Results tagged “ISP Interconnection”

May 29, 2015 2:20 PM

The Historical Evidence Supporting the ISP Discrimination Theory

The primary justification for "strong" net neutrality rules is always that there is insufficient competition in the infrastructure services market.  The theory that insufficient competition in an Internet access market enhances the ISP's incentives/ability to discriminate against "off-net" traffic sources (content, applications, or interconnection facilities of smaller rivals) is a foundational premise of the Commission's recent Net Neutrality/Broadband Reclassification Order

Today, we're going to look at the origins of this theory--in competition law--and whether there is any historical evidence to validate this concern.  This may seem risky, because if historical evidence isn't conclusive, it can be claimed as "support" for a lot of different theories. 

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For example, "ancient astronaut theorists" (as the History Channel calls the UFO crowd) point to surprisingly-advanced ancient wonders throughout the world (e.g., pyramids, or other very large inland structures) as "evidence" that aliens were responsible for these accomplishments.  While some [non-History-Channel-viewers] will be inclined to dismiss ancient astronaut theories, these theories cannot be disproved, either.  On the other hand, if the historical evidence is conclusive, it can rule out inconsistent theories.  Is "ISP market share=interconnection degradation" theory at least as viable as ancient astronaut theories?

WorldCom "Will . . . Become the Internet"

The quote above was from an antitrust complaint, filed by one of WorldCom's smaller rivals in the Internet backbone market, in 1998.  GTE Complaint at ¶2.a.  (emphasis in original)  The smaller rival was no beginner, it was GTE--the country's largest integrated local/long-distance telephone company (at a time when virtually all Internet traffic was carried on telephone company facilities). 

Moreover, GTE wasn't crazy to be concerned.  If you had a crystal ball, you could not have positioned yourself better than WorldCom did through a series of acquisitions from '94-'96, which--you may recall--was when the commercial Internet took shape.  By the end of 1997, WorldCom was the largest provider of Internet backbone capacity in the country. 

So, when WorldCom sought to acquire the second largest Internet backbone--MCI--in November 1997, the DoJ was concerned that the post-merger firm would control between 40-70% of the Internet backbone market.  In early 1998, the Economic Policy Institute estimated that 62% of the entire Internet's revenue would need to traverse the MCI WorldCom backbone, and 50% of all ISPs would be dependent on access to the firm's backbone network. 

A Flawed Theory Takes Root

GTE believed so strongly that the MCI-WorldCom merger threatened its ability to compete in both the Internet backbone, and long-distance, markets that it filed its own private antitrust suit to enjoin the MCI-WorldCom merger in May 1998.  In GTE's Complaint, the company explains its concerns:

all of the major backbones . . . are . . . dependent upon each other for interconnection. They thus find it in their independent interests to cooperate to maintain and upgrade the capacity of interconnection among their networks in order to offer their customers ubiquitous, high-quality access to the whole Internet. . . .  By concentrating . . . the two largest Internet backbone networks to create one dominant national network, the merger will give MCI-WorldCom a stranglehold over the burgeoning Internet and the incentive and ability to stifle competition from all other rival Internet backbone operators, including GTE.
GTE Complaint, at ¶2.a.  Interested readers should look at GTE's full Complaint, as (I promise) you'll find it all sounds very familiar. 

GTE's case never made it to trial, because the facts of the Complaint would soon become less clear.  In July of 1998, MCI agreed to spin off its own Internet backbone to Cable and Wireless; after which the DoJ cleared WorldCom's pending acquisition of MCI with a press release.  The FCC issued its Order clearing the transaction soon after the DoJ's Press Release. 

"So Much for Grand Efforts by Regulators to Dictate Outcomes"

MCI's divestiture of its Internet backbone didn't work out as the DoJ and FCC had hoped.  There were soon allegations that MCI had "pulled a fast one," and had not provided C&W much more than the physical assets of its Internet backbone business.  C&W sued MCI WorldCom in March of 1999. 

Undeterred, WorldCom announced it was buying Sprint for $115B in October of the same year.  In November of 1999, C&W aired its grievances at a Congressional Hearing on the Sprint/WCOM merger.  A little over a month later, Carleen Hawn wrote an incredibly insightful short piece for Forbes, entitled "Swimming with Sharks."   

In her article, Ms. Hawn recounts C&W's complaints, but notes significant industry disagreement about which side was to blame.  According to Jim Crowe, founder of Level 3, the divestiture would never have worked as expected by DoJ, because C&W lacked a domestic U.S. network with which to interconnect the MCI backbone network.  C&W would, therefore, have had to purchase domestic Internet transit capacity.  (Note: this would have been right before Internet transit prices began a swift, steep, and inexorable, period of decline.  See, Dr. Peering table of Internet transit prices.)  

