Two federal decisions, the repeal of net neutrality and the merger of AT&T and Time Warner, have disturbed the US telecommunications market this week, putting companies such as Netflix under threat.

First, the US district court has approved an $85bn merger between AT&T and Time Warner, potentially producing one of the largest creation and distribution companies worldwide. The decision is expected to encourage Comcast to make a similar bid for 21st Century Fox in an attempt to further consolidate the market. Comcast is already the US’s largest internet service provider (ISP) with 25.87 million subscribers in 2017.

At the same time, the repeal of the Federal Communications Commission’s (FCC) net neutrality rules will effectively permit telecommunications companies such as AT&T to prioritise their own content over that of their competitors.

AT&T has produced little content in the past, but the addition of Time Warner now gives the company more of a foothold in the entertainment sector, adding brands such as Warner Bros, HBO, TBS, TNT, and CNN. With the new FCC reforms, AT&T’s will undoubtedly become more powerful and profitable.

AT&T General Counsel David McAtee said in a statement: “We are pleased that, after conducting a full and fair trial on the merits, the court has categorically rejected the government’s lawsuit to block our merger with Time Warner. We look forward to closing the merger on or before 20 June so we can begin to give consumers video entertainment that is more affordable, mobile, and innovative.”

For Netflix and other online streaming companies, this shifting power dynamic threatens profitability.

 

Top internet service provider (ISP) by state

 

FCC reforms, net neutrality repeal will worry Netflix

Together, these two developments should be a cause for concern for on-demand services such as YouTube and Netflix. This merger, and more importantly, Comcast’s potential takeover of 21st Century Fox, means that connectivity in the US will be made up of an oligarchy of massive content library ISPs.

Software providers such as Netflix and Alphabet could be left paying a premium to deliver content to their own subscribers. In short, the combination of these two developments puts companies such as Netflix in a much weaker bargaining position with ISPs in the future.

To a large extent, consumers will not miss out as ISPs will want to deliver desirable content. However, if this slowly degrades the Netflix or YouTube experience then consumers could move with the content.

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It has been described by the Washington Post as the ‘cable-ification’ of the internet.

GlobalData Global Telecom Conusmer Services senior analyst Tammy Parker tells Verdict: “It is true that ISPs might now assess higher access charges to content providers, such as Netflix or other over-the-top (OTT) providers like Sling TV and YouTube TV, whose services consume large amounts of bandwidth.

“Those content providers would likely pass any increased access costs along to consumers. There are lots of nuances to agreements between the ISPs and the big broadband users though, so it remains to be seen how those might or might not change.”

How can online entertainment providers respond?

It is not all doom and gloom for entertainment software providers such as Netflix and Alphabet; there are options they can take to mitigate damage.

Alphabet already provides some internet services through its subsidiary Google Fiber, which provides fibre-to-the-premises services in some locations in the US. Alphabet originally had big ambitions for Google Fiber but has faced cutbacks in recent years. Alphabet will reportedly need to reaffirm its commitment to Google Fiber, in light of the uncertain road ahead.

TechCrunch editorial manager Danny Crichton said on this issue: “One interesting dynamic I could see forthcoming would be Alphabet creating strategic partnerships with companies like Netflix, Twitch and others to negotiate as a collective against ISPs. While all these services are at some level competitors, they also face an existential threat from these new, vertically merged ISPs. That might be the best of all worlds given the shit sandwich we have all been handed this week.”

A stronger investment in Google Fiber, or perhaps a strategy incorporating 5G technology, could give Alphabet leverage in negotiations with ISPs.

Netflix, on the other hand, will most likely have to break into the connectivity market. As negotiating contracts with Comcast and AT&T becomes more difficult, Netflix’s popular range of shows gives it some leverage.

Crichton adds that if Netflix, which closed on 12 June with a market cap of $158bn, has lost considerable negotiating power in light of the developments; then how can emerging on-demand entertainment start-ups hope to compete with the new powers afforded to ISPs?

Finally, the repeal of the FCCs net neutrality rules is not set in stone. US Congress still has the power to block the decision through the Congressional Review Act, which it used earlier in the year to reverse the FCC’s broadband privacy framework. The US Senate has already voted in favour of maintaining net neutrality, but the reversal would also require support from the US House of Representatives.

Parker added: “At the end of the day, the same competitive factors will guide ISPs and vertically integrated broadband/content providers to continue serving their customers and partners equitably.

“Meanwhile, approval of the AT&T and Time Warner merger removes uncertainty that was keeping other M&A activity on the back burner. We can expect to see more vertical merger activity going forward. For example, a battle royale is brewing that would involve Comcast and The Walt Disney Company, which each desire to own the bulk of 21st Century Fox.”