AT&T and Verizon Communications may be the next big Internet service providers to strike a deal with Netflix to provide a direct connection from the video service to broadband customers.
On Monday, a day after Netflix announced a commercial deal to connect directly to Comcast's network, AT&T and Verizon each acknowledged that they have been in talks with Netflix to strike a similar commercial deal in which these ISPs would connect directly to Netflix's content delivery network to deliver better quality video to home broadband users who are subscribed to the Netflix service.
On a conference call with investors Monday morning, Lowell McAdam, CEO of Verizon Communications, said that it makes sense for heavy data users on the Internet to help contribute their investment to keeping the Web healthy by helping defray the cost of network upgrades.
"We are pleased to see Netflix and Comcast agree on an arrangement," he said during the call. "And we have had discussions with Netflix ourselves."
McAdam further discussed the potential deal later in the morning during an interview on CNBC's investment show "Squawk on the Street." He said that Verizon and Netflix have been talking about a deal for the past year. He didn't give any indication of when an agreement might be announced but he said that he thought there was a "good opportunity here" for both companies.
AT&T also acknowledged in a statement that it too has been in talks with Netflix over a similar deal.
"We're in discussions with Netflix to establish a more direct connection between our networks, similar to agreements we have with others, so that AT&T broadband customers who use Netflix can enjoy an even better video experience," a spokesman for AT&T said.
Netflix wouldn't comment directly on the negotiations with these companies, but it has previously acknowledged that it's been in contact with all major Internet provider players regarding its Open Connect content delivery network.
The Net neutrality misconnection
The recent Comcast deal, along with the news that AT&T and Verizon may sign similar agreements with Netflix, has stirred up a hornet's nest of speculation and quite frankly misinformation about how these deals likely violate the Federal Communication Commission's Open Internet rules, which were thrown out by a federal appeals court last month.
Comcast announced its deal with Netflix on Sunday after a long dispute over whether Netflix would pay Comcast for connecting directly to its broadband network. The terms of the deal have not been made public, but based on its previous public posturing, Netflix reluctantly agreed to the arrangement. The fact that Comcast, the largest cable TV and cable broadband provider in the nation, is about to get even bigger due to its proposed $45 billion merger with Time Warner Cable may have spurred Netflix to finally accept Comcast's commercial terms.
Netflix's capitulation to Comcast's terms has made some consumer advocates cry foul. But the truth is that neither the Comcast deal nor any deals that Netflix may strike with AT&T, Verizon or any other ISP has anything to do with Net neutrality. Comcast, AT&T, and Verizon are not deliberately blocking or deliberately slowing down transmission of Netflix service. And these ISPs are not asking Comcast to pay for "priority" access over their broadband networks to reach customers.
A lesson on how the Internet works
So what is going on here? And what are these deals really about?
Video traffic on the Internet, like the service that Netflix runs, is very sensitive to delays. As a result the Internet is built in such a way that content is distributed throughout the network in what's known as content delivery networks, or CDNs. These services strategically place servers throughout the Internet and then they cache certain content, like streaming video, on these servers, so that when customers request a particular video it can easily and quickly be delivered to them. This reduces overall traffic on what's known as the Internet backbone. And it results in a more efficient use of network resources. It also greatly improves performance and quality of service.
Companies, such as Akamai, Cogent, Limelight, and Level 3 run these types of networks. And Internet content companies, such as Netflix, Amazon, Apple, and many others sign up for their services to deliver their content to consumers. These CDNs act as middlemen between the content companies, such as a Netflix, and the ISPs, like Comcast, Verizon, and AT&T.
Companies that use the CDN services pay Akamai, Cogent, and others for distributing their content. And the CDN network providers then have commercial arrangements with the ISPs. In other words, Netflix may pay Cogent a fee to distribute its videos through its CDN. Then Cogent strikes a deal with each of the ISPs, such as Verizon or Comcast, to terminate that traffic on the local broadband networks.
It's a system that has worked well for content providers, broadband providers, and consumers since the Internet was started.
Netflix introduces 'Open Connect'
Netflix is one of the largest content providers on the Internet. It accounts for about 30 percent of all traffic on the Internet in the US during peak hours, according to Sandvine, which runs fixed and mobile data networks worldwide and reports on what is taking place on them. Because Netflix delivers such high volumes of video to its consumers, the company decided a few years ago to build its own content delivery network or CDN. This new service, which it developed only for its own Netflix video service, is called Open Connect.
The idea behind building its own CDN is that if Netflix can provide the distribution function itself, it won't have to pay a third party to deliver its content. If it controls the content until it hits the local ISP networks, it can ensure a better experience for its customers. The way it works is that instead of using Cogent's servers around the edges of the Internet, Netflix sets up its own servers throughout the Internet closer to where its customers live. Because the CDN network that Netflix has established is completely controlled by Netflix and since it doesn't need to share capacity with any other traffic the way it would if it was using a commercial CDN service, the company can provide a better quality of service for its streaming video.
Netflix's claims that it provides better service quality over its own network have largely been proven by the company's own performance data. Looking at reports of individual performance metrics of major ISPs, Netflix customers have seen a degradation in service quality on networks, such as Comcast and Verizon, which do not subscribe to its CDN service.
While some journalists have misinterpreted this data to suggest that Comcast and Verizon are purposely slowing traffic from Netflix in what would be a clear Net neutrality violation, the reality is that the service quality has been degrading because of network congestion on the commercial CDN services that are delivering the bits of Netflix traffic to the ISPs. Meanwhile, performance for customers on ISPs that do subscribe to its CDN service have actually held steady or improved.
Netflix: Value added service or freeloader?
Because its CDN service improves service quality and actually makes the ISP's broadband service more appealing for customers, Netflix has argued that it should not have to pay the same fees that commercial CDN operators must pay to connect to the ISP. Instead, ISPs should be thrilled that Netflix has made its service more efficient and improved performance for their shared customers. And as a result, ISPs should allow Netflix to connect directly to their broadband networks for free.
Many ISPs throughout the world have agreed to Netflix's interconnection terms. Smaller US ISPs, including cable operator Cablevision, have also agreed to allow Netflix to connect free of charge to its network.
But the biggest ISPs in the US, such as Comcast, Time Warner Cable, AT&T, and Verizon don't buy Netflix's reasoning. While they would like to improve the Netflix service for their customers, they don't think that Netflix should get a free ride on their network. They argue that it costs them money to upgrade their networks to handle the increasing demand from Netflix subscribers. And they expect Netflix to pay for access to their broadband network just like any other CDN provider.
"In order to keep the Internet vibrant, we have to make the investments," Verizon's McAdam said on CNBC. "If someone comes in with a lot of load on the Internet, video for instance, you have to get that to an efficient place."
He added that the commercial arrangements such as the one that Netflix struck with Comcast, works well for helping ISPs fund the necessary network upgrades.
"We make money by carrying traffic," he said during the Verizon conference call with analysts Monday morning. "And it's only natural that heavy network users help contribute to the investment to keep the Web healthy."
Correction, February 27 at 8:54 p.m. PT: The original version of this story got the name of Netflix's new service wrong. It's called Open Connect.