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.

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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)

Beck

Glenn Beck and his independent network TheBlaze are not happy about Time Warner Cable and Comcast merging operations and think it will concentrate too much power in the hands of a single entity that already ignores independent voices seeking a spot on the cable dial.

Beck left Fox News Channel to help start a new network — TheBlaze — that began as GBTV, an online streaming video operation. In the fall of 2012, the network, which airs more than 40 hours a week of new programming, secured exclusive carriage on Dish, the satellite television provider. Now that the exclusivity agreement has expired, TheBlaze management and viewers have launched a very vocal campaign to get the channel on cable systems across the country. The venture has been modestly successful with smaller cable operators like Buckeye Cablevision in Ohio and ETC Communications in Michigan. Beck’s network can also be seen on Cablevision’s lineup in the suburbs of New York City. But for most of the country, the only way to watch is to stream it online for $9.95 a month/$99.95 a year. Large cable systems have so far shown little interest in picking up the network.

“Comcast is one of the bigger pains in the neck for TheBlaze,” Beck told his radio listeners.

“Since launching the GetTheBlaze campaign, 50 small, midsized and major cable systems have begun carrying our network,” said TheBlaze CEO Chris Balfe. “These are the cable systems that must be responsive to their customers to survive. Monopoly type [multichannel video programming distributors] like Comcast and Time Warner Cable do not have a good history of listening to customers or supporting independent programmers whose content is in demand like TheBlaze. While we are skeptical that giving Comcast even more market power will benefit consumers, promote competition or lead to more diversity of voices, we will continue our successful campaign because eventually, even giants have to listen to what their customers want.”

“Look, the amount of decision makers, which is so surprisingly small in the industry in general, is potentially getting smaller,” Steve Krakauer, TheBlaze’s vice president of digital content told POLITICO. “Keeping up the fight is so important.”

Cable industry observers agree that life can be difficult for an unaffiliated independent cable network. Ovation found itself thrown off Time Warner Cable’s lineup for nearly a year because of a lack of original programming and miniscule ratings. But networks owned by studios like Universal or large broadcasting entities like Viacom stay, despite similar viewer response. Ovation had no leverage to compel continued carriage. Networks owned by larger companies often do, because they are packaged and sold to cable operators in a bundle. A cable company refusing to carry one low-rated cable network could be threatened with a much more expensive rate for the channels it does want or even face the loss of larger, must-have channels owned by the same company.

Polka

Beck isn’t alone being concerned.

The American Cable Association, a trade group that represents small and medium-sized cable operators, said it is carefully considering the potential impact of the merger on the cost of video programming sold to smaller operators.

“ACA has long acknowledged many problems in the pay-TV market, including the soaring cost of retransmission consent and sports networks and the record-setting number of broadcaster-imposed TV signal blackouts,” CEO Matthew Polka said in a statement. “ACA will be looking closely to see whether this transaction makes matters worse for small and medium-sized cable operators and their customers.”

(Image Courtesy: Mizwhiz)

Sharing your Netflix or HBOGO account with those outside of your immediate family is a no-no, but password sharing with friends, co-workers or extended family members is a reality acknowledged by two of the largest video streamers in the business.

HBO’s Richard Plepler is well aware of the password sharing phenomena, but he doesn’t consider it a material issue. In fact, he admitted HBO is in the video addiction business and believes if non-paying viewers get a taste of HBOGO and get hooked on its lineup, they are more likely to become paying subscribers themselves.

While some on Wall Street may consider that lost revenue left on the table, BTIG Research Analyst Rich Greenfield agrees with Plepler.

“Leaving comedy aside, we suspect password sharing is a very real issue for Netflix as an online-only subscription service and is becoming a growing problem for HBO/HBOGO, as personal entertainment devices proliferate and bandwidth improves,” Greenfield writes. “We believe Plepler’s answer from his Buzzfeed Brews interview that the key is to build ‘video addicts’ that love the HBO brand is the right answer and we believe Netflix management shares that view.  Ultimately, we believe easy access across all devices with great content will drive people to pay for your service.”

