Netflix: ISPs Kill Web Freedom, Suck All Profits

Netflix (s NFLX) isn’t going to take the bashing of its video streaming service lying down anymore. The online video rental company met with the FCC Tuesday and released a letter it filed Wednesday that shows how it really feels about broadband caps, ISPs’ arguments about the overwhelming traffic video will cause and the profits such caps can capture for ISPs. The fight is a crucial one as ISPs start implementing broadband caps and try to halt Netflix in other ways, such as the argument over peering with Level 3 Communications (s lvlt).

In a letter to Representatives Fred Upton (R-Mich.) and Henry Waxman (D-Calif.), Reed Hastings CEO of Netflix (s nflx) expresses disappointment that members of Congress are trying to hobble the FCC’s attempts to implement some type of network neutrality rules. Hastings’ letter was mild enough, but it included an earlier letter to Secretary General of Canadian Radio-television and Telecommunications Commission Robert Morin that dropped quite a few bombshells. Canada has recently allowed the country’s wireline operators to impose higher wholesale costs for smaller ISPs, which has resulted in some of the smaller ISPs crying foul and being forced to cap their customers’ broadband in order to contain their own costs.

But the letter also includes a report commissioned by Netflix that shows those higher wholesale costs are far greater than the costs associated with delivering the network traffic. The report sets out to dismantle the popular argument made by ISPs that a ton of Netflix streaming makes it impossible for wireline operators to keep up and make money, which is why they must cap broadband services. We have long-argued that this strategy is merely a revenue grab, and if congestion were the primary problem, ISPs would implement congestion pricing as opposed to per-GB overage fees. Here’s what Netflix told Canadian regulators:

Netflix’s evidence on the cost of incremental Internet bandwidth, provided in a report by Lemay-Yates Associates Inc. (“Lemay-Yates Report”), establishes that as the average incremental cost of Internet traffic by “heavy users” is likely 1 cent or less per GB, Bell’s wholesale UBB [usage-based billing] rates provide margins in excess of 99 percent. This belies any argument that such rates are primarily intended to recover any additional costs to the system: rather, such excessive margins clearly have more to do with maximizing the size of the incumbents’ windfall.

Here’s what Hastings told the Congressmen:

“The ISPs’ costs, however, to deliver a marginal gigabyte from one of our regional interchange points over their last mile wired network to the consumer is less than a penny, and falling, so there is no reason that pay-per-gigabyte is economically necessary. Moreover, at $1 per gigabyte over wired networks, it would be grossly overpriced.”

Included with the two letters is the Lemay-Yates Report that offers a breakdown of the costs that Bell Canada presumably incurs from each gigabyte of traffic. I really want Netflix to order one of those for AT&T (s t) and Comcast (s cmcsa) as well, since those two companies have broadband caps that now mean that over half of the U.S. deals with such caps. And even if you aren’t a huge web user, check out my colleague Mathew’s experience to understand why caps are so problematic for individual consumers that are forced to become network cops, or Om’s post on why they are so bad for innovation. By the way, Hastings agrees, saying in his letter to the Congressmen, “Moves by wired ISPs to shift consumers to pay-per-gigabyte models instead of the current unlimited-up-to-alarge-cap approach, threatens to stifle the Internet.”

But first, check out the numbers the Lemay-Yates report offers up:

The cost for the wholesale delivery of incremental Internet traffic via the local access cloud has been estimated to range from a penny per GB to 1.4 cents per GB for average heavy users ranging from 60 to 250 GB of usage per month, well above the current average usage of all Internet users, which has been estimated to be around 24 GB per month in 2011 in Canada.

The report then goes on to show that in cases of a telecommunications network set up like Bell Canada’s, more traffic actually lowers the fixed cost on a per gigabyte basis, even after taking into consideration the need to add more ports. Additionally, the Lemay-Yates report notes a similar cost model would apply in cable as well. This type of research needs to be conducted in the U.S. with the aid of pricing information requested by the FCC, especially since in its decision to implement network neutrality the FCC also opened the door to usage-based billing. Because if a market isn’t competitive — and our last-mile broadband access market isn’t– then the FCC needs to demand price transparency to ensure that ISPs aren’t gouging service providers such as Netflix or Level 3 as well as consumers.