What Will Pay For The Online Video Explosion? Transit Bandwidth Inflation

Everyone talks about the explosion of internet video traffic. Everyone talks about the explosion in the bandwidth required to carry it. But no one talks about who is going to pay for it. There is one likely source: transit bandwidth inflation.

Robert X. Cringely is hit or miss as far as I’m concerned. He’s on a rant lately about how Google (GOOG) is secretly planning to control the universe by purchasing dark fiber. I don’t buy it. However, the benefit of his frequent delusions are the interesting sources he uses to make his arguments. His most recent post cites a paper (.pdf) that investigates the costs of video distribution on the Internet.

Lazy Blog Reader Summary of Paper: P2P distribution of media is radically cheaper than distributing it yourself using your own datacenter or outsourcing it to a CDN like Akamai (AKAM). By a factor of 1000.

Not a huge surprise to folks who understand how the Internet works. Everyone from the datacenter that hosts this blog to Akamai to your ISP pay for the right to transmit and receive bits on the Internet. The big cost contributor to the non-P2P applications, and what makes them more expensive, is transit bandwidth - the cost of transporting bits from the NBC or CBS datacenter to the eyeballs in the household.

My blog sits on a shared server at Mediatemple. Mediatemple pays for connectivity to the Internet cloud that allows these bits to reach your screen, typically a fixed price per Mb/s. The rate companies like Mediatemple pay for transit is highly elastic - the more they buy the better rate they get.

Akamai’s business is technically complex, but fundamentally it is about buying transit bandwidth low and selling high. Big bandwidth users like Akamai pay the least for transit so there is an economy of scale in their business. They couple this with a distributed computing infrastructure that allows content owners to stay out of the datacenter business. But a big source of their advantage in the marketplace is the arbitrage gains of reselling transit bandwidth.

If this is a source of competitive advantage then this is the critical question - who has the lowest transit bandwidth costs?

It’s the Telcos and Cablecos themselves. If Verizon (VZ) wants to distribute content to subscribers, their transit costs are zero. They don’t need to peer with anyone, in fact the Akamais of the world pay to send data into Verizon’s network.

Theoretically, this means that the Telcos and Cablecos could all enter the CDN business with a structural cost advantage. I have little faith in the creative business strategy of these companies, but I have full faith in their ability to extract a pound of flesh from others. And I think this day is coming.

Therefore it would seem that folks like Verizon (VZ), AT&T (T), Comcast (CMCSA), Time Warner Cable (TWC), Cablevision (CVC), etc are in a very good position to charge higher transit costs into their network, as the majority of traffic growth (Video) is going into their network.

The amount of bandwidth going into Verizon’s network destined for FiOS customers watching YouTube may explode, but the costs of carrying it will explode too. Verizon has a monopoly on the connectivity to these eyeballs. Theoretically, they could charge whatever they want for transit into their network.

Akamai and others will grimace at this bill but can effectively pass this cost on to their customers. It’s the content providers that will ultimately absorb the increase.

As a result, Network neutrality will never need to happen. Carriers will simply charge more for everything. Cablecos and Telcos can simply keep their transit rates flat while the amount of bandwidth explodes. Since they own all the end customers, maybe they even jack up rates. And surprise surprise, the cost of transit bandwidth no longer is headed to the floor (note log y-axis):

Carrier transit bandwidth cost inflation will pay for the video bandwidth explosion. Prediction: Total fees paid for transit into Cableco and Telco networks are going way, way up. Couple this with the possibility of the Mb/s transit bandwidth rates increasing and you can see the carriers are sitting on a very attractive source of cash flow. This cash will finance whatever new infrastructure they care to purchase, and maybe a little (or a lot) left over to pay shareholders.

That is, of course, if they can keep legitimate content providers from using P2P to eliminate the need to pay transit altogether. That scenario completely destroys the above assumption. I’ve said before P2P isn’t a business, it’s a catalyst to force media companies to distribute digital content. It’s clear to me it’s also the only weapon they have to avoid transit bandwidth inflation.

Full Disclosure: Author is long AT&T and Verizon