But Netflix can’t succeed without a lot of help from its partners in the digital supply chain. The company is only as good as the programming it offers. And content owners are apparently inclined to drive a harder bargain these days: Netflix paid a whopping nine times as much for streaming rights in the second quarter of 2011 as it did the same quarter a year earlier.

More relevant here is Netflix’s rapid shift from being a supplier of rental DVDs by mail to video-streaming delivery on demand. The company last month separated its DVD-by-mail service from its streaming business by creating a DVD-only subscription and raising the base price for the combined service by nearly 60 percent, a move that raised the ire of many subscribers.

Netflix increasingly depends on the telephone companies and cable companies to deliver entertainment via broadband Internet to computers, TVs, and mobile devices such as the iPad. Indeed, at some periods of the day, Netflix video streaming constitutes almost 30 percent of all Internet traffic in the United States during peak periods. So it’s not surprising that the company is butting heads with Internet service providers—think everybody from Verizon Communications to Cox Communications to Time Warner Cable—over the issue of how the costs of streaming are covered.

To date, suppliers of wireline (as opposed to wireless) broadband have generally used the salad bar model: consumers pay a fixed monthly fee for all they choose to download. But that’s changing. AT&T and Comcast are now charging according to usage above monthly caps.

Netflix is crying foul: the last thing it wants is for subscribers, who buy their entertainment from a dozen vendors, to be counting bytes. But can the company make a case for regulatory intervention?

In principle, maybe. But it’s not easy to demonstrate that broadband caps are anticompetitive. More precisely, it is far from obvious that the shift away from flat-rate pricing reflects an attempt to increase revenues that would not be possible if there were more competition among Internet service providers.

Most of the cost of providing Internet services reflects the cost of building the massive networks of cables and switches that carry the digital traffic. When a network isn’t fully utilized, the cost of delivering another e-mail message—or, for that matter, all 86 episodes of “The Sopranos”—is next to nothing. Hence flat-rate pricing, in which users share the network costs with fixed monthly payments but pay nothing extra to watch another hour of James Gandolfini making mayhem, is easy to justify in economic terms.

Well, it’s not that simple. Internet providers must design their systems to deliver high-quality signals at peak-use periods. Indeed, no form of content is more sensitive to congestion slowdowns than streaming video. So the most efficient pricing system would be one that charged extra for service at periods of peak demand, reflecting the reality that a good portion of network capacity is only intermittently needed.

Internet providers haven’t tried peak-load pricing, most probably because they believe that residential customers would find it both confusing and unfair. In fact, they fear that alienating subscribers by using any approach to tying prices to how much system capacity is used (or when). And while we can’t say for sure why they’re just now moving toward “two-part” pricing in which customers pay a flat rate for the first big dollop of bytes and then pay extra for greater use, our best guess is that the alternatives look worse. They must somehow find ways to pay for explosive increases in use by some customers as they join the rush to entertainment via video streaming—but without increasing monthly bills for more modest users.

That’s not how David Hyman, Netflix’s general counsel, sees it. He argues that competition in Internet service is inadequate and that the providers are using the growing demand for video streaming as an excuse to raise total charges.

That’s a hard case to sell. If ISPs really have market power and are itching to exploit it, why switch to a pricing structure that’s sure to draw the attention (and ire) of a deep-pockets, high-profile company like Netflix?

A more plausible argument is that Netflix’s success has led the ISPs to covet a piece of their streaming-video business, and they’re using discriminatory pricing to gain a competitive advantage in selling entertainment. Hyman notes that the systems of AT&T and Comcast exempt their own video-streaming programming from bandwidth caps, giving users a financial incentive to avoid third- party vendors such as Netflix.

Should this be allowed? The policy debate about Internet discrimination has focused on access—allowing outside content providers to use the network without paying discriminatory fees to the service provider—which is not in question here. The issue is really whether a broadband provider should be permitted to charge users by the byte but waive the fee for viewing content it is selling in competition with Netflix (or Hulu, You Tube, or others.).

Much, we think, turns on the practical impact on competitors and consumers, which under current pricing schemes doesn’t appear large. For example, AT&T is charging $10 for 50GB, which amounts to less than 20 cents for a typical standard-definition movie. And that cost only kicks in beyond the 150GB cap per month, which is enough for roughly 300 hours of programming via the Internet. (High-definition programming uses more bandwidth; just how much more depends on the degree of digital-code compression.)

Of course, caps could be reduced, and fees for use above the cap could be raised, which would have a greater impact on competitors. So it makes sense for the Federal Communications Commission to keep an eye on Internet providers’ pricing schemes. But there’s a cost to intervention—at best, the hourly fees for battalions of regulatory lawyers, at worst deterrence to innovation. Therefore, we think that the bar should be set pretty high. In particular, price discrimination should only be the government’s business, if other content providers are put at a significant disadvantage, and consumers (as opposed to content providers) suffer as a result.

Netflix, we’re rooting for you—but not at the expense of hobbling innovation on the Internet.

