McAdam

The head of Verizon believes two concepts will become Internet reality in the short-term future:

1. Those that use a lot of Internet bandwidth should pay more to transport that content;
2. The “intelligent” Internet should prioritize the delivery of certain traffic over other traffic.

Welcome to a country without the benefit of Net Neutrality/Open Internet protection. A successful lawsuit brought by Verizon to toss out the Federal Communications Commission’s somewhat informal protections has given Verizon carte blanche to go ahead with its vision of your Internet future.

Lowell McAdam, Verizon’s CEO, answered questions on Tuesday at the Morgan Stanley Technology, Media & Telecom Conference, attended by Wall Street investors and analysts.

McAdam believes groups trying to whip Net Neutrality into a major issue are misguided and uninformed about how companies manage their online networks.

“The carriers make money by transporting a lot of data,” McAdam said. “And spending a lot of time manipulating this, that accusation is by people that don’t really know how you manage a network like this. You don’t want to get into that sort of ‘gameplaying.'”

McAdam believes there is nothing wrong with prioritizing some Internet traffic over others, and he believes that future is already becoming a reality.

“If you have got an intelligent transportation system, or you have got an intelligent healthcare system, you are going to need to prioritize traffic,” said McAdam. “You want to make sure that if somebody is going to have a heart attack, that gets to the head of the line, ahead of a grade schooler that is coming home to do their homework in the afternoon or watch TV. So I think that is coming to realization.”

But McAdam also spoke about the need for those generating heavy Internet traffic to financially compensate Internet Service Providers, resulting in better service for content producers like Netflix — not considered ‘priority traffic’ otherwise.

“You saw the Netflix-Comcast deal this week which I think — or a couple weeks ago — which is smart because it positions them farther out into the network, so they are not congesting the core of the Internet,” said McAdam. “And there is some compensation going back and forth, so they recognize those that use a lot of bandwidth should contribute to that.”

McAdam reported to investors he had spoken personally with FCC chairman Tom Wheeler, who seems to be taking an even more informal approach to Net Neutrality than his predecessor Julius Genachowski did.

Verizon’s machine-to-machine program is likely to be a major earner for the company.

“In my discussions with Tom Wheeler, the Chairman, he has made it very clear that he will take decisive action if he sees bad behavior,” McAdam said, without elaborating on what might constitute ‘bad behavior.’ “I think that is great; great for everybody to see that. And I think that is what we would like to see him do, is have a general set of rules that covers all the players: the Netflixes, the Microsofts, the Apples, the Googles, and certainly the Comcasts and the Verizons. But the only thing to do is not — you can’t just regulate the carriers. They’re not the only players in making sure the net is healthy. And I think we all want to make sure that investment continues in the Internet and that customers get great service.”

Verizon has already reported success monetizing wireless broadband usage that has helped deliver growing revenue and profits at the country’s largest carrier. Now McAdam intends to monetize machine-to-machine communications that exchange information over Verizon’s network.

McAdam believes within 3-4 years Americans will have between five and ten different devices enabled on wireless networks like Verizon’s in their cars, homes, and personal electronics. For that, McAdam expects Verizon will earn between $0.25 a month for the average home medical monitor up to $50 a month for the car. Verizon is even testing wireless-enabled parking lots that can direct cars to empty parking spaces.

For those applications, McAdam expects to charge enough to guarantee a 50% profit margin.

“These can be very nice margin products,” McAdam told the audience of investors. “So even at $0.25 if you are doing 10 million of them and it’s 50% or better margins, those are attractive businesses for us to get into.”

Netflix has agreed to compensate Comcast in return for assurances that the cable company’s subscribers would no longer be caught in the middle of a dispute between Comcast and one of Netflix’s content distributors.

The multi-year agreement between the two companies will bring Netflix direct access to Comcast’s broadband network with a Service Level Agreement that will guarantee streaming stability for customers who have loudly complained about Netflix’s deteriorating performance.

