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Digital Empires Strike Back

30 Jun, 2014 By: Erik Gruenwedel

After bulking up, packing on customers and content, Amazon and Netflix are starting to throw their weight around. Amazon — the world’s largest online retailer — just launched a smartphone and a music-streaming service with 1 million songs free to 20-plus million Prime subscribers, who also have streaming access to tens of thousands of movies and TV shows.

Netflix, the subscription streaming business-model pioneer, now has a global base of more than 48 million subscribers, including 35 million in the United States. That’s more subscribers than rival HBO has domestically or the proposed Comcast/Time Warner Cable union.

Both companies stream original programming, in addition to spending billions for exclusive rights to third-party content from Hollywood studios, making them top players in entertainment. As such, Netflix and Amazon have raised the bar to entry, effectively hindering most of the competition.

While Amazon’s ongoing battles with book publishers may have garnered much of the spotlight, the controversy also coincided with a reported wrinkle in contract talks with Warner Home Video.

The e-commerce behemoth had stopped preorders on heavyweights such as The Lego Movie, 300: Rise of an Empire and Transcendence (which streets July 22), among others, while it ironed out a new distribution deal with the studio. Amazon has reinstated Warner preorders.

The two sides reportedly are near a resolution in the dispute in which Amazon is seeking more favorable terms with home entertainment’s biggest studio.

While the situation is not the first time Amazon has sparred with a Hollywood studio over pricing, it was the first time the company used preorders as a negotiating tactic.

Meanwhile, Amazon has apparently transferred select Warner television shows from its Prime Instant Video platform to its transactional video service, Amazon Instant Video.

“A company [in today’s media world] needs to control either the content, or the pipes. If it has neither, it’s a mere middleman, consigned to low or no profitability,” Neil Irwin wrote about Amazon in The New York Times.

Netflix appears to be trying to accomplish both.

Netflix Plays Politics

Netflix CEO Reed Hastings has spearheaded a well-documented public campaign criticizing recent interconnection agreements the subscription streaming pioneer ironed out with Comcast and Verizon to ensure their Netflix subscribers get the fastest possible streaming speeds.

“Some big ISPs are extracting a toll because they can,” Hastings wrote in a March 20 blog. “They effectively control access to millions of consumers and are willing to sacrifice the interests of their own customers to press Netflix and others to pay.”

While Netflix apparently sought out the peering agreements, it also considers them a nasty byproduct of an Internet ecosystem that allows broadband traffic into homes to be controlled by a few powerful ISPs.

In an act of bravado, Netflix earlier this month began emailing Verizon subscribers alleging the telecom operator was responsible for their fluctuating streaming speeds. Verizon consumers got this warning while trying to stream Netflix video: “The Verizon network is crowded right now. Adjusting video for easier playback.”

In a terse blog response, Verizon said the slow streaming speeds were likely due to the way Netflix routed its Internet traffic and not the telecom’s ISP network.

“This [Netflix] claim is not only inaccurate, it is deliberately misleading,” Verizon wrote. Following threat of litigation, Netflix agreed to discontinue the emails.

But the tactic worked, getting the attention of the Federal Communications Commission. Tom Wheeler, chairman of the FCC, agreed to scrutinize the details surrounding the controversial “peering” agreements.

“At the heart of this is whether ISPs that provide connectivity in the final mile to the home can advantage or disadvantage content providers, and therefore advantage or disadvantage consumers,” Wheeler said in a statement.

That Wheeler — a former top cable industry lobbyist in favor of tiered streaming channels — agreed to the inquiry speaks volumes about Netflix’s influence. Indeed, Wheeler himself is a Netflix subscriber who has admitted to experiencing rollercoaster streaming speeds.

Whether the government’s look under the ISP “hood” will result in increased regulation or even expanded net neutrality provisions is a matter of opinion. Net neutrality, the concept of treating all Internet traffic equally, does not currently encompass peering and interconnection issues.

“The FCC has no control over commercial peering deals, even under Title II,” said Frost & Sullivan media/tech analyst Dan Rayburn.

The FCC has little jurisdiction over ISPs as they are currently classified as information services and not telecommunication landlines, Rayburn noted. But there is growing sentiment that ISPs should be reclassified as utilities (under Title II of 1934 Telecommunications Act), which would fall under FCC purview.

Regardless, Rayburn says it is all for show.

“[The FCC] will look at it, whatever that means, but even they have agreed they won't do anything about it,” he said. “Legally they can’t.”

While some in the media have portrayed net neutrality as a battle between ISP robber barons and the people, Netflix’s “victim mentality” on the issue is ludicrous, according to Wedbush Securities analyst Michael Pachter.

“If ISPs need to charge to build more infrastructure, which enables Netflix to dominate primetime bandwidth usage, the SVOD service should underwrite some of the costs,” Pachter said. The analyst believes ISPs have three options: Either pay for the infrastructure upgrades through reduced profits and lower returns for their shareholders, charge consumers directly, or pass the costs to firms such as Netflix.

“Netflix is trying to make sure it doesn’t have to pay, but it isn’t saying ISPs don’t need to charge someone,” Pachter said. “It’s like taxes: ‘Don’t tax me, don’t tax you, tax the other guy.’ Somebody has to pay.”

Courting the Competition

While Netflix seeks expanded regulatory protection in the United States, in Europe the service is aligning with erstwhile competitors such as cable and telecoms as it readies launches in four countries by the end of the year. Befitting its market leader status, Netflix reportedly is in talks with Deutsche Telekom regarding a joint marketing campaign when the company launches service in the country by the end of the year.

Meanwhile, Amazon Prime signed its first license deal with Lionsgate U.K. for streaming access to the mini-major’s TV programs in Britain. Amazon also made inroads in Germany, where it inked a license agreement with Starz Digital Media for the first two seasons of “Spartacus” and the six-part prequel Gods of the Arena.

And earlier this year it inked a groundbreaking deal with HBO for select catalog programs — making Amazon Prime the first third-party subscription streaming service to offer HBO programming.

Analyst Pachter believes Amazon has secured higher-profile content licenses this year (compared to Netflix) because it represents a counterbalance of sorts to the SVOD pioneer’s burgeoning empire.

“Netflix absolutely has zero clout with consumers, especially in Europe,” Pachter said. “There is not a lot of brand loyalty. Amazon, on the other hand, has some because it already is in Europe and it is ‘the everything store.’”

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