Neither video service is open to a sharing free-for-all, however. Both Netflix and HBOGO limit customers to two concurrent video streams at a time. Try for a third and an error message appears. Netflix seems willing to monetize this hidden audience and is now testing subscription rates that vary depending on the number of simultaneous streams a customer wants. The tested plans:

• $6.99 a month for one stream (SD only);
• $7.99 a month for two streams in SD or HD (the current plan);
• $9.99 a month for three streams in SD or HD;
• $11.99 a month for four streams in SD or HD.

For Netflix, the increased revenue that can be earned by charging different rates for concurrent streams might prove a win-win proposition because many lurkers may be unwilling to buy their own account.

Cable operators have had less success being nonchalant about password sharing and have limited most streaming of cable channels to within a customer’s home because of restrictive programming contracts. Many cable networks fear password sharing could lead to non-paying customers getting access to their programming for free.

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HBO’s Richard Plepler explains why password sharing is a non-issue for HBOGO. (Video courtesy: Richard Greenfield, BTIG Research) (1:32)

Just weeks after Time Warner Cable and CBS settled a dispute over retransmission fees, other broadcasters and networks are preparing to make new demands for increased compensation from their cable, satellite, and telco IPTV partners at prices likely to provoke more blackouts.

Despite repeated protestations from Time Warner that over-the-air stations and networks deserve lower fees than cable-only networks, once the two parties went behind closed doors, the cable company quickly agreed to pay considerably more for CBS programming. Sources say CBS made a deal that will run up to five years and includes more than $1.50 in fees per subscriber, up from between 50-85 cents per month, depending on the city served, under the old contract. CBS had asked for about $2 a month. Effectively, the company will earn more than that because Time Warner also agreed to renew both the CBS Sports Network and Smithsonian Channel, which cost extra.

“There is a new template here. Two dollars is the new holy grail,” Wunderlich Securities analyst Matthew Harrigan told Reuters.

Fox was the highest paid network before the CBS deal, collecting close to $1.25 per month per subscriber. ABC receives 50-65 cents and NBC less than that.

Harrigan predicts the other networks will race to raise their own prices, with Time Warner Cable (and others) likely forced to raise rates early next year to cover increased costs.

In the war for compensation, programmers hold most of the leverage.

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The Wall Street Journal reports the dispute between Time Warner Cable and CBS set new industry precedents on the value of broadcast stations and networks and how their programming is distributed on digital platforms. (2 minutes)

There have already been local station blackouts in 80 cities so far this year, with the likelihood last year’s record of 91 markets will be broken before Thanksgiving. In almost every instance where a popular network is involved, the pay television provider eventually capitulates because of subscriber complaints or cancellations.

Moonves

Time Warner Cable admits its dispute with CBS cost the company business, both from prospective new customers going elsewhere and customer disconnects. Time Warner also spent money advertising its side of the dispute and paid to distribute free antennas to affected subscribers.

CBS’ Les Moonves had predicted Time Warner would eventually meet most of the network’s compensation demands before football season arrived. He was right.

“CBS is the winner. Content owners always win these negotiations, it’s just a matter of how much they won,” said Craig Moffett of Moffett Research. “They have all the leverage. Consumers don’t get mad and trade in their channel when these fights drag on. They go looking for a different satellite or telephone company.”

Almost 200,000 Time Warner Cable television customers left during the second quarter, and company officials admit that trend continued during the third quarter as the dispute dragged on. Time Warner Cable is likely to end the year with fewer than 11.5 million video subscribers, a loss of several hundred thousand this year.

Sources say one major sticking point that kept CBS off Time Warner Cable systems for nearly a month wasn’t about money. Instead, it was about digital distribution rights.

Time Warner Cable wanted CBS on its TV Everywhere app TWCTV and was also concerned about CBS selling content to online video streaming competitors that could accelerate cord-cutting.

Time Warner Cable did win permission to offer Showtime on its digital streaming platform and on apps for portable devices. But Time Warner will not get to carry local CBS-owned stations on streaming platforms, a significant blow. The cable company will also have to pay more for streamed and on-demand content.