The controversial arrangement has probably established a precedent for other large Internet Service Providers likely to seek compensation to handle Netflix traffic. As of this evening, both AT&T and Verizon have already acknowledged they are negotiating with Netflix for similar arrangements.

Caught in the middle of the dispute are Comcast customers paying for a reliable Internet connection and getting slowing connections and re-buffering problems while attempting to watch Netflix content during peak usage times.

One side accuses Comcast of violating Net Neutrality while the other blames Netflix for dumping enormous Internet traffic on Internet Service Providers without compensation for network upgrades. Also in the crossfire is Cogent, a third-party company delivering Netflix content to Comcast’s front door.

How Netflix Distributes Its Streaming Movies and TV Shows

Netflix has traditionally avoided owning the “pipes” that distribute movies and TV shows to paying customers. Instead, it usually contracts with “transit providers” to send content from Netflix headquarters on to “content distribution networks (CDN)” that manage video streaming. A Netflix video may pass through a number of connections on a variety of independently owned networks before it arrives at the front door of your Internet Service Provider. Companies like Comcast handle “the last mile” of the journey that began at Netflix and ends at your computer or television set.

Netflix does not rely on just one transit provider to handle its traffic. Level 3, Cogent, and XO Communications all reportedly serve in that capacity, depending on where traffic is headed. The same is true for the CDN’s Netflix contracts with to regionally stream content to each subscriber.

Netflix determines how to handle your streaming movie request behind the scenes, selecting a CDN that is close to you and capable of delivering the most stable streaming experience at that moment. If you are a Comcast or Verizon customer, Netflix often selects Cogent to handle its content. Cogent is also well known for its relatively low cost.

If you are served by Cablevision, Frontier, or certain other providers like Google Fiber, Netflix will instead direct your streaming request to a CDN located within your provider’s own network. These “Open Connect” boxes store Netflix content in a type of cache and can stream it to customers directly without sending video packets across multiple third-party networks. Theoretically, Open Connect offers an efficient and stable way of distributing Netflix content to customers. It also saves Netflix money and in return, it costs the ISP nothing — Netflix pays for the equipment and service.

Cogent vs. Big Telecom

Netflix and YouTube together are now estimated to cover 50 percent of all video traffic on the Internet, and that traffic is growing. Cogent dutifully passes that video content along to Internet Service Providers like Verizon and Comcast that have customers waiting to watch. But it is a two-way street. Any outbound traffic from customers could also be forwarded to Cogent to send on. Traditionally, both sides have managed the traffic by gradually increasing the bandwidth and speed of their connections to one-another. But as Netflix traffic grows and grows, companies like Comcast and Verizon believe they are being saddled with the costs to upgrade their networks in ways that are out of proportion to the traffic they send in the other direction. ISPs often grumble about the cost but keep on upgrading to keep paying customers happy. Verizon and Comcast are suspected of dragging their feet on those upgrades in an effort to win compensation.

Verizon and Comcast argue they should be paid by content producers responsible for generating tons of Internet traffic to help cover the cost of upgrades. Instead, Netflix offered its Open Connect boxes, which keep Netflix traffic within an ISPs own network, reducing the necessity of constantly upgrading connections with other transit providers. Verizon and Comcast don’t want Netflix’s solution — they want cold hard cash.

Conflict of Interest

Some network engineers cannot understand all the controversy about Comcast’s arrangement with Netflix. Some believe Netflix is simply shifting traffic away from third-party Cogent to Comcast directly, presumably at a cost savings. They suggest customers will be happy that streaming quality is restored and Netflix also wins a guaranteed level of performance they never had with Cogent.

But that argument does not explain why Netflix was compelled to make a financial arrangement with Comcast. The two companies have been in negotiations on the subject of traffic compensation for months. Many industry observers believe those talks went nowhere until Netflix customers began complaining about the increasing network slowdowns. Some even dropped their Netflix subscriptions over the issue.