Thus, post-merger MCI WorldCom's market position was unaffected by the divestiture, as its share of the backbone market continued to grow faster than rivals.  In January 2000, Hawn states, "MCI WorldCom is simply more dominant than ever," concluding, "so much for grand efforts by regulators to dictate outcomes."  

A Dominant Gatekeeper . . . Isn't Abusive?

But, if the MCI backbone divestiture did nothing to diminish MCI WorldCom's dominance in the Internet backbone market, what was the outcome?  If GTE's theory was correct, MCI WorldCom would now have "both the incentive and the ability to act opportunistically to degrade the quality of interconnection and increase costs for its rivals."  GTE Complaint ¶23. 

Apparently, though, even with 60% of the revenue-generating traffic on the Internet being dependent on its network, MCI WorldCom never found it profitable to act on its incentives/ability to degrade rivals' interconnection terms.  Indeed, there's no evidence they--or any other ISP (either with respect to access or backbone transit)--has ever acted on such an incentive.  But it would take more than a decade for a court to make this finding.  

The Theory Goes to Court

There are two lasting legacies of GTE's theory of dominant ISP discrimination: 1) the general justification for the FCC's current Net Neutrality/Broadband Reclassification Order, and 2) Cogent's peering strategy.  Beginning with its very first ISP peering dispute, with AOL in 2002, Cogent has been the torch-bearer for GTE's never-tested (at the time) theory.  In fact, Cogent has wheeled out this argument every time it's been de-peered (which is a lot--partial list here), and most of the time it files something new at the FCC, or speaks to the press.

So, it was only a matter of time before Cogent tried to really test the GTE theory in an adjudicatory proceeding.  In 2011, Cogent filed a complaint with the French competition authority, alleging, among other things, that France Telecom's peering ratio (of 2.5X) constituted anticompetitive discrimination, as was France Telecom's refusal to unilaterally add capacity in violation of the firm's prior peering agreement.  Customers of France Telecom experienced congestion when downloading content from Cogent client, Megaupload

In many ways the French competition authority was the most sympathetic forum for this claim.  European competition law--with respect to dominant firm behavior--gives much more weight to preserving opportunities for smaller, and mid-size, firms (U.S. antitrust laws tend to focus primarily on economic efficiency).  See here at pp. 5-6/16.  French competition law is more favorable (than E.U. law) to smaller firms versus dominant rivals, and includes the notion of "abuse of a situation of economic dependence."     

But, Cogent could not make the theory overcome its facts; real-life ISPs simply don't discriminate as predicted.  The French competition authority ruled against Cogent.  See summary here.  Cogent appealed the decision, and a French appellate court affirmed, noting that peering was not an "essential facility," and is in no way functionally different from, or inferior to, transit.  See summary here.    

It Costs More $$ to Believe a Theory than Our Own Lyin' Eyes

In May of 1998, the commercial Internet had only been around for a few years.  At the time, GTE's concern that a "dominant" firm would abuse its position to degrade access to, and raise prices of, interconnection facilities needed by its smaller rivals was not an unreasonable concern. 

However, GTE's concern was immediately put to the test in actual market conditions, and it proved inaccurate.  More recently, as noted, Cogent failed to convince a regulator, under the most lenient standards, that it was harmed by the dominant firm's observance of international peering standards.  A French appellate court agreed, and confirmed this finding.

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Yet the "dominant ISPs will harm consumers/competitors" theory--unlike the ancient astronaut theories--continues to pick up traction from sources that should be more skeptical.  But, unlike the ancient astronaut theories, continued belief in the GTE theory is not harmless.  Last week, in a policy memo, Hal Singer of the Progressive Policy Institute describes some of the many costs--in terms of services and innovations foreclosed, and investments forgone--of continuing to believe in the possibility of a theory that our "own lyin' eyes" have never seen happen.


March 4, 2015 12:42 PM

The FCC Avoided a Bigger Disaster on Interconnection . . . for Now

In case you didn't notice, the FCC's press release describing its decision to reclassify broadband Internet access is a little different on the subject of interconnection than Chairman Wheeler's "Fact Sheet" 3 weeks earlier.  The FCC's press release from last week is substantially similar to the Chairman's fact sheet, except that it contains no reference to the classification of  the "service that broadband providers make available to 'edge providers.'"

