Jackson Jambalaya

Karl Denninger makes some penetrating observations about Netflix in The Market Ticker blog.  Simply put, Netflix has done quite well for itself - by unloading its operating costs onto carriers such as Verizon.  That is changing and Netflix's future as well. 


The Wall Street Journal reported this week:

Netflix Inc. subscribers have seen a lot more spinning wheels lately as they wait for videos to load, thanks to a standoff deep in the Internet.

The online-video service has been at odds with Verizon Communications Inc. and other broadband providers for months over how much Netflix streaming content they will carry without being paid additional fees.

Now the long simmering conflict has heated up and is slowing Netflix, in particular, on Verizon's fiber-optic FiOS service, where Netflix says its average prime-time speeds dropped by 14% last month. The slowdown comes as Netflix is rolling out the new season of its Emmy-winning series "House of Cards."....

Verizon has a policy of requiring payments from networks that dump more data into its pipes than they carry in return. "When one party's getting all the benefit and the other's carrying all the cost, issues will arise," said Craig Silliman, Verizon's head of public policy and government affairs..... Article

Folks, this is math.

Specifically arithmetic, which you're supposed to understand in grade school.

Let's do a bit of it.

Let's assume a relatively small town. We'll presume it has 10,000 homes in it with cable internet service.

We'll further presume that 20% of them are watching a streaming video presentation over Netflix between the hours of 7 and 10 PM. And we'll put some parameters on that -- between those homes that are running two or more streams, and those using just one but in high def, the average bandwidth they consume is 2Mbps.

This set of numbers is for my convenience, of course. But this is a small metro area; I will point out for the peanut gallery that Chicago has 1 million households. So if we're talking about Chicago, multiply these numbers by 100.

So our 2,000 households are consuming 2Mbps each, or 4 Gigabits per second from 7 - 10 PM.

In one small town.

The question is this -- where's the revenue for that?

Remember, Netflix caused the bandwidth consumption and they collected $8 per person per month for it. So from all 2,000 of those users they collected $16,000 last month.

In total.

I assure you that nobody can provision 4 Gigabits of network transport to a set of servers somewhere geographically-distant (for any reasonable definition of "distant" that requires mechanized transport beyond a pair of shoes) from a provider's infrastructure terminating at 2,000 individual points for $16,000 a month.

And yet this is not the entirety of the requirement, because there are people doing other things, such as having a Skype video call, sending email, browsing the web and generally screwing around.

No, this $16,000 is the delta in collected funds for the extra bandwidth over that baseline that is generated, and every penny of it is going to Netflix.

If you're wondering why Netflix doesn't stick a content server in that provider's space, paying a commercially-reasonable fee for it (hint: power and cooling are not free and neither is physical space) the reason is simply that doing so for any reasonable concentration of users, and a group of users that generate 4Gbps of required bandwidth is certainly a "reasonable" concentration, would instantly bankrupt the firm.

To put further numbers on this there are 5,000 towns in the United States that have more than 20,000 population.

You do the math on that one.

The noise coming from the FCC is amusing. The fact of the matter is that while the FCC can mandate whatever it wants it cannot make money materialize out of thin air, and the above numbers suggest that Netflix wishes to impose a low-latenacy, high-bandwidth and near-zero jitter delivery requirement of 20,000 Gbps (that's 20 terabits/second) every night from 7 - 10 PM -- for which it has a tiny fraction of the revenue required to pay for it.

You can't buy or build that sort of capacity for $8/month/household. You in fact probably can't buy or build it for ten times that much if most of it has to travel beyond the local provider's infrastructure. The premise Netflix has run, and "investors" have accepted, is that someone else will eat the firm's operating expenses, and that Netflix will successfully not only cram that down someone else's throat but will be able to continue to do so in perpetuity as it presses upward the amount of data flow required for it's "newer" and "higher-definition" video streams -- an escalation that has already moved the bar higher, at its best-quality setting, by a factor of four.

Oh by the way, while you were not paying attention Netflix also issued $400 million of new debt yesterday.

Look, folks -- the company had $112 million in net income for all of 2013. They don't have the money to pay for moving and maintaining their content to the edge of these providers' infrastructure, feeding it from there. That would be commercially reasonable for an ISP to expect from them and in fact would be exactly identical treatment, that is, net neutral, to what Verizon would have to do were it running its own Netflix competitor. Rest of post