Despite the lack of definitive information, several outlets reported over the past weekend (Feb 23) the same news: Netflix is paying Comcast for direct access to its customers. For someone who watches the market from some distance, that’s bad news on top of the recent discussions regarding net neutrality.

Technically speaking, Comcast did nothing wrong. But on the long term, this move may have consequences that will affect the entire market — even outside the US, where Comcast should have no impact (but it will).

The main argument that Comcast and all other major telecommunication companies and broadband providers use, all around the world, is that they are carrying Netflix bits “for free”. It’s far from true. The end customer is paying to access whatever they want. It just happens that a lot of customers like Netflix. In the customer’s mind, they are already paying for that.

Let’s concede an important point: Comcast does have to keep investing in its network to provide for the ever growing user’s hunger for bandwidth and content. It’s an enormous cost. As a network engineer myself I really understand how hard and expensive it is to build and operate such a network. That’s the main argument raised against net neutrality.

However, even ignoring net neutrality, there’s a strong reason why Comcast should not charge Netflix, and should instead find ways to fund its growth via its customer base. It’s all about market efficiencies and long term effects.

Charging Netflix is an indirect tax on all Netflix users, even those who are connected to a competitive provider who doesn’t receive the same payment that Comcast do. It causes have a number of indirect and totally undesirable side effects including:

1. It’s a hidden cost. It discourages Comcast to actively trying to find better ways to handle its traffic growth. All it has to do is charge Netflix for the extra costs.
2. It discourages competition. A competitive company has no incentive to deploy a network because its competitive edge will be at least partly negated by the advantage Comcast gets by charging Netflix.
3. It raises costs for all users, independent of the ISP of choice. Netflix will be forced to raise its price for everyone to pay for the “Comcast Tax”.
4. It’s an indirect cost that is going to be more expensive than if it was a direct one. If Comcast were to charge its customers a higher price to compensate for the extra investment, it would have every incentive to take care as not to make its service way too expensive. But as Comcast got the extra cash by charging a third party, they’re able to include some extra margin in the deal, which amplifies the overall cost impact.

Comcast got to this point by abusing its position of dominance in the broadband access space. Netflix could do very little about it. Customer ignorance also played a role; many people aren’t really able to discern if any performance problem is Comcast or Netflix’s fault (but even if they knew, they couldn’t do anything about it too).

In this case, Comcast had the upper hand and got to play the bully. But that doesn’t mean that Netflix may not become susceptible to playing the bully card itself, if it ever gets the chance. Netflix could try the same game: charging providers to connect to its network, so their end users will have faster access and higher quality content. If they ever do it, they’ll be guilty of the same sin.

There’s a debate going on now on the role of regulation. Some people believe that regulation alone can solve the problem, for instance, by requiring strong net neutrality rules. But others think that regulation causes more problem than it solves (and let’s agree that there are many great examples of botched regulation all around the world). Many regulations that are designed to protect the customer end up having the opposite effect.

This question is complicated by the fact that there are already a lot of regulations at play. For instance, everything concerning rights-of-the-way (RoW for short) affects the ability of competitors to offer broadband service to customers. The complexity of these regulations and the cost involved in dealing with them is one of the reasons why competing for local access is so difficult and expensive.

However, what is clear in this case is that something has to be done. What is not clear is if the solution is to create more regulations, or to reduce and simplify the existing ones.

There are many pieces in the broadband access business that are now bundled in a single integrated service. Complex regulations become necessary as the business get bigger. Breaking up big companies is a standard play in government intervention — one that despite all outcry, quite frequently has produced great results, as it was the case with Standard Oil and the AT&T breakup. After the initial shock, the smaller companies get the incentive to compete again, and a new wave of fast paced innovation and growth follows. What’s better, breaking up big companies potentially allows to simplify the regulations. Clear company boundaries can be set, allowing for simpler rules for business that allow for small companies to enter the market and compete. But that’s a subject for a separate post.