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.)

A case in point: the charge that the chairman is abandoning sacrosanct principle in blessing the idea that it’s OK for telecoms to charge by the byte. Washington is probably the only place in America where paying for what you consume (“usage-based pricing” in econ-speak) is suspect. No, wait; there’s Disney World, too. But you get the idea.

Nobody complains when Starbucks charges more for a vente cappuccino than for a tall, and even your average 7-year-old knows it will cost more for the whole family to see the new “Harry Potter” movie than for the single teen ahead of them in line. Why shouldn’t the same concept apply to the Internet, when a minute of streaming video can use 1,000 times as much bandwidth as a two-page e-mail?

Against this common sense, Art Brodsky of Public Knowledge claims that linking what customers pay to how much they consume is just “an excuse for not building out your network.” Brodsky concludes — though without the benefit of serious bean-counting — that usage pricing could drive up the cost of Netflix streaming service about fivefold, to $60 a month.

That seems high, but we really don’t know. Reed Hastings, the CEO of Netflix, apparently isn’t worried. He recently told a reporter that usage-based pricing “doesn’t particularly scare us.” And he cited Netflix’s experience in Canada, where tiered-pricing plans have proved “pretty generous.”

What we do know is that the telecoms need a way to make a buck as they expand their networks, to accommodate the exploding demand for video. The investment will be especially daunting for the mobile carriers, which must build advanced generation wireless networks — so-called 4G and LTE systems — to be able to serve up video in high definition for millions of new smartphones and mobile tablets. While it might be possible to raise everybody’s rates equally to recoup the cost (provided the government prohibited discounts to light users), it would be wasteful and unfair.

Other critics complain that the Genachowski framework would give network operators the option to offer specialized services including “paid priority,” which would guarantee the quality of bandwidth-sensitive apps like VoIP calling and movies on demand. Right now, streaming movies occasionally break into pixel soup, and Internet phone calls way too often reverberate with echoes. Genachowski would allow operators to prioritize access when networks are overloaded — and to charge accordingly.

Seems reasonable to us. Why shouldn’t Netflix, Hulu and Skype (more precisely, their customers) be able to buy such enhancements in the same way everybody can choose between overnight delivery and ground