(This post was also published on CNET.com.)

In 2007, Comcast, the giant cable company and Internet service provider, faced a marketing problem. A relatively small number of subscribers were hogging huge swaths of bandwidth, as they traded movies and music with others. (Some of the exchange was legal, some of it probably not.) Comcast responded by limiting upload speeds for customers using peer-to-peer networks.

After an investigative reporter from the Associated Press caught the company blocking a transfer of the King James Bible using BitTorrent (leading one blogger to ask, “Why does Comcast hate Jesus?” a couple of advocacy groups, Free Press and Public Knowledge, filed a complaint with the FCC. The agency ordered Comcast to stop.

Three years later, in Comcast v. FCC (PDF), a federal appellate court reversed the FCC’s order. But the court simply ruled that the FCC had overstepped its jurisdiction; it never addressed the legality of Comcast’s behavior.

Comcast, it’s worth noting, could have dealt with its peer-to-peer problem by switching to a pricing model that charged according to use. But the company feared that customers were wed to salad-bar-style pricing and would bolt at the change. Thus, apparently for competitive reasons, Comcast chose instead to block the offending traffic.

Now we can see why. Verizon, which is about to roll out its version of 4G high-speed wireless-data service, says it is planning to charge according to use. Verizon is worried that 4G will make it so convenient to move huge video files over wireless links that it would face a Comcast-like problem, if it didn’t charge by the bucket of data.

Meanwhile, AT&T has beaten Verizon to the punch, announcing that new iPhone customers will pay by the megabyte. (Existing customers with all-you-can-eat plans will be allowed to keep them.)

Verizon’s admission immediately brought forth criticism from the blogosphere. And the FCC wasn’t far behind: it is already preparing new regulations to prevent “bill shock“–you know, when dad finds out that little Jennifer has downloaded every episode of “True Blood” and “The Vampire Diaries,” and stuck him with a $400 cell phone bill.

The irony, of course, is that Comcast ran afoul of the FCC, in part, for failing to use tiered pricing to ration bandwidth. Now, apparently, Verizon has caught the FCC’s attention by deciding to charge according to usage.

The FCC may do no more than require carriers to notify customers when they’ve exceed their allotted megabytes–something AT&T is apparently planning to do, even without a nudge from Washington. Still, we’d much prefer that the FCC stay out of data-service-pricing decisions altogether, letting the carriers adjust to changing technology and market conditions.

Telecommunications markets don’t always get it right. But we doubt that the regulators could do better.

(This blog post was published earlier on CNET.)

We don’t know whether Congress will let the FCC get away with it – lobbyists on both sides are already shopping for new vacation houses in Aspen — or what the commission would actually do with the authority if it wins the political battle.   But we do know this is very bad news for those who fear that the uncertainty will slow both the expansion of Internet capacity and the pace of innovation.

Not to worry, explains Mr. Genachowski: He and his fellow Democrats on the FCC have no intention of fitting up the Internet with the sort of corset that old Ma Bell used to wear. But the long, dreary history of the FCC, which has rarely hesitated to go where angels fear to tread, has got to make you wonder.

The specifics of this issue make it especially troubling. The Internet has blossomed without regulation, bringing the rich fruits of the information revolution to most Americans. Moreover, there is no plausible story to be told that broadband providers aren’t competing their little heads off; indeed, there is solid evidence that competition is alive and well in the broadband business. And if there ever were cause for concern, there is no reason to believe that the threat of regulation or antitrust intervention wouldn’t keep the industry on the straight and narrow. In short, the FCC is asserting its right to impose solutions where there are no significant problems.

We know that markets don’t always work. But it is astonishing that Washington seems prepared to deliver one market that most assuredly does into the hands of a gang that rarely shoots straight.

Comcast, America’s largest cable company, ran afoul of the FCC in 2007 when it chose to discriminate among Internet users by providing slower service for peer-to-peer networking, which was hogging disproportionate amounts of bandwidth. In disciplining Comcast, the FCC both asserted jurisdiction over the Internet and its right to adjudicate the issue without a formal rulemaking.

The court, for its part, decided that the FCC overreached its statutory authority. But that begs the more fundamental question: should there be rules prohibiting discrimination of this sort by Internet service providers? One could imagine other ways in which Comcast could have discouraged excessive use of bandwidth by peer-to-peer users. It might, for example, have charged everybody by the byte rather than by the month. But for competitive reasons, Internet service providers have thus far been reluctant to go this route. Do we really want the government rather than the marketplace to make this call?

It may, in the end, serve the public interest to bar some forms of discrimination by Internet providers. But the Comcast case illustrates how problematic it will be to draw hard and fast lines. The antitrust agencies already have authority to regulate the competitive practices of the industry. Congress should think long and hard before delegating power to the FCC in the Internet arena – and, if it does, should insist that the agency use its new authority solely to advance consumer welfare and efficiency, not as a catch-all rationale for enforcing the agency’s views on net neutrality.