The Chairman's "Edge Service" Classification Proposal Was Really Unpopular

On the last day that parties could lobby the Commission, (February 19th) Google had meetings with senior advisors for the Chairman and the two Democratic Commissioners.  In these meetings, Google persuasively argued that "the Commission should not attempt to classify a "service that broadband providers make available to 'edge providers,'" because "this supposed additional service does not exist." Ex Parte (Internal quote to Chairman's "fact sheet.")   On the eve of the Commission's vote, the Wall Street Journal reported that "the FCC tweaked its language to address Google's concern."  

Without this report, it would be hard to know who to credit for killing a truly reckless idea.   That's because the following 5 parties all made arguments against the Chairman's proposed "new service" on the same day as Google:  Akamai, Free Press and New America's Open Technology Institute, National Hispanic Media Coalition, and Cox Communications.

When you somehow manage to get Free Press, New America, and the National Hispanic Media Coalition to oppose an additional Title II regulatory classification--because it makes your original Title II reclassification look even more legally suspect--that's when you know you've gone too far.  

The Importance of Direct Interconnection Agreements

The scariest aspect of the Commission's proposal must have been the FCC's casual willingness to disturb these companies' existing arrangements with ISPs by mandating the future terms on which they and others would be able to obtain interconnection.  For companies with little to no regard for the terms of their existing interconnection agreements, like Netflix and its transit vendors, the Commission could not make their situation worse.  But, for the leading Internet companies, the Commission must have appeared alarmingly ignorant of/indifferent to the importance of these agreements to Internet traffic delivery.

Reason 1:  The Disintermediation of Internet Traffic

In 2009, the University of Michigan, Arbor Networks, and Merit Network presented the results of the largest traffic study since the advent of the commercial Internet.  The study showed that, between 2007 and 2009, Internet traffic delivery changed radically.  Over only 2 years, Internet transit (the traditional "intermediary" between ISPs) became dramatically less important as a traffic delivery vehicle.  

Instead, major content providers began delivering more and more content directly to the consumer's ISP (either through their own networks or CDNs).  Accordingly, since 2009, the "tech giants" have been accelerating their investment in network assets and data centers to route their high bandwidth traffic directly to efficient delivery points in the ISP's networks.

Reason 2: Interconnection Agreements Reflect Valuable Investment

As the Internet has evolved to more efficiently deliver high-bandwidth content to consumers, the largest content providers--including Netflix for the first 4 years of its streaming service--have placed a premium on placing content closer to the customer.  Therefore, the largest traffic sources have entered into agreements to directly exchange traffic with their customers' ISPs.  When these agreements provide for the settlement-free exchange of traffic, it is because this reflects the mutual benefits received by both parties.  

CapEx Graph 1.jpgSince parties to settlement-free "peering" arrangements each provide the other with valuable network facilities, or other benefits, this value can be observed by looking at the investment the parties put into their networks (i.e., capital expenditures).  To get an idea of the importance of those agreements to Internet companies, consider the increase in capex by the largest Internet companies since 2009.

Regulation of Interconnection Terms Could Devalue Previous and Future Investment

As we can see from the chart above the major Internet companies have undertaken a massive amount of capital spending over the past 6 years in order to efficiently deliver content and services to consumers.  To be sure, not all of the Internet companies' capex is driven by traffic delivery interconnection concerns, but the increase in these companies' capex since 2009 correlates with the findings of the University of Michigan, et al., traffic study referenced above.  Moreover, news reports have confirmed spending on improved data networking infrastructure as a capex driver. See, e.g., here and here.   

This capital investment has been made by edge companies and CDNs with the expectation that it will allow these firms to provide a better experience to their customers than their competitors provide.  Indeed, Google notes that it has entered into peering agreements with some of the largest ISPs because it is "unable to use transit to reach users on those networks with reasonable quality." Ex parte at 2 (emphasis added.)

The risk of requiring ISPs to provide interconnection as a separate common carrier service was articulated succinctly by Akamai, which handles 15-30% of the world's Internet traffic.  Akamai argued that the FCC must not mandate the terms and conditions of ISP interconnection, because if the ISPs are required to provide access on equal terms to all:   

This is not technically feasible and the result could be access for none, which would decrease the performance, scalability, reliability and security of the Internet.
Akamai, February 20th ex parte at 1 (emphasis added).  In other words, Akamai understands and accepts that it "must often compete with others for access to ISP facilities."  Akamai, February 9th ex parte, at 3 (emphasis added). But, does the FCC accept interconnection as a legitimate element of competition?