Netflix CEO Reed Hastings admitted he made a deal with Comcast to restore customer confidence in Netflix and end subscriber frustration. It was also increasingly clear Comcast was in no hurry to improve things on its own, despite the fact its own customers were the ones most directly affected.

So why wouldn’t Comcast (or Verizon or Time Warner Cable) take Netflix up on its offer of free Open Connect boxes that would reasonably solve streaming problems without forcing anyone to spend a fortune on upgrades? Simply put, all three companies are direct competitors of Netflix. Helping Netflix offer a top quality streaming experience is not in the best interests of Comcast (or others) that are facing potential cord-cutting customer losses in their subscription video businesses. Verizon has partnered with Redbox to deliver streamed video, Comcast operates Streampix, its own online streaming service, and Time Warner Cable offers a variety of on-demand and streamed video content for its cable TV subscribers. None of these services have suffered from traffic congestion issues.

ISP Payday

What About Net Neutrality? What About Paying Customers?

With Net Neutrality tossed out by the courts, there is little any regulator can do to resolve disputes until Net Neutrality can be properly enforced under a stronger regulatory framework. Some argue the congestion issues creating the problems with Netflix are not a true violation of Net Neutrality in any event because providers are not artificially prioritizing traffic.

They are simply not keeping up with upgrades that just so happen to directly impact a competitor while leaving their own services unscathed.

Providers also seem characteristically unconcerned about complaining customers, passing blame for the problem on to Netflix. Besides, they remind you, paying for an Internet connection alone does not entitle you to any guarantee of performance.

The Dam Breaks

With this week’s agreement between Comcast and Netflix, both AT&T and Verizon wasted no time admitting they are both seeking compensation from Netflix as well. Other providers are likely to follow.

Netflix warned investors that paid agreements with ISPs could adversely affect its earnings due to increased costs. Although stopping short of suggesting price increases for Netflix customers could come as a result, Wall Street wasted no time worrying about the financial impact of deals like the one between Netflix and Comcast.

The Wall Street Journal reported the momentum appears to be shifting in favor of large Internet providers like Comcast and AT&T and away from content producers.

Janney Capital analyst Tony Wible suggested Comcast’s toll booth could create a barrier for other content producers if the cable company asks for significant compensation.

“Although there is no prioritization benefit [from the deal], we suspect that the exchange of money for resolution/performance could (if large) effectively limit competition,” said Wible. “In essence, Netflix could be trading [profit] margins for subscribers. Few others can match Netflix’s [spending budget to acquire content] without incurring massive losses. The competition may now have to cope with additional fees that sway their willingness to compete if they do not already have a large subscriber base.”

In other words, a new Internet startup could face hard questions from investors about how it intends to cover ISP demands for compensation in return for a suitable connection to reach customers. A large venture like Netflix has enough resources to handle those costs and negotiate for a better deal while a smaller startup may not.

[flv]http://www.phillipdampier.com/video/WSJ Netflix Comcast Agreement 2-24-14.flv[/flv]

Netflix has signed a deal with Comcast to ensure smooth streaming, in what is being called a landmark agreement. Wall Street Journal reporter Shalini Ramachandran explains the agreement. (3:39)

“…every kitten grows up to be a cat. They seem so harmless, at first, small, quiet, lapping up their saucer of milk. But once their claws get long enough, they draw blood, sometimes from the hand that feeds them. For those of us climbing to the top of the food chain, there can be no mercy. There is but one rule: Hunt or be hunted.” — Francis Underwood

Addicts of Netflix’s hit series House of Cards may need to grab a card of a different kind to cover overlimit fees charged by your Internet Service Provider for blowing past your usage allowance.

As online video streaming moves into the realm of 4K — the next generation of high-definition video — watching television shows and movies online could get very expensive because of the massive file sizes involved. It’s all just in time for ISP’s increasing enforcement of usage caps.

