Google, Verizon and the Netflix Business Model
Colin Dixon
Senior Partner, Advisory
August 11, 2010
Three independent but related announcements on Monday reveal the power of the Internet to reinvent distribution. They also highlight the importance of net neutrality in maintaining the delicate balance that currently sustains the business models of some of the biggest online players. Google and Verizon talked about their plan for Net Neutrality, Netflix continued to shore up its streaming catalog and AT&T announced U-verse TV-Everywhere content to the mobile phone. All three announcements are interesting in themselves. But taken together they illustrate how even minor changes to the status quo could destroy the most robust of online business models.
Google, Verizon and Net Neutrality
On Monday, Google and Verizon issued a joint policy statement on how the two companies thought net neutrality should be handled and what the FCCs role should be in enforcement. There are seven “key elements” to the Google-Verizon (or Goover) proposal of which five are supportive of the general concept of equal treatment for all on broadband. The fifth and sixth, however, create carve-outs for “differentiated services” and wireless broadband.
The fifth policy states:
“Fifth, we want the broadband infrastructure to be a platform for innovation. Therefore, our proposal would allow broadband providers to offer additional, differentiated online services, in addition to the Internet access and video services (such as Verizon's FIOS TV) offered today … such online services must be distinguishable from traditional broadband Internet access services and are not designed to circumvent the rules. The FCC would also monitor the development of these services to make sure they don’t interfere with the continued development of Internet access services.”
This statement would allow Verizon to sell some of the FIOS bandwidth to a new service – such as 3D TV or medical monitoring – as long as the new service didn’t interfere with a customer’s broadband service. In other words, FIOS broadband and the new service would be peers on the FIOS infrastructure – separate but equal. In principle, this approach sounds fine. After all, it is Verizon’s network and they should be able to monetize it as they see fit. To test this policy let’s examine a hypothetical service called Google Express.
Suppose Google were to work with Verizon to launch a new service called Google Express on Verizon’s FIOS network. This service would not utilize a customer’s broadband connection but would be provided on a separate, guaranteed channel on the FIOS infrastructure and would carry just Google services. Google Express would still leverage the Internet to deliver content to Verizon’s network but the journey through Verizon’s network to the customer would be via this guaranteed path to the subscriber separate from broadband. Google Express would be faster and the video of better quality than Google on broadband. In effect, by doing this Google and Verizon would have established a private Internet service; a service that leverages the Internet but is not public at all.
The sixth Goover policy statement is far more straightforward. It states that none of the net neutrality rules apply to wireless broadband except that network management policy must be clearly stated.
Potential Impact on AT&T and Netflix
How could these policy statements impact Netflix and AT&T announcements?
AT&T announced that it will allow TV streaming to smartphones for U-verse TV customers. Under the sixth policy statement there would be nothing to stop AT&T from prioritizing this service over other services on their wireless network. This prioritization would affect all wireless broadband users in a particular area, not just those using the service. To satisfy the network management policy provision all AT&T would have to do is state that, by policy, it prioritizes certain video services on the wireless network. This, of course, is pretty tough for a consumer wanting to watch Netflix video on his iPhone!
Netflix continues to expand its streaming library. Epix, the newest PayTV movie channel, is negotiating to provide streaming rights to Netflix for movies from Paramount, Lionsgate and MGM. Netflix is reportedly paying $1B to Epix over the life of the deal. How can Netflix afford such a huge sum? The company pays $600M a year in postage fees. If the company can persuade most of its customers to switch to streaming it can take that money and apply it to content deals such as Epix. But what has all this to do with the Goover policies?
Netflix is making a big bet that streaming is the future of the company’s business. But if competitors can leverage the fifth policy to launch private Internet services the companies will enjoy an unfair advantage over an Internet-broadband service such as Netflix. Netflix’ business model is based on delivery over open, non-discriminatory broadband networks. If, to be competitive, Netflix has to start paying operators for preferred access, the advantages of streaming delivery are likely to evaporate. Keeping in mind the big bet Netflix is making on content licensing for streaming, this could result in the collapse of the entire business model.
Conclusion
Is the Goover policy statement a good starting point for Net Neutrality legislation, as the companies suggest? I, for one, am uncomfortable with two companies that stand to gain or lose so much shaping the initial conversation. However, we should be grateful to them both for helping to show the enormous potential ramifications of net neutrality. Getting it right will allow Internet-based business models to flourish and compete in an open market while, at the same time, providing network operators the incentives to invest in network upgrades. Getting it wrong could have dire consequences for Internet services and operator services alike.
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