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Remember way back (you know, like four years ago) when Netflix was primarily a mail-order DVD company? Things have changed a lot since then.
Now Netflix–which has become a key player in online video–wants to kill the Comcast/Time Warner Cable merger. Its announcement comes, not coincidentally, on the heels of a letter Senator Al Franken sent asking Netflix to help him stop the deal. His stated aim: to prevent Comcast from becoming (in the scare words of internet scolds everywhere) “the gatekeeper of the internet.”
But far from imperiling consumers’ access to video content from both online distributors and independent cable channels alike, the deal is likely to improve it.
Geoffrey Manne
Geoffrey Manne is Executive Director of the International Center for Law and Economics. His recent paper on the Comcast/Time Warner Cable merger is available here. ICLE is a nonprofit, nonpartisan research center. Disclosure: The author’s work is supported in part by financial contributions from broadband and content providers.
Yesterday the House Judiciary Committee held a hearing on the merger, and Netflix (and the interconnection issues raised by big content companies like it) was a hot topic. Of particular concern to several of the Committee’s members was the recent interconnection agreement between Comcast and Netflix and what it might suggest about Comcast’s ability to keep competitors from mounting a real challenge to Comcast’s video service. They really needn’t fret so much.
The Comcast/Netflix agreement—trotted out by Franken as Exhibit A in the “big is bad” story—actually demonstrates the resilience and competitive balance of the market. Put simply, Netflix decided to pay Comcast to deliver its content directly instead of paying a third party transit provider. There’s nothing unique in this, nor is there any need to protect Netflix in this sort of commercial dealing.
Comcast didn’t force Netflix to pay for “prioritization,” as some have suggested. Rather, these two sophisticated players simply reached a business arrangement (at Netflix’s behest, no less). By eliminating the middleman, Netflix was able to improve service and reduce transit costs—in exactly the same way companies like Google, Microsoft and Amazon have done.
But Senator Franken has presented Netflix with an opportunity to leverage politics to get a better deal. Recently Netflix and its CEO, Reed Hastings, have taken Franken up on his offer and written letters and blog posts to warn us of the anticompetitive threat of a Comcast/Time Warner merger. Hastings even managed to raise the spectre of Net neutrality—a completely different issue—in the hope of confusing regulators and stopping the transaction.
Remember, Netflix is no small startup in need of congressional protection. It accounts for as much as 30 percent of all broadband traffic; in fact, just two percent of Netflix users account for 20 percent of all broadband traffic. A direct relationship between Comcast and Netflix should allow both companies to better manage Netflix traffic flowing to and over Comcast’s network, and could improve both companies’ incentives and ability to handle issues arising from Netflix users’ enormous traffic demands.
The transaction substantially improves on the status quo, wherein all cable users subsidize Netflix’s customers. And one thing is certain: The deal has already improved Netflix’s service–its speeds are up 65 percent on Comcast’s network.
If Netflix does end up paying more to access Comcast’s network over time, it won’t be because of the anticompetitive exercise of market power or this merger. Instead, it would be an indication of an evolving market and the increasing popularity of online video—a positive trend for Netflix and consumers alike.
The inconvenient truth for merger naysayers is that greater concentration among cable operators has actually coincided with an enormous increase in output and quality of video programming. Among other things:
2. Over the same period, spending on video programming increased 29 percent —faster, even, than the much-maligned increases in cable subscription prices.
3. Meanwhile, broadband speeds have doubled, video quality has improved dramatically, and new features have been rolled out (from better DVRs to better user interfaces to expanded on-demand offerings).
That’s not to say that these quality improvements were caused by the increased concentration among cable operators, but they were not diminished. And there’s little risk that the merger would change any of this.
The merger will have no effect on Comcast’s (i.e., NBCUniversal’s) share of national programming, nor on its incentives to distribute competing programming that it doesn’t own. Comcast already has no ownership interest in the overwhelming majority of content it distributes—and yet it readily distributes it, because consumers demand it. And it will continue to face pressure from consumers and content providers to do so at high-quality and ever-increasing speed.
While Comcast will have a slightly larger share of national distribution post-merger, its share will still be less than 30 percent. Courts have repeatedly deemed a 30 percent market share to be insufficient to confer buyer power in video distribution markets.
As for Netflix, Comcast has every incentive to keep the online video spigot open to satisfy insatiable consumer demand for Netflix’s content, earning revenue on broadband subscriptions to make up for what it may lose from cord-cutting. Even Reed Hastings recognizes the two companies’ symbiotic relationship. In a recent shareholder letter Hastings acknowledged that “consumers purchase higher bandwidth packages mostly for one reason: high-quality streaming video.”
The ability to realize returns–including returns from scale–is essential to incentivizing continued network investments. The cable industry today operates with a small positive annual return on invested capital (ROIC), but it has had negative cumulative ROIC over the entirety of the last decade. In fact, on invested capital of $127 billion between 2000 and 2009, cable has seen economic profits of negative $62 billion and a weighted average ROIC of negative five percent. Meanwhile, Comcast’s stock has significantly underperformed the S&P 500 over the same period.
But this is not the stuff of headlines. “Bigger is badder,” on the other hand, is an easy sell: People love to hate Comcast. And while the economics of the video programming market are admittedly complex, some comprehension of market dynamics is crucial to understanding the competitive implications of this merger—and why it should help, not harm, consumers.
Another thing it’s important to keep in mind during all of the hysteria around the proposed merger is that the very markets alleged to be harmed here were created by Comcast and other broadband providers. Merger opponents like Netflix and Franken seem to have forgotten their broadband history. Long before Netflix even considered using the internet to distribute video content, Comcast was investing in the technology and infrastructure that ultimately enabled the Netflix of today. It did so at enormous cost–tens of billions of dollars over the last two decades–and considerable risk.
Without broadband, consumers would still be waiting for Netflix DVDs to be delivered by snail mail–and Netflix would still be spending three-quarters of a billion dollars a year on shipping.
So while it doesn’t make for very dramatic headlines, the truth is that neither the video distribution market nor the broadband market is endangered by vertical or horizontal integration. No matter how many times naysayers like Netflix and Al Franken say it, the proposed merger simply won’t harm the video programming market.
In the end, Comcast may get bigger, but consumers’ access to faster, higher-quality and more-varied programming should only continue to get better.
Disclosure: The author’s work is supported in part by financial contributions from both broadband and content providers.
Editor: Emily_Dreyfuss[at]wired[dot]com
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