Gizmodo just did the math for those intending to spend a weekend watching the entire second season of the made-for-Netflix series in high-definition:

Streaming in 1080p on Netflix takes up 4.7GB/hour. So a regular one-hour episode of something debiting less than 5GB from your allotment is no big deal. However, with 4K, you’ve got quadruple the pixel count, so you’re burning through 18.8GB/hour. Even if you’re streaming with the new h.265 codec—which cuts the bit rate by about half, but still hasn’t found its way into many consumer products—you’re still looking at 7GB/hour.

But you’re not watching just one episode, are you? Of course not! You’re binging on House of Cards, watching the whole series if not in one weekend then certainly in one month. That’s 639 minutes of top-quality TV, which in 4K tallies up to 75GB if you’re using the latest and greatest codec, and nearly 200GB if not. That means, best case scenario, a quarter of your cap—a third, if you’re a U-Verse customer with a 250GB cap—spent on one television show. Throw in a normal month’s internet usage, and you’re toast.

Sure you can send 900+ emails, download hundreds of songs, upload hundreds of pictures, and play online games 24 hours a day, but you can’t also watch one standard and one HD movie a day at the same time without blowing well past your AT&T DSL limit.

What is worse is that h.265 is still more theoretical than actually available to most consumers, so customers will either have to settle with degraded video or prepare to eat close to 19GB an hour at the highest resolution. No wonder Netflix has introduced video degradation settings to save you from your ISP’s arbitrary cap. Of course, your video quality will suffer, especially on a big screen television.

Comcast customers (and presumably Time Warner Cable customers also eventually subjected to Comcast’s cap) will still have a generous 100GB left over to watch, browse, and send that avalanche of e-mails usage cappers love to boast about. If you live in the reality-based community and have a family active online, that 100GB isn’t going to go too far. Video game addicts regularly face downloading huge updates, many ranging from 8-12GB apiece. Call of Duty: Ghosts? That’s 39.5GB. Madden NFL 25? Another 12.51GB, says Gizmodo. Using a file backup cloud storage service can also eat your allowance for breakfast.

Gizmodo also mentions Sony’s Unlimited Video service has 70 titles (and growing) available in 4K. A Sony representative admits a single two-hour movie will burn up 40GB. Watch a few of those and you are well on your way to blowing your allowance Vegas-style.

AT&T cooked up the arbitrary de facto standard overlimit fee now adopted by many American ISPs, and granular it isn’t. Exceed your allowance by even 1 kilobyte and you will be charged an extra $10 for 50 extra gigabytes. Because AT&T, Comcast, Suddenlink, and others are not already paid enough for broadband service and their modem rental.

Online video is the online application most likely to put you over your limit. Most ISPs don’t like to talk about that, however. They prefer to explain caps in terms of activities no online user is likely to ever exceed, including sending thousands of e-mails, viewing hundreds of thousands of web pages, transferring boatloads of songs and images, and watching YouTube videos at low resolution.

If you don’t watch online video, your cable or phone company thanks you for paying for cable television instead. If you haven’t used a peer-to-peer network in years, chances are you won’t exceed any limits either. But as Internet usage continues to evolve, anything that appears to be a competitive threat delivered over your ISP’s broadband pipe can be effectively controlled with the elimination of flat rate Internet service and imposing overlimit fees that deter usage.

Few were surprised more by the sudden announcement that Comcast was seeking to acquire Time Warner Cable all by itself than the negotiating team from Charter Communications.

Working for weeks to settle how Comcast and Charter would divide the second largest cable company in the country between them, they learned about the sudden deal with Comcast the same way the rest of the country heard about it — over Comcast-owned CNBC.

After Charter endured weeks of rejection from Time Warner Cable executives over what they called “a lowball offer,” Comcast had entered the fray to help Charter boost its offer and bring more cash to the table to change Time Warner Cable’s mind. In return, Comcast expected to acquire Time Warner’s east coast cable systems and much more.

That is where the trouble began.