CapEx Graph 2.jpgThe Commission Should Not Displace Competition with Regulation

Netflix, Cogent, and Level 3 assert that they cannot get interconnection with the ISPs--on the terms they would prefer--because of a lack of competition.  But, as Akamai explained, companies seeking the most efficient terms of distribution to the ISP's customers are competing with each other for the best access to these customers.  Could it be that competition is the reason the transit companies aren't getting the terms they want?

Compare the sum of the capex of Netflix's distribution chain over the relevant time period, with their competitors.  Is it surprising that Internet transit wants the FCC to "level the playing field?" 

Transit is at a disadvantage relative to direct interconnection because the Internet has evolved.  For the content distributors sending the most traffic, transit has not been the preferred solution for a long time.  But competition, and not a lack thereof, produced this outcome.  

Unlike the major focus of the larger net neutrality debate--which is concerned with adopting rules to foreclose future ISP service offerings--the regulation of interconnection terms and conditions is fraught with risks to existing service configurations.  The FCC must be careful not to use prescriptive regulation of ISP interconnection terms--in the name of competitive "neutrality"--to foreclose innovative firms (and their customers) from reaping the benefits of their own ideas, risks, and investments.

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December 23, 2014 1:07 PM

The Netflix/Comcast Dispute Pt. 3: Did Netflix Mislead Its Customers?

We've, so far--in parts 1 and 2 of this series--looked at some of the justifications Netflix provides for providing inferior service to its customers served by Comcast for months on end, beginning at some time in 2013.  See, e.g., this Netflix ex parte letter, at p. 2. also, slides 33/34 of this ex parte presentation.   We could finish up by taking a look at each side's claim that the other was the real "cause" of the congestion--but that would miss the point of whether interconnection rules, or the lack thereof, were responsible for consumer service disruptions in this case.

Absent any truly shocking new information coming to light (such as learning that Netflix's contract with Cogent was intended to harm consumers, for example, by expressly forbidding Cogent from purchasing supplemental capacity to relieve congestion for its retail customers), it doesn't matter which party is "right" as a matter of Internet policy.  Rather, the immediate question is whether consumer disruption was the unavoidable consequence of this "policy dispute" (though it was unclear whether the dispute between Netflix, Cogent, and Comcast was a "policy," or ordinary business, dispute when it was settled).  

Netflix Knew Congestion Would Impair It's Service

In its Terms of Use for its customers, Netflix designates that Delaware law control any dispute with its customers.  See, Netflix Terms of Use, para. 11.b.  As was mentioned in the blog  dealing with the Cogent-Comcast interconnection agreement, Delaware law holds that "[a] party does not act in bad faith by relying on contract provisions for which that party bargained, where doing so simply limits advantages to another party."  

Thus, Netflix should/would have anticipated that Comcast would "rely[] on contract provisions for which [it] bargained."  Given that Comcast's actions were entirely predictable (and not in bad faith), Netflix would also have known that adherence to its "principle" (of not paying the ISP for transit) would lead to service-affecting levels of congestion for its customers.  So, if Netflix knew that the combination of its planned course of action and Comcast's predictable reaction would cause its customers to receive congestion-degraded service, did Netflix have any obligation to its customers under Section 5 of the FTC Act?

Was Netflix's Failure to Disclose Congestion an Unfair or Deceptive Practice?

Section 5 of the FTC Act prohibits "unfair or deceptive acts or practices" that affect commerce.  An act or practice may be found to be unfair where it "causes or is likely to cause substantial injury to consumers which is not reasonably avoidable by consumers themselves and not outweighed by countervailing benefits to consumers or to competition."  See, FTC Unfairness Statement.   The FTC is likely to find an act or practice to be deceptive if "there is a representation, omission or practice that is likely to mislead the consumer acting reasonably in the circumstances, to the consumer's detriment." FTC Deception Statement

It seems fairly clear that Netflix's provision of compromised service, without disclosure, was an "unfair practice" in the sense that consumers could not have anticipated, or avoided injury.  Moreover, it would be hard to speculate that Netflix's actions--of not notifying consumers to expect degraded service--had some countervailing consumer benefit.  Thus, let's look at whether Netflix also engaged in a deceptive act or practice.  