In the end, CBS got almost everything it wanted and Time Warner Cable was handed back its largely unfulfilled wish list and a bigger, retroactive bill subscribers will eventually have to pay.

“We wanted to hold down costs and retain our ability to deliver a great video experience to our customers,” Time Warner Cable CEO Glenn Britt said in defense of the agreement. “While we certainly didn’t get everything we wanted, ultimately we ended up in a much better place than when we started.”

Moonves gloated to various trade publications and investors that CBS went unscathed after the month-long dispute.

“Our national ad dollars did not go down,” Moonves told attendees at the recent Bank of America/Merrill Lynch Media Communications & Entertainment Conference. “There were no such things as make-goods and there was no harm done financially to CBS Corporation.”

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CBS’ Les Moonves has won his dispute with Time Warner Cable, says Les Moonves in this interview with Bloomberg TV. (10 minutes)

Comcast owns both NBC and the cable companies that carry its local affiliates.

Cable rate increases are not likely to stop with the agreement with CBS. Analysts predict NBC, ABC, and FOX will be seeking similar rates when their contracts come up for renewal. Altogether, every cable, telco IPTV, and satellite subscriber could see rates increase up to $6 a month for the four major American networks.

“Any time one of these larger networks sets the new standard in terms of pricing for their programming, the rest follow,” Justin Nielson, an analyst for SNL Kagan, told Hollywood Reporter. “In most cases it’s been CBS and FOX trailblazing what the rates should be and then ABC and NBC following.”

Comcast-NBC’s Steve Burke is already there. Burke told investors affiliates should be paying 20 to 25 percent more for cable networks such as USA, Bravo, SyFy, CNBC and MSNBC .

“We’re not paid as much as we should be given our rating and positioning by cable and satellite companies,” Burke said. “I see no reason why we won’t sort of draft behind the other broadcast networks and get paid in a similar way.”

Burke predicts NBC will earn between $500 million to $1 billion annually from increased retransmission consent fees comparable to what CBS and FOX receive.

Next week, DISH Networks faces the expiration of their contract with ABC/Disney-owned channels, including the Cadillac-priced ESPN. The outcome of renewal negotiations may serve as an indicator for where rates are headed in the world of retransmission economics.

A growing number of elected officials in Washington are paying attention as they and their constituents live through one programmer blackout after another. At least four pieces of legislation have been introduced to deal with the problem in very different ways, according to Bloomberg News:

The Satellite Television Extension and Localism Act

This law, known as STELA, dates to 2004 and gives satellite companies a license to provide local TV stations, just as cable operators do. The current law is set to expire at the end of 2014, with most observers calling its reauthorization a near certainty. The debate is mainly over how “clean” the STELA reauthorization bill will be as it emerges from the legislative process, with the pay TV companies urging lawmakers to address the issue of retransmission disputes. Broadcasters are working for a “clean” bill, written narrowly to address the satellite companies’ immediate needs. “There’s nothing clean about the current retransmission system,” says Brian Frederick, a spokesman for the American Television Alliance, a coalition of pay-TV companies. Two House committees held hearings on the law this week. A final bill and vote are expected next year.

Video CHOICE (Consumers Have Options in Choosing Entertainment)

Representative Anna Eshoo, a Democrat who represents much of Silicon Valley, introduced this bill Sept. 9 aimed at ending blackouts. “Recurring TV blackouts, including the 91 U.S. markets impacted in 2012, have made it abundantly clear that the FCC needs explicit statutory authority to intervene when retransmission disputes break down,” Eshoo said in a press release. (The FCC gets involved now only if one party accuses the other of negotiating in bad faith.) The bill would unbundle broadcast stations from a cable package and prohibit a broadcaster from requiring a pay TV operator to take affiliated cable channels to obtain more popular channels. That issue is at the heart of why Cablevision sued Viacom in February, following a contentious negotiation.

