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Look Forward Bring Sexy Back | Final Project: Netflix & Net Neutrality | 12/06/2014
Qais Al Shihabi, Andrew Meyers, Sharif Karmally, Juan Zarruk
Table of contents
EXECUTIVE SUMMARY...................................................................3
BACKGROUND............................................................................... 3
Look Forward Bring Sexy Back | Final Project: Netflix & Net Neutrality | 12/06/2014
Qais Al Shihabi, Andrew Meyers, Sharif Karmally, Juan Zarruk
Look Forward Bring Sexy Back | Final Project: Netflix & Net Neutrality | 12/06/2014
Qais Al Shihabi, Andrew Meyers, Sharif Karmally, Juan Zarruk
Exhibit 1 lays out the current Internet landscape. ISPs - such as Verizon and AT&T - act as
information carriers between the content providers and the residential customers. Residential
customers pay a fee to the content providers to access their material and pay the local internet
Look Forward Bring Sexy Back | Final Project: Netflix & Net Neutrality | 12/06/2014
Qais Al Shihabi, Andrew Meyers, Sharif Karmally, Juan Zarruk
providers for access to the Internet backbone. Content providers also pay royalties to content
creators, such as Disney, Fox, etc., depending on content agreements between the companies.
Due to the fact that most residential customers only contract with one service provider to access
the internet backbone (similar to how customers only contract with one phone company), local
ISPs tend to function like a monopoly. Importantly, while content providers and residential
customers pay a fee to access the internet backbone, ISPs do not discriminate based on the
data shared. In other words, data provided to customers from Netflix and data provided to
customers from John Morgans Game Theory blog are treated as equal and given equal priority.
Ending Net Neutrality could result in a number of changes to how the internet works. Key
changes including blocking, throttling and paid prioritization.
Blocking ISPs could block content that is not commercially affiliated with it
Throttling ISPs could speed up, and slow down, certain content at its own discretion
Paid Prioritization ISPs could charge certain content providers a fee in order to be in
the fast lane, thereby relegating non-paying providers to the slow lane.
Given the importance the Internet plays in modern life, the debate around Net Neutrality has
drawn passionate advocacy on both sides. Content providers are concerned about being priced
out of competition by bigger, well-funded competitors. Additionally, the regulators are concerned
that paid prioritization and throttling could kill innovation of future products. Conversely, ISPs
feel squeezed and would like the opportunity to price discriminate to extract more value from
content providers, who tend to be major users of bandwidth. Net Neutrality is an issue with
many disparate stakeholders that needs to be deeply scrutinized.
Look Forward Bring Sexy Back | Final Project: Netflix & Net Neutrality | 12/06/2014
Qais Al Shihabi, Andrew Meyers, Sharif Karmally, Juan Zarruk
Look Forward Bring Sexy Back | Final Project: Netflix & Net Neutrality | 12/06/2014
Qais Al Shihabi, Andrew Meyers, Sharif Karmally, Juan Zarruk
Started in 1997 as a movie rental company, Netflix initially operated under a traditional pay per
rental model, but soon in 1999 started disrupting the market by offering unlimited DVD rentals
using a monthly subscription model. Later in 2007, when they delivered its billionth DVD, the
Company introduced its online streaming service that has allowed it a very rapid growth in the
U.S. and worldwide. As of July, 2014 the company operated in more than 50 countries and had
around 50 million subscribers, out of which around 70% are in the U.S. But the growth in users
has also come with a significant increase in the amount of bandwidth that is used for streaming
the online video, resulting in a fight between Netflix and the main ISPs, where the first one
blames the second one for discriminating and slowing down their streaming traffic. Comcast and
Verizon are two of the players with whom the company has held public fights that have received
wide media coverage, but with whom Netflix finally settled on interconnection agreements that
grant them faster connections to the ISPs networks (Comcast by the beginning of 2014, Verizon
by the end of the first semester). As it can be seen in the following exhibit, the improvement in
the users download speeds is evident and almost immediate after the deals were done.
Exhibit 2 - Netflixs speed on Comcast and Verizons networks4
But these agreements raise the question on how much power the ISPs already have and to
what extent they can use it to force content providers to pay additional fees to have fast access
to their infrastructure. In this example, although Netflix initially opposed to pay for high-speed
access, it finally had to agree in order to preserve customer satisfaction levels. This
dissatisfaction was expressed by Netflixs CEO, Reed Hastings during an interview on May,
20145:
Comcast is paid for 10 megabits or 50 megabits for about $30-80. Consumers
deserve to get those speeds they pay for and Comcast is responsible for the delivery
of those speeds. Comcast would like to charge us and then also charge the consumer.
4 Team analysis, using data from: http://ispspeedindex.netflix.com/
5 http://www.washingtonpost.com/blogs/the-switch/wp/2014/07/11/netflix-ceo-qa-picking-a-fightwith-the-internet-service-providers/
7
Look Forward Bring Sexy Back | Final Project: Netflix & Net Neutrality | 12/06/2014
Qais Al Shihabi, Andrew Meyers, Sharif Karmally, Juan Zarruk
Thats great for their business and I dont blame them for trying. But I dont think thats
the right way to set it up.
Other; 22%
Netflix; 34%
Facebook; 2%
MPEG; 3%
BitTorrent; 3%
SSL; 3%
YouTube; 13%
12%
iTunes; 4% HTTP;
AmazonVideo;
2% Hulu; 2%
From a revenue perspective, Netflix is also the market leader followed closely by Youtube with
similar revenue, and by Hulu, a much smaller player in the current market. Youtubes business
model based on free content, gives the company the highest margins amongst its close
competitors that have to incur in costs to pay for the content they stream.
Exhibit 4 Content providers market share7
2013, $Bn
Revenue
Netflix
4.4
Youtube
3.5
Hulu
1.0
Look Forward Bring Sexy Back | Final Project: Netflix & Net Neutrality | 12/06/2014
Qais Al Shihabi, Andrew Meyers, Sharif Karmally, Juan Zarruk
(-) COGS
Gross profit
Margin
3.1
1.3
30%
2.0
1.5
43%
0.7
0.3
30%
The market for ISPs, is even more concentrated with the top 3 players controlling approximately
70% of the total users, with Comcast leading over its competitors.
Exhibit 5 ISPs market share8
Others; 17%
Frontier; 2%
Charter; 5%
Comcast+TWC; 38%
CenturyTel; 7%
Verizon; 11%
AT&T; 20%
2013, $Bn
Revenue
(-) COGS
Gross profit
Margin
Comcas
t
10.3
4.2
6.1
59%
AT&T
8.4
5.9
2.4
29%
Verizon
6.1
3.4
2.7
44%
Other/Regulator
Regulatory Fees
$Comcast paid a fine of $16/share in 2009 for NN violations
8 http://www.digitalcrazytown.com/2014/02/comcast-twc-broadband-reach-could-be.html
9 COGS for Youtube and Hulu based on market analysts estimates