Netflix Knew It Was Selling Inferior Service.  According to Netflix, for the entire history of its streaming service, someone (a 3d party CDN) has always paid the ISP for the incremental capacity necessary to ensure its traffic was delivered without congestion. Florance Declaration  ¶¶ 29-41.  Furthermore, as even Comcast points out, Netflix's decision to artificially limit its transit vendors--based on Netflix's "principle" of not paying for ISP capacity or paying anyone that does--meant that these vendors' capacity between their networks and Comcast were bound to become overwhelmed, resulting in congestion.  See, e.g., Declaration of Kevin McElearney, Comcast, at ¶¶ 23-25  

Netflix has established that its Comcast customers received a "substandard" grade of service even though the consumer was paying for, and expected, the "standard" grade of service.  Florance Declaration ¶¶ 51-55.  Nonetheless, Netflix kept selling service to Comcast customers, knowing that--as long as its transit vendors' lacked sufficient throughput capacity at points of interconnection with Comcast--each incremental customer would contribute to the service degradation experienced by all Netflix/Comcast customers.  

Netflix Deceptively Failed to Disclose Its Comcast-Specific Service Level.  The FTC, in its 1983 Deception Statement, states that "the practice of offering a product for sale creates an implied representation that it is fit for the purposes for which it is sold." Deception Stmt., n.4.   The FTC has further explained that,

Where the seller knew, or should have known, that an ordinary consumer would need omitted information to evaluate the product or service . . . materiality will be presumed.
Id. Under the circumstances, and without knowing the extent, length, or degree of degradation to expect, it was impossible for an "ordinary" Comcast broadband consumer to evaluate prospective Netflix service.  Thus, Netflix's knowledge of, and omission of, relevant information about Netflix's Comcast-specific congestion service impairment was "material" and, therefore, deceptive.  

Consumer Protections Can't Be Ignored and Be the Basis for Interconnection Rules

Netflix tells the FCC that, "when Netflix's traffic was congested it did everything in its power--short of paying Comcast an access fee--to alleviate the congestion . . . ."  Netflix Petition to Deny at 62. (emphasis added).  The notion that Netflix "did everything in its power"--short of doing the one thing it knew would resolve its service disruptions, and what it ultimately did do--is fallacious, and simply another way of stating that Netflix did just what it intended to do.  

If the FCC believes that consumers will benefit from interconnection rules, it should adopt rules after careful consideration.  But the Commission should not to deceive itself into thinking that "consumer welfare" is served by preemptively granting concessions to prevent behavior that is otherwise flatly proscribed by existing consumer protection laws.

December 19, 2014 12:22 PM

The Netflix/Comcast Dispute Pt. 2: Was Netflix Surprised?

As we mentioned yesterday, Section 5 of the FTC Act prohibits companies from engaging in "unfair or deceptive acts or practices."  A lot of the FTC's inquiry focuses how a reasonable consumer would expect to be treated.  Today we'll look at Netflix's contention that, as an OVD, Comcast has an incentive to discriminate against it.  We'll also look at whether Netflix, when it changed its manner of distribution to customers of large ISPs (i.e., most U.S. customers) in 2013, observed ordinary distribution practices for providers of video streaming service.  

If Netflix seems to be the victim of a discriminatory refusal by Comcast to continue to provide uncompensated inbound capacity to Netflix's transit providers (notwithstanding the parties agreed-upon limits of settlement-free capacity), then it couldn't have expected congestion would affect its service. Similarly, if Netflix used normal industry practices for distributing streaming video service, then it could not have foreseen that its service would fail to meet reasonable consumer expectations--and could not have been expected to disclose to these consumers that their grade of service would be below "normal."  

Does Comcast Have an Incentive to Discriminate Against Netflix?

Demonstrating the "incentive/ability to discriminate/exclude" is an essential allegation for any complainant to establish as part of a credible theory of unilateral harm to competition by a dominant firm.  In its Petition to Deny the Comcast-TWC Merger, Netflix attempts to satisfy this element by reciting general statements by the DoJ and FCC to justify settlement conditions in prior mergers.  Netflix recites theoretical statements that an integrated MVPD/ISP (i.e., Comcast) "may" have the incentive discriminate against an OVD.  Netflix seems to be hoping the Commission will assume that it is that hypothetical OVD/discrimination target; and, given that Comcast ("Satan's ISP®") is involved, it's doubtful the FCC will question Netflix's implied victimization.
 
Netflix Service Is a Complement to MVPD Service.  Netflix never directly says that it has been the target of discrimination by Comcast.  Even if we assume that Comcast would--irrationally, according to this GigaOm analysis--favor its lower margin service over its higher margin service (to which Netflix is critical), there is no evidence that Netflix's streaming video service is a substitute for Comcast's subscription video service. 

