Sunday, July 17, 2011

Netflix Economics I: The Cost of Going Streaming

Here is an excerpt from a rather long, but generally very interesting analysis of the Netflix business model.

Netflix's customers have responded by rapidly switching: in its most recent quarter (Q3), the company said that 66% of its subscribers watched instantly more than 15 minutes of a TV episode or movie compared to 41% for the same period of 2009, and 61% for the second quarter of 2010. In Q4, a majority of Netflix subscribers will watch more content streamed from Netflix than delivered on DVD.

So many of Netflix's 16.9 million customers are streaming videos, in fact, that they account for 20% of all internet traffic during a typical evening, according to Sandvine, which makes network-monitoring equipment. (We find this number hard to believe, but anything close to it is still very substantial.)

From a casual standpoint, it just seems cheaper to stream movies and television directly to your existing TV, over your existing internet connection rather than troubling the postman to deliver it. Plus, with streaming, there is no plastic DVD waste created as a byproduct.

But, there's more to the DVD-streaming tradeoff than meets the eye. What is cheaper -- accounting for 20 percent of Internet traffic or mailing hoards of DVDs through the mail -- is not as obvious as it first appears. On the scale that Netflix uses America's bandwidth, there is a real cost to going streaming. Netflix doesn't currently pay for this cost, not even indirectly through customers who have to pay more for more intensive usage of bandwidth.* According to the article, this may change soon.
Another major threat to Netflix is internet providers starting to charge for high usage rather than offering unlimited downloading for a flat rate. It goes without saying that streaming video is very bandwidth intensive and, as noted earlier, Netflix may account for as much as 20% of all internet traffic during a typical evening. Such high usage by Netflix's customers is slowing down the internet for everyone and is one of the reasons why Cisco predicts that internet traffic will triple by 2014. To accommodate this, carriers like AT&T and Comcast will have to invest billions of dollars - and will of course look for a return on this investment, most likely by shifting to a pay-for-usage model that would make Netflix's streaming content much more expensive.
There are a lot of other points to pick apart in this analysis. Not all of them are right. For the sake of focus, I'll leave my comments on those ideas to another post. For now, have a read. It is an interesting perspective.

*This was a big issue in late 2010 when new guidelines were released to govern how Net Neutrality applies to competition between Internet Service Providers like Comcast and content delivery services like Netflix. Here is what I had to say back then (and here is what Jeff Ely had to say, which is a hundred times more comprehensive and detailed).

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