Eshoo’s bill would also require the FCC to study programming costs for sports networks in the top 20 regional sports markets. The rising fees for sports programming—led by ESPN—is considered one of the major influences behind rising cable bills and the power that content creators such as Disney hold in negotiations. Cable companies have praised Eshoo’s bill, while broadcasters are not fans. Don’t expect to see it get far in a Republican-led House.

Television Consumer Freedom Act of 2013

This bill, introduced in May by Senator John McCain (R-Ariz.), would end the long era of the cable television bundle, that phenomenon by which you pay for hundreds of channels and find yourself watching only about two dozen, or fewer. This summer, Connecticut Senator Richard Blumenthal signed on as a Democratic co-sponsor, but there’s been no similar sponsors on the House side. Blumenthal explained his support of the bill in an August interview with the Hollywood Reporter:

“What I hear from cable consumers overwhelmingly is, ‘give us freedom of choice. Don’t make us pay for something we don’t want and won’t watch. Why am I paying for—you name a channel you don’t like or five or ten or them—just so I can watch the one I do want.’ That’s overwhelmingly the sentiment of people who buy this product. So this bill just gives voice and force to that sentiment.”

Next Generation Television Marketplace Act

This bill from Representative Steve Scalise, a Louisiana Republican, and former South Carolina Senator Jim DeMint, also a Republican, dates to December 2011 and would deregulate the entire television market, top to bottom. It would repeal compulsory copyright licenses, the legal mechanism by which content owners are required to let pay TV companies carry their programs, if they are paid a fee for the content. The bill, which would also dismantle the system of retransmission fees, is essentially an exercise in carrying free-market ideology to its logical conclusion. The problem? It would require a countless number of individual deal negotiations—any radio or television station that wanted to carry programming (i.e., all of them)—would need to strike deals with every programmer, yielding an inefficient system that would likely prove unworkable. Lawyers would love the bill, but don’t expect it ever to pass Congress.

In fact, none of these bills are expected to pass through both the gridlocked House and Senate this year.

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CNBC also talked with CBS’ Les Moonves about CBS’ views towards compensation and distributing content online. (13 minutes)

For the third time, legal action from the four largest commercial television networks to shut online streaming service Aereo has been denied.

In a 10-2 decision, with one recusal, the 2nd Circuit Court of Appeals denied an attempt to re-hear the case by the full appellate court.

Following disposition of this appeal on April 1, 2013, Plaintiffs-Appellants filed petitions for rehearing in banc. An active judge of the Court requested a poll on whether to rehear the cases in banc. A poll having been conducted and there being no majority favoring in banc review, rehearing in banc is hereby denied.

Circuit Judge Denny Chin strongly dissented from the majority’s decision, joined by Circuit Judge Richard C. Wesley. Chin firmly took the side of the broadcasters, fearing if Aereo was permitted to continue operating, it could quickly mean the end of free over-the-air television. He believes the service exists only because of a precarious loophole:

“The majority’s decision elevates form over substance. It holds that a commercial enterprise that sells subscriptions to paying strangers for a broadcast television retransmission service is not performing those works publicly. It reaches that conclusion by accepting Aereo’s argument that its system of thousands of tiny antennas and unique copies somehow renders these transmissions “private.” In my view, however, the system is a sham, as it was designed solely to avoid the reach of the Copyright Act and to take advantage of a perceived loophole in the law….”

Just about every over-the-air network and major station in the New York City area is opposed to Aereo. Among those filing suit against its continued operation:

• Networks: ABC, CBS, NBC, FOX, PBS, Univision, and Telemundo
• Stations: WNET, WPIX, WNJU

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Barry Diller, the force behind Aereo, tells Bloomberg News he expected to get sued when he provided viewers with an alternate way to watch television. Diller says networks and stations are simply uncomfortable with change and that Aereo poses no threat to them. (3 minutes)

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Bloomberg Industries director of North American research Paul Sweeney looks at Aereo’s impact on television broadcasters and how it could eventually threaten their revenue streams. He speaks on Bloomberg Television’s “In The Loop.” (2 minutes)