Instead, all available evidence suggests the contrary--that Netflix offers a complementary service.  Netflix's CEO has said as much, as have the cable companies and satellite companies that want to make Netflix accessible on their set-top boxes, and the large ISPs that offer "free" Netflix service as a marketing tool to attract new customers to their higher tiered services. 

Thus, it is unlikely that Comcast would intentionally degrade such an important complementary service as Netflix, because any devaluation of a complementary service damages the value of the other complementary component (Comcast).  Moreover, if Netflix believed that it was the target of anticompetitive tactics by Comcast, it would not have waited for a merger before complaining to--or filing a complaint with--the FCC or the DoJ. 

Did Netflix Use Reasonable Methods to Deliver Streaming Videos?

Since various parts of the FTC's unfair or deceptive analysis focus on practices that a "reasonable" person might consider unfair or misleading, let's try to get an idea of how other online streaming content is delivered--as the quality of other similar services informs consumers' reasonable expectations regarding online streaming video quality.  Since Netflix's customers noticed that Netflix's congestion-affected service was below their expectations, let's look at how other providers of online streaming video distribute the quality consumers expect of "streaming video service" generally.     

WWE Network.  The same week that Netflix announced its direct interconnection agreement with Comcast, the WWE (World Wrestling Entertainment) launched the WWE Network--a 24/7 online channel broadcast in 720 HD.  Moreover, because the WWE was, for many years, the largest consistent source of MVPD pay-per-view revenues, it would seem that the cable companies would not want to see this content successfully migrate from the MPVD platform to the Internet.

The WWE Network has received generally good reviews with respect to its streaming performance; and no complaints of ISP discrimination have surfaced.  The WWE Network is delivered through a partnership with MLB Advanced Media.  MLBAM, in turn, uses the Akamai and Level 3 CDNs. 

Free Porn.  As the Tony award winning musical, Avenue Q, reminds us (and the FCC is well aware), "[t]he Internet is for porn."   When you stop smirking, consider that many estimate that the volume of adult site traffic is comparable to Netflix's share of Internet traffic. See here, and here.  Moreover, like the WWE Network, the migration of adult videos to the Internet has hurt cable companies' PPV revenues.     
 
Mind Geek is the largest of all streaming adult video providers; its CTO says the company is one of the top 5 consumers of Internet bandwidth in the world.  Mind Geek uses "two of the largest CDNs in the world" to carry its traffic--not that much different from the way Netflix distributed videos (when it cared about congestion).

The "Next Netflix." Every smaller streaming site that I looked at, and which discussed their Internet transit partners, used more transit networks than Netflix.  Many providers that focus on hosting video streaming also offer multiple "CDN-style" server sites at multiple points within major ISP service territories.  See, e.g., Rackspace (9 transit networks & 219 edge locations) and AdultHost.com, which "ensure[s] congestion free" content delivery by: 1) sending packets over the "least congested" route (vs. shortest, like BGP), 2) uses at least 7 different Internet transit networks.    

So, it seems unlikely that Comcast tried to degrade Netflix's traffic by deliberately allowing its transit providers' interconnection points to congest.  Similarly, it doesn't seem like Netflix even used the same standards of distribution that a free porn monopoly provides viewers.  Thus, it was plausible that Netflix knew its customers in Comcast's territory were in for a prolonged period of substandard service.  In the next post, we'll look at the possible implications under the FTC Act. 


***Relevant Facts***

Here is a brief recitation of the relevant facts for purposes of our discussion.  Unless otherwise cited, the facts are taken from the Declaration of Ken Florance http://apps.fcc.gov/ecfs/document/view?id=7521825167 , Netflix's Vice President of Content Delivery, submitted in support of Netflix's Petition to Deny the Comcast-TWC Merger (FCC Docket No. 14-57).

For most of the history of Netflix's streaming video delivery service, Netflix believes that Comcast has required Netflix's third party vendors to pay an additional fee to cover some (or all) of the cost of Netflix-specific capacity augmentation at interconnection points.  Netflix describes 3 instances between 2009 and 2010 where it believes CDNs needed to purchase additional capacity to alleviate congestion issues. Florance Declaration ¶¶ 29-41.

Netflix acknowledges that the volume of its traffic does increase demand for ISP-bound capacity at its vendors' points of interconnection with Comcast.  Moreover, these costs are incremental and specific to the particular point of exchange between Netflix's Internet transit vendor and the ISP.  Florance Declaration at ¶ 46. 

