Netflix Couch

Source: Netflix.

Cable Internet service customers with data caps and a Netflix (NASDAQ:NFLX) subscription are about to get some relief. Netflix is reencoding its entire library to optimize the bitrate at which it sends video streams to your home on a per-title basis. In other words, streaming Netflix won't take up as much of your precious Comcast (NASDAQ:CMCSA) data.

The move also means that customers with limited Internet speeds -- for example, those in international markets that Netflix is expanding to -- will have a better experience streaming Netflix compared with other streaming services. They'll see less buffering and better picture quality. The per-title encoding approach provides yet another way for Netflix to differentiate itself from the growing competition.

Data caps are bad news for cord cutters
For Internet subscribers without a pay-TV subscription, streaming video is often their main form of video entertainment.

Comcast CEO Brian Roberts says that just 5% of customers are affected by the data caps. While about 20% of Comcast Internet subscribers don't take its video service, they may take video service from a telecom or satellite competitor. Putting the percentage of Internet subscribers without any form of pay-TV subscription at around 5% is a reasonable assumption, which is more in line with national numbers for broadband-only households.

My point is, the percentage of customers affected by data caps is proportional with the percentage of customers who rely on Netflix and other streaming services for video entertainment. That implies that cord cutters are more adversely affected by data caps than pay-TV subscribers are. Naturally, that benefits Comcast by adding a disincentive for cord cutting or requiring cord cutters and cord-nevers to pay more for their Internet subscription. (Comcast offers additional data at $10 per 50 GB or an extra $35 for unlimited data.)

Netflix, on the other hand, gets the blame for using up all of a customer's data allocation. That can cause subscribers to watch less on the streaming service and devalues it, reducing Netflix's ability to retain subscribers and raise rates.

Netflix fights back
This isn't the first time Netflix has had to battle Comcast when it comes to how much data it's sending to its network. Despite buying up transit on all available routes into Comcast's network that didn't require any sort of access fee in 2013, Comcast was still keeping all lanes congested for Netflix traffic. Comcast customer complaints were redirected to Netflix, as viewing during peak hours became nearly impossible.

In early 2014, Netflix reached a peering agreement with Comcast that enabled its traffic to flow freely (well, it really cost a lot) into Comcast's network. Netflix had to pay for access to Comcast's customers.

With the implementation of data caps and the recent expansion, Netflix is getting hit again. Netflix can provide better video quality at lower resolution for animated features (which have lots static images) compared with an action movie. There's no reason for those to be encoded at the same bitrate for each resolution (e.g., 1080 HD) Netflix streams. Likewise, determining optimal bitrates on a per-title basis can reduce bitrates by up to 20% for live-action titles. Overall, this approach reduces the total data needed to stream Netflix all the time.

Not only will the new per-title encoding process enable Netflix to better serve customers with data caps, but it also benefits the aggregate customer base, as total data sent across the network declines. Since Netflix pays Comcast based on how many megabytes it uses per second sustained, it will reduce its fee paid to Comcast. (Netflix has similar peering agreements with three other major ISPs.) As a result, Netflix might not have to increase prices as much.

Netflix could also realize a third benefit as it expands internationally where Internet speeds can be lacking and often rely on mobile networks. By encoding at a bitrate appropriate for a specific title and given a certain bandwidth, Netflix can provide an optimal viewing experience. So customers in areas with slow Internet connections can still enjoy high-definition video for things such as animated series and decent quality for more action-filled scenes.

Overall, the potential for Netflix to save itself money, save its customers money, and expand internationally because of its new encoding process is very valuable. Netflix is already testing the new encoding process with a small batch of customers and will roll it out more broadly over the next few months.

 

Adam Levy has no position in any stocks mentioned. The Motley Fool owns shares of and recommends 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.