According to Bloomberg News, the talks broke down because Charter wanted to hold onto as many Time Warner Cable assets as possible. Comcast chief financial officer Michael Angelakis expected Charter to divest more than just the New England, New York, and North Carolina Time Warner Cable systems. Angelakis also wanted control of Time Warner’s valuable regional sports networks in Los Angeles. When he didn’t get them, he stormed out of a meeting threatening to do a deal for Time Warner Cable without involving Charter at all.

The Wall Street Journal confirms the account, adding that both Comcast CEO Brian Roberts and Angelakis agreed the talks with Charter seemed to be going nowhere.

Roberts

Roberts called a secret meeting with top Comcast executives including Angelakis, Comcast Cable head Neil Smit, Comcast’s lobbying heavyweight David Cohen, and NBCUniversal CEO Steven Burke. Roberts asked each about the options on the table and their conclusion was to buy Time Warner Cable by themselves and cut Charter out of the deal.

Within days, Comcast CEO Brian Roberts reinitiated talks with Time Warner Cable CEO Robert Marcus. The two companies had talked off and on ever since Charter Communications set its sights on acquiring Time Warner Cable. It was clear from the beginning Marcus and his predecessor Glenn Britt were cool to Charter’s overtures. Not only was Charter a much smaller operation, it also had a checkered past including a recent bankruptcy that wiped out shareholder value and was loaded with debt again.

The alliance between Charter and Liberty Global’s John Malone was also unsettling. Those in the cable industry had watched how ruthless Malone could be back in the 1990s when a then much-smaller Comcast secretly attempted to acquire control of Tele-Communications, Inc. (TCI) — then the nation’s largest cable operator run by Malone. Malone was furious when he learned about the effort and went all out to kill the deal, acquiring the stake Comcast sought himself.

Malone’s cable empire would eventually fall with the sale of TCI to AT&T just a few years later. When AT&T decided it didn’t to stay in the cable business, it sold TCI’s old territories to Comcast, making it the largest cable operator in the country.

Malone

Malone’s brash attitude has also occasionally rubbed the cable industry’s kingpins the wrong way, especially in his public comments. Last year, Malone criticized Roberts’ more conservative operating style, which means Comcast pays a higher tax rate. Malone specializes in deals that leave his acquisitions with enormous debt loads, manipulating the tax code to stiff the Internal Revenue Service. In June, Malone was back again criticizing the lack of a unified national cable cartel better positioned to defeat the competition.

Under his leadership at TCI, many cable programmers didn’t get on TCI’s cable dial unless they sold part-ownership to TCI. Competitors were dispatched ruthlessly — home satellite dish service, then the most viable competitor, strained under TCI-led efforts to enforce channel encryption.

TCI-owned networks routinely required satellite subscribers to sign up with the nearest TCI cable system, which often billed them at prices higher than what cable subscribers paid. Subscribers had to buy not one, but eventually two decoder modules for several hundred dollars apiece before they could even purchase programming. The cable industry also worked behind the scenes to promote and defend enhanced zoning laws that made installing satellite dishes difficult if not impossible, and denied access to some programming at any price, unless it was delivered by a cable system.

Malone called today’s divided industry “Snow White and the Seven Dwarfs” and insisted on a new major consolidation wave to enhance “value creation” and deliver some major blows to satellite and telephone company competitors.

Despite Liberty Global’s ongoing consolidation wave of European cable systems, his lack of financial resources to put his money where his mouth was left Time Warner Cable executives cold.

Already loaded with debt, Malone’s part ownership stake in Charter could not make up for Charter’s current status — a medium-sized cable operator with dismal customer ratings primarily serving smaller communities bypassed by larger operators.

A deal with Charter would mean Time Warner Cable’s bonds would be downgraded to junk status.

Moody’s Investor Service warned Charter’s offer to acquire Time Warner Cable was primarily financed with the equivalent of a credit card, and would leave the combined entity with $60 billion in debt with bonds promptly downgraded to junk level. Time Warner Cable had always considered its bonds “investment grade.”

