michael Nielsen has no position in any stocks mentioned. The Motley Fool recommends Netflix and Vodafone. 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.