Saturday, February 22, 2014

Netflix: is the joy ride over?

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

Mr. Denninger argued:

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

Interesting stuff. 

16 comments:

Anonymous said...

KF,
Glad you read some Karl. Really bright guy. The NFLX story will be interesting to follow. Keep up your good work.

Anonymous said...

Wtf. You have to pay for your internet access in order to be able to watch Netflix, so it's not like the internet providers are going broke. Yeah, I pay Netflix $8 a month. But I pay AT&T U-Verse $65 a month.

Anonymous said...

Karl is a bright guy. Unfortunately, someone told him.

Anonymous said...

5:24 Read the article before commenting. Your price is going to go way up, either by Netflix raising prices to cover the cost they are currenting shifting to ISPs, or by the ISPs raising prices.

OR, the ISPs may just throttle down the service to deliver only the bandwidth Netflix is paying them for, which means goodbye picture quality, hello Redbox.

The peopl subsidizing your Netflix experience are no longer willing to do that. Sorry.

Anonymous said...

but no one is subsidizing my netflix experience. I pay Netflix for content. I pay Comcast (or at&t or Verizon or whomever) to deliver it. and as the previous poster stated... it's not $8 a month. this is just business propaganda "we can't afford to deliver, build, provide, whatever at this price". it's all BS. america has some of the slowest speeds but our service costs the most. look at the data for Europe as an example. some US cities have decided to build and manage their own high speed network loops at a fraction of the cost that "commercial" networks charge to rent theirs. they do it to encourage business growth... not gouge their customers. and don't get me started on actual cable content... such as why do I have to "subsidize" ESPN (a LARGE percentage of your cable bill) or the HSN when I don't want to?

Anonymous said...

This is absolute propaganda to try and reverse the FCCs stance on net neutrality and fleece American consumers for more money.

http://www.forbes.com/sites/igorgreenwald/2013/01/15/the-cable-bills-too-high-heres-why/

http://www.scientificamerican.com/article/competition-and-the-internet/

We already pay way more than all other industrialized nations for substandard bandwidth. The reality is that Netflix doesn't need to be charged more because the consumer is already paying for this "extra" usage, and it'll only get worse.

Get ready for astronomical cable and internet bills when there are zero options in your market.

http://motherboard.vice.com/blog/if-comcasts-merger-happens-itll-be-thanks-to-a-mountain-of-lobbyist-cash

The reality is that internet providers have been enjoying an amazing return for years while the internet was in its infancy. Most users were doing light internet browsing and email, while large bandwidth consumption was the exclusive dominion of nerdy kids in the 18-24 demographic downloading music and playing video games. Netflix, Pandora, Spotify, Skype, etc span all demographics, and when baby boomers are sitting down to watch House of Cards, it requires the cable companies to actually provide the service they sell.

Here is the real crime. You, the consumer, entered into a contract to receive a certain speed. By throttling Netflix they are breaching this contract. We all should be calling our congress person and demanding net neutrality, and forcing cable companies to provide the service we [over]pay for.


Anonymous said...

Netflix will be the next Blockbuster.

KaptKangaroo said...

Do any of you actually belong to EFF?

Also, on the subject of internet neutrality - do you really have an opinion? Or, are you waiting to take it in the shorts?

Anonymous said...

5:24, 8:09 and 8:29 (who is either the same crank or share the same talking points): Please refute Denninger's specific points IF you have read the article, which seems unlikely........

Anonymous said...

9:36, he (they) have, you just don't like what he/they are saying. Why don't you refute the points he/they raised?

Kingfish said...

Netflix just folded on Comcast.

Anonymous said...

we are not the same person and I believe my original post @8:09 stands for itself. capitalization of fiber optic cables already has a built-in profit margin upwards of 200%. including this built-in profit margin, true costs per GB of data is dirt cheap... something like 1.9 cents a GB (thus it costs about a nickel to deliver your Netflix movie). the problem is when everyone wants to watch a movie at the same time and the cable's bandwidth is maxed. the companies do not wish to add capacity unless someone else is on the hook to pay for it (they wish to keep their built in profit margin). if you assume the average internet service bill is $50... that's an insane amount of data delivery you have already paid for. if you wish to go further... google the profit margins of the large telecom firms... they are not hurting for cash and instead of building more bandwidth or updating outdated equipment... they go out and lobby congress (to keep profits high) or buy another company to have less competition.

Anonymous said...

11:16 "whining" is not stating a point. I also pay for Netflix and an ISP. After reading Denninger's post I realize there are major problems ahead.

Anonymous said...

KF - please define "folded".

Technical problems (i.e., throttling) or they got dropped totally by Comcast?

Anonymous said...

6:13 - Just Google "netflix" and look at the news headlines that come up.

Anonymous said...

Utterly wrong. As others have pointed out, we pay Comcast and Verizon to deliver that content.

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