When its traffic was carried on third party CDN networks, Netflix was aware of the costs being incurred on its behalf, but "in the short term Netflix was insulated from a sudden price increase." Florance Declaration at ¶ 39.  While Netflix was using CDNs, its performance over cable systems seemed uniformly better than even on the most advanced telco systems.  http://techblog.netflix.com/2011/01/netflix-performance-on-top-isp-networks.html

While its service was good using 3rd party CDNs, Netflix explains that, "[a]fter the Akamai, Limelight, and Level 3 CDN congestion episodes [2009-2010], Netflix began transitioning its traffic from CDNs (all of whom, we believed, were paying Comcast's new terminating access fee) to transit providers in our continued effort to avoid terminating access fees."  Florance Declaration at ¶ 40.  (dates in brackets added).  Thus, in February, 2012, Netflix signed an agreement with Cogent for Internet transit service.  Cogent began transitioning traffic to Netflix in August 2012.  Florance Declaration ¶ 41.

Based on customer complaints about service quality, Netflix's service deteriorated immediately upon switching to Cogent transit and progressively deteriorated over the next year. Florance, at ¶ 51.  However, beginning in October 2013, Netflix reports a very high level of customer dissatisfaction and cancellations, due to "Netflix's inability to do anything to change the situation."  Florance ¶ 52 (emphasis added).


 
Continue reading The Netflix/Comcast Dispute Pt. 2: Was Netflix Surprised?
December 4, 2014 3:05 PM

Internet Interconnection: Bad Faith Is No Basis for Good Policy

A few weeks ago, President Obama, acting on some seriously bad advice, formally urged   the FCC to, among other things, consider regulating Internet interconnection agreements.  The "facts" that brought an ordinarily well-functioning market, based on two decades of voluntary agreements, into the President's regulatory cross-hairs were, of course, the highly-publicized disputes surfacing earlier this year involving Netflix, Cogent (one of Netflix's primary Internet transit vendors), and Comcast (at first, and then a series of other large ISPs).  

The only thing that is clear at this point is that there is a lot more information for the FCC to gather, especially from Netflix and Cogent.  The information that is available strongly indicates that the Comcast episode (and each subsequent ISP-specific iteration) was an anomaly, and not likely to repeat itself.  This, alone, should tell us to be wary of rushing to supplant a competitive market with regulation.

Moreover, because of the unique nature of this congestion event--and the fact that such an event had not happened before--the FCC must try to understand everything it can about this event before the Commission even thinks about adopting new rules.  Comprehensive rules are only the answer if the problem is that market participants have no ability/incentive to reach mutually-beneficial voluntary agreements.

Yet, in the present case, the parties were able to reach voluntary agreements; Netflix with Cogent, and Cogent with Comcast.  Therefore, before the Commission concludes that carrier-to-carrier agreements cannot work, it must ask: why didn't the voluntary interconnection agreements produce a timely, efficient outcome in the present instance?    

The Relevant Cogent-Comcast Congestion Facts

For our purposes, we only need to focus on a limited set of facts.  We'll take our facts exactly as presented by Netflix and Cogent (in their bid to obtain regulatory concessions in the FCC's review of the Comcast/TWC merger).  Specifically, we will refer to the Declaration of Ken Florance, Netflix's Vice President of Content Delivery, and the Declaration of Henry Kilmer, Cogent's Vice President of IP Engineering.

--In February, 2012, Netflix signed an agreement with Cogent for Internet transit service, which it would use to deliver traffic coming off CDN agreements later that year.  Cogent began transitioning traffic to Netflix in August 2012.  Florance Declaration ¶ 41.

--Cogent does not provide specific information about its settlement-free agreement with Comcast, but we can discern: 1) the agreement applies to traffic falling within a certain inbound/outbound ratio, 2) the agreement has been in place since sometime in 2008; and 3) for the first 5 years of the agreement, the parties were able to abide by the mutually-agreed-upon terms without issue.  Kilmer Declaration ¶¶ 17, 55, 61-64 and the attached Letter from Arthur Block, General Counsel, Comcast Corp. to Robert Beury, Chief Legal Officer, Cogent, dated June 20, 2013 ("Block Letter").

--Cogent also points out that: 1) it does not believe Comcast is its "peer" and that Cogent only agreed to exchange traffic with Comcast on a settlement-free basis because of Comcast's "market power," and 2) Cogent does not believe there is any reasonable basis for "in/out ratio," which defines the range of traffic volumes subject to exchange on settlement-free terms. Kilmer ¶¶ 42-45, and ¶¶ 55-60.

