Why The FCC Chose To Believe A Lie

| About: Netflix, Inc. (NFLX)
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FCC chair Julius Genachowski admitted yesterday that the agency is choosing to believe a lie. The lie is that it costs real money to move bits. It doesn't.

HowStuffWorks recently looked at real costs, based on a new undersea cable now crossing the Atlantic. Their estimate, which assumes a handsome profit for the cable operator, is 1.9 cents. Per gigabyte. The real cost of streaming a Netflix (NASDAQ:NFLX) movie? About five cents.

There is an economic argument to be made about Internet traffic, based on congestion. If everyone is trying to use their cable modem at the same time to stream a Netflix movie, then traffic has to slow, because cable Internet is designed as a shared system, a certain amount of bandwidth shared among some hundreds of homes. (I know. I wrote the book on this for the industry in the mid-1990s.)

So if we're to charge anything but a flat rate for broadband Internet service, it should be based on time of day. Stream your Netflix into a DVR player at night, when traffic is lower, and you should pay a slightly lower rate for that traffic.

But that's not how the cable operators like Comcast (NASDAQ:CMCSA) and Time Warner (NYSE:TWX) want to proceed. What they want to do is set a price per-bit, an imaginary price completely unrelated to the actual cost of delivering that traffic to people.

Why? Netflix.

Netflix is competing with Comcast and Time Warner in the delivery of movie and TV content. Comcast and Time Warner own cable channels that are threatened by this competition. After all, if someone can get all the content they want for $8/month from Netflix, why not just buy a $50/month ISP contract instead of spending $150/month for cable channels?

The "cost" argument is a nonsense, because Netflix is investing in the technology needed to bring its content as close to the customer as possible. Or consider Google's YouTube (NASDAQ:GOOG), which charges nothing. That's because their costs are virtually nothing as well.

No. This is about content. Comcast and Time Warner are vertically-integrated producers of content, like the big Hollywood studios of the 1940s. Netflix not only threatens their control, but threatens to limit the size of their market. Why? Because cable channels are bundled, and this bundling - forcing consumers to take channels they don't want in order to get those they do - is at the heart of the business model that gives us 150 channels with nothing on.

Netflix is just a store for content, and can't deliver this cash flow to the cable networks. Can't have that. So buy into a lie, the lie that it costs money to move bits, that the Internet really is "a series of tubes," and the problem is solved.

Fact is you're not paying for the bits. You're paying for what the bits contain, the content owned by the cable operators who control your access to the bits.

Disclosure: I am long GOOG.