Charter’s first clue something was wrong came when Comcast stopped returning e-mail and phone calls. That’s always cause for alarm, but Charter officials had no idea Comcast was secretly negotiating with Time Warner Cable one-on-one. In fact, Comcast’s Roberts was negotiating with Time Warner Cable over a cell phone while attending the Sochi Olympics.

Malone finally got the word the deal was off just a short while before Comcast and Time Warner Cable leaked the story to CNBC.

Ironically, it was Malone who convinced Comcast to seek out a deal with Time Warner Cable. Comcast’s thinking had originally been it had grown large enough as a cable operator and sought out expansion in the content world, acquiring NBCUniversal. But Malone warned online video competitors like Netflix would begin to give customers a reason to cut cable’s cord or at the very least take their business to AT&T or Verizon’s competing platforms.

Comcast executives were convinced that gaining more control over content and distribution was critical to protect profits. Only with the vast scale of a supersized Comcast could the cable company demand lower prices and more control over programming. By dominating broadband, critics of the deal warn Comcast can also keep subscribers from defecting while charging higher prices for Internet access and imposing usage limits that can drive future revenue even higher.

Just like the “good old days” where customers had to do business with the cable company at their asking price or go without, a upsized Comcast will dominate over satellite television, which cannot offer broadband or phone service, as well as the two largest phone companies — AT&T, which so far cannot compete with Comcast’s broadband speed and Verizon, which has pulled the plug on further expansion of FiOS to divert investment into its highly profitable wireless division. If Comcast controls your Internet connection, it can also control what competitors can effectively offer customers. Even if Comcast agrees to voluntarily subscribe to Open Internet principles like Net Neutrality, its usage cap can go a long way to protect it from online video competitors who rely on cable broadband to deliver HD video in the majority of the country not served by U-verse or FiOS.

David Raphael ran into trouble using his Verizon Internet connection last month, discovering major slowdowns when accessing Amazon’s cloud-server ‘AWS,’ which in addition to serving his employer also feeds Netflix video content to customers.

“One evening I also noticed a slowdown while using our service from my house,” Raphael writes on his blog. “I realized that the one thing in common between me and [my employer] was that we both had FiOS internet service from Verizon. Since we host all of our infrastructure on Amazon’s AWS – I decided to do a little test – I grabbed a URL from AWS S3 and loaded it. 40kB/s.”

Internet slowdowns while accessing different websites is nothing new. Just ask anyone trying to watch YouTube in the early evening.

But what was different this time is that a Verizon representative seemed to openly admit the company is purposefully throttling certain web traffic, as this chat screen capture suggests:

“Frankly, I was surprised he admitted to this,” Raphael writes. “I’ve since tested this almost every day for the last couple of weeks. During the day – the bandwidth is normal to AWS. However, after 4pm or so – things get slow. In my personal opinion, this is Verizon waging war against Netflix. Unfortunately, a lot of infrastructure is hosted on AWS. That means a lot of services are going to be impacted by this.”

That would certainly be the case as many large content distributors increasingly rely on cloud-based delivery services to reach subscribers over the shortest and fastest possible route. But broad-based interference with web traffic would also throw a major wrench in Verizon’s core marketing message for FiOS — its fiber-fast speed when compared against the cable competition. If subscribers notice their Netflix experience degraded to speeds that resemble dial-up, cable companies are going to get a lot of returning customers.

We reached out to Verizon for comment and it turns out the company has not declared war on Netflix after all.

“We treat all traffic equally, and that has not changed,” says Verizon spokesman Jarryd Gonzales. “Many factors can affect the speed a customer’s experiences for a specific site, including, that site’s servers, the way the traffic is routed over the Internet, and other considerations.  We are looking into this specific matter, but the company representative was mistaken. We we’re going to redouble our representative education efforts on this topic.”