The Perils of All-You-Can-Eat

Breathes there a Netflix user with a Blu-ray player so dead, who never to himself hath said,
“There ain’t no way unlimited free downloads are going to last!”

Netflix has announced that it is eliminating the free “all-you-can-stream” video service that has been bundled with its monthly rent-by-mail plans. Starting September 1, customers who want to watch Netflix on demand must pay $7.99 a month over and above the monthly fee for unlimited DVD rentals by post. This is the same fee that Netflix’s streaming only customers pay.

The change in rates likely reflects the additional costs Netflix is incurring to deliver video over the Internet.

Netflix users are also facing higher costs on another front. Service providers are slowly phasing out unlimited data plans. AT&T already has done so for its wireless and wireline DSL data services. New users must opt for a fixed rate plan that caps data use, with additional per-gigabyte billing once the user goes above the cap. Since video consumes bandwidth in the largest chunks, users who watch lots of streaming video, whether from Netflix, Hulu, YouTube CinemaNow or other Web-based video service–increasingly bundled with ion-board Blu-ray DVD software–are likeliest to be hit.

For consumers, however, bandwidth caps mark the end of a highly desirable pricing phase where Internet connectivity was marketed as a flat-rate add-on to either cable or phone service. To be sympathetic, the change is jarring, as most consumers are unaware of how dramatically household data consumption has risen.

Bandwidth caps are a reaction both to this spike in consumption and the added costs that the particular characteristics of video data add to the network. Video, unlike other types of Internet data, like email and graphics, is not bursty nor fault-tolerant. When transmitting an email, for example, network devices will keep resending packets of information until receipt is acknowledged. Even if some packets are lost, network intelligence is good enough to replace them. Video, on the other hand, is not bursty; it crosses the network like water through a faucet . And time sensitivity of video create problems when packets are lost. Too much congestion means loss of signal. If video is going to work properly, it needs to be managed effectively, and that requires additional investment on the part of the service provider.

Unfortunately, David Hyman, Netflix general counsel, has expressed shock and outrage that unlimited bandwidth might end and thinly suggested that it was time for authorities to step into regulate the price of broadband service. While that argument plays to the policy urge to regulate cable and telephone companies at every turn, what Hyman left out was the fact that by independent estimates, Netflix accounts for almost 30 percent of the data that crosses the Internet in North America, making it the largest single source of downloaded traffic.

But Hyman couldn’t be so frank, lest he appear to be asking regulators to give Netflix something for nothing. Instead he linked the issue to content competition, cable and DSL providers are implementing bandwidth caps to hobble companies like Netflix, which deliver video content in competition with cable.

But it’s not so much that Netflix competes with content—it’s that video is a voracious consumer of bandwidth. In fact, any application consuming as much bandwidth would create the same problem. Wyman is trying to divert attention from this core issue–how service providers can economically respond to bandwidth consumption–by crying “anti-competitive.”

If the phone and cable companies had the unfair advantange Wyman claims. Amazon and Wal-Mart wouldn’t be entering the video-on-demand business. These companies, not the service providers, are Netflix’s real competition, and they will face the same cost challenges.

Bandwidth caps are not illegal, abusive or monopolistic. “All-you-can-eat” is merely a pricing model, popular in many businesses, from restaurant buffets to theme parks, where relative consumption across the customer base is fairly level and predictable. But once consumption increases beyond the supplier’s ability to manage costs, or becomes less uniform or predictable, its economics break down.

Netflix should know. Although now priced separately, it still markets its mail and streaming services as “all-you-can-watch” for one flat price. Yet some have said that Netflix will delaying DVD mailings to customers who reach 20 videos a month. The company implicitly admitted as much, at one time stating in its terms of service that it gives priority to lower volume users, although that clause no longer exists in the terms of service.

A risk of the flat-rate model is that it can create a sense of entitlement for users. The protests that arise when businesses try to move away from these models can be troublesome for public relations, but that doesn’t mean that regulators should step in. When it comes to “all-you-can-eat” models, Netflix should be cautious about “calling the kettle black.” They may find soon themselves in the same situation as their policy targets.