Why Did Netflix Decide To Pay Comcast?

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Netflix

Has Netflix‘s (NASDAQ:NFLX) recent deal with Comcast set a new precedent in the Internet industry? The answer to this questions lies in what really encouraged the company to ink an agreement wherein it will deliver its content directly to Comcast and pay a certain amount to maintain the quality of service. Was it a sound business decision, or was Comcast deliberately slowing down Netflix’s streaming in order to profit from it, as it now will? We can only speculate about these possibilities but going by the facts it becomes clear that additional cost burden on Netflix will be minimal and the quality of streaming will improve, which is good for the subscribers as well as for the future growth of the company. Strictly speaking, Netflix will be paying Comcast instead of a third party network provider so this is more of a vendor shift. Let’s examine why Netflix may have made this move.

Our price estimate for Netflix stands at $250, implying a discount of more than 40% to the market price.

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Exploding Data Necessitates Streaming Quality Management

Netflix’s streaming business has grown rapidly in the last few years. In the U.S. alone, the company has increased the number of streaming subscribers from 21.7 million at the end of 2011 to 33.4 million by the end of 2013, registering a growth of 54%. As a result, the streaming data has also posted a phenomenal rise. Due to the ongoing trend of binge watching, the data load on broadband networks increases significantly during peak times, which is evident from a report published by Sandvine in late 2013. According to the firm, Netflix accounts for roughly 32% of the peak Internet traffic in North America, whereas the second contender YouTube stands at around 19%. [1] There is good chance that this figure would have gone up by now. Netflix has laid emphasis on quality of video, which is another reason why its data traffic far exceeds that of YouTube.

As a result, several Comcast customers have complained about slow streaming from Netflix during peak hours. Netflix wants to solve this problem by directly delivering its content to Comcast’s network, thus eliminating middlemen, and the agreement will guarantee a certain level of service. This is not a first deal of its kind, as several other Internet behemoths including Facebook and Google have similar agreements. We believe that this is a good development for Netflix as it will not only eliminate the uncertainty around relationship between the content provider and broadband network owners, but will also help the company maintain its service quality, which is essential for its future growth. The only thing that could change our opinion is if Comcast leverages its position to demand sharp price increment in the future. This could potentially hit Netflix’s margins and force it to pass on these costs to customers, thus hindering the subscriber growth.

Notes:
  1. Netflix, YouTube gobble up half of Internet traffic, CNET News, Nov 11 2013 []