--According to the Block Letter, Comcast states that, in a capacity planning meeting in the fall of 2012, Cogent told Comcast it did not anticipate needing additional capacity in 2013.  Kilmer at pp. 17-18 of 18.

--In a recent ex parte letter, Cogent only disputes that it affirmatively represented that it would not need additional capacity in 2013. Here at 3.  Cogent does not dispute that it failed to provide any advance notice to Comcast that it anticipated needing additional capacity.   

Good Faith and Bad Faith in the Performance of Contracts

In contract law, there is a general presumption that parties to an agreement will perform their duties fairly and honestly, so as not to deprive the other party of the benefits of their bargain.  This presumption is a part of every contract, and is called the implied covenant of good faith and fair dealing. 

The converse of the implied covenant of good faith is, of course, bad faith.  Bad faith, however, goes beyond simply failing to perform a substantive provision in a contract.  Rather, it is defined as an "intentional dishonest act . . . misleading another, entering into an agreement without the intention or means to fulfill it, or violating basic standards of honesty in dealing with others."   

Defining bad faith in novel circumstances can be difficult, but Professor Stephen Burton, in a Harvard Law Review article in 1980, observes that parties frequently relinquish "future opportunities" to enter into contracts, and these same parties also have some discretion as to how they perform the contract.  Therefore, Professor Burton explains, "[b]ad faith performance occurs precisely when discretion is used to recapture opportunities foregone upon contracting." This test has become a widely-employed benchmark for determining bad faith by state courts. (The Burton article is not available online, but here is a great article by Prof. Robert Summers discussing the Burton test and Good Faith generally).

Did Cogent Exercise Bad Faith By Intentionally Disregarding the Terms of Its Settlement-Free Interconnection Agreement with Comcast?

As an experienced provider of Internet transit services, Cogent would have known how much Netflix traffic it could carry and still be within the terms of its settlement-free interconnection agreement with Comcast.  Instead of limiting the amount of traffic it would accept from Netflix, Cogent went ahead and agreed to accept as much as Netflix wanted to send.  Considering, as well, Cogent's expressly-stated contempt for the traffic ratio (which limited Cogent's future opportunities), it is impossible not to construe Cogent's willful disregard of the traffic ratio as an attempt to "recapture opportunities forgone upon contracting."  

While Cogent tries to insist that Comcast was being unreasonable by asking Cogent to observe the terms of the parties' agreement, the Delaware Supreme Court, not long ago, affirmed that "[a] party does not act in bad faith by relying on contract provisions for which that party bargained, where doing so simply limits advantages to another party." Here, n. 26.  The opinion of the Delaware Supreme Court is relevant because many firms, including Netflix, designate Delaware in contracts designating a choice of law.

Fool Comcast Once . . .

It seems obvious, in retrospect, that Comcast could not anticipate--and was not willing, or prepared, to deal with--Cogent's level of bad faith performance.  It is clear from Comcast's response to Cogent's escalation letter, in June 2013, that Comcast has no intention of treating Cogent's persistent disregard of a crucial term as a "total breach."  Comcast asks only that Cogent purchase transit for that amount of traffic which exceeds the parties agreed-upon ratio.

But, when Cogent refused Comcast's option for preserving the original agreement, while accommodating Cogent's demand for greater capacity, Comcast would have been within its rights to give Cogent notice of its intent to terminate direct interconnection with Cogent.  Because, if Comcast's customers were hitting The Pirate Bay a little too hard (demanding more Cogent-bound capacity), that's what Cogent would have done.  

In 2008, Cogent apparently decided that its settlement-free interconnection agreement with European ISP TeliaSonera had become unappealingly one-sided.  Cogent (probably?) provided whatever notice its agreement with Telia required, and then--fairly suddenly (according to reports)--Cogent simply stopped carrying Telia's traffic. 

In hindsight, Comcast would have best served its customers by simply terminating the agreement.  Though, this course of action would have led to a temporary disruption in service--as Cogent's customers sought other alternatives--it would not have led to the protracted degradation in service that consumers instead had to suffer.  

Nonetheless, the existence of this event will make the system of voluntary network interconnection that comprises the Internet less vulnerable to a future bad faith breach in a critical portion of the supply chain.  Parties to future voluntary interconnection agreements are now much more likely to craft agreements so as to insure against protracted periods of deteriorated service.  A few isolated instances of bad faith should not cause the FCC to abandon its faith in the fundamental structure of the Internet as we know it.