Tallying the Cost to Netflix in Verizon's Victory Over FCC

Streaming Video Leader Trying to Lessen Its Burden on Networks

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Verizon's legal victory over the Federal Communications Commission's so-called net neutrality efforts opens the door to new costs for Netflix and other internet companies.

The FCC regulations struck down by the U.S. Court of Appeals in Washington yesterday required internet service providers to treat all online traffic equally, rather than giving preference to companies willing to pay extra fees for faster service.

With the restrictions lifted, carriers like Verizon, AT& and Time Warner Cable could be free to charge internet companies higher rates for preferred treatment, expenses that may ultimately be passed on to consumers -- or advertisers. But Netflix, Google's YouTube and Amazon, meanwhile, may face higher costs of doing business, changing the industry's economics.

In Netflix's case, the expenses could climb into the hundreds of millions of dollars a year, according to Wedbush Securities.

"Goodbye, open internet," said Jennifer Fritzsche, an analyst at Wells Fargo & Co. in Chicago. "There's definitely a risk that Netflix customers will have to pay more, though it will probably take at least a year for it to take effect."

Streaming services have contributed to Internet congestion, putting a strain on networks. Monthly traffic over phone and cable lines has more than doubled over the past year during peak hours, according to Sandvine Inc., a provider of data-management software. Netflix, the world's largest subscription video-streaming service, accounts for about 32% of all peak traffic in North America, Sandvine estimates.

Carriers have argued that the biggest bandwidth hogs should share in the costs of sending their content to customers. The idea is to charge Netflix or Google the equivalent of first-class handling, so that "House of Cards" or YouTube videos can get guaranteed quicker delivery.

Verizon wants a "two-sided market," involving payment for internet service by subscribers and by companies that want to reach them, Helgi Walker, a lawyer for the New York-based carrier, told the appeals panel.

The cable industry, the biggest provider of broadband service in the U.S., has looked at applying monthly data caps -- an approach that's already common with wireless carriers. But that would punish consumers, said Michael Pachter, an analyst at Wedbush in Los Angeles. Companies would rather approach Netflix, ESPN and other bandwidth heavyweights to strike revenue-sharing agreements, he said.

Squeezing Netflix instead
"The correct capitalist response would be to charge the end user, but no vendor wants to go to the customer to hammer them if it can be avoided," Mr. Pachter said. "The elimination of net neutrality means they can go to Netflix and squeeze them instead."

Joris Evers, a spokesman for Los Gatos, California-based Netflix, declined to comment on yesterday's ruling.

Still, the FCC has an opportunity to tackle net neutrality again. The court decision threw the issue back to the agency, which may now attempt to rewrite the rules. The FCC also will consider appealing yesterday's decision, Chairman Tom Wheeler said.

"The FCC has the authority -- and has the responsibility - - to regulate the activities of broadband networks," Mr. Wheeler, a Democrat, said in a blog post last night. "We will have ample opportunity to debate ways and means, to consider specifics in specific cases as they arise."

Comcast -- the biggest U.S. broadband provider, with more than 20 million broadband customers -- agreed to operate under open Internet rules after it acquired NBCUniversal in 2011. So it won't be able to take advantage of yesterday's ruling. The terms of that agreement with government regulators ends in 2018.

The Philadelphia-based company pledged yesterday to keep the internet "open and vibrant."

Time Warner Cable, the second-biggest cable company, said it will remain focused on providing customers the best possible service, "including unfettered access to the web content and services of their choice."

"This commitment, which long precedes the FCC rules, will not be affected," Eric Mangan, a spokesman for the New York-based company, said in a statement.

While such remarks leave the door open to new fees, broadband providers will probably take things slow, said Don Bowman, chief technology officer of Sandvine. "The court of public opinion weighs heavily here, which means we probably won't see any sudden, rash actions," he said.

Netflix has worked to lessen the burden of its streaming service on networks. As part of that effort, the company has been trying to persuade internet service providers to install its Open Connect server within their network infrastructure.

The server stores copies of Netflix's most popular content, helping deliver smoother, clearer streams of movies and TV shows. The system also saves cable providers money on transport costs and reduces the strain that occurs during prime-time viewing hours, according to the company.

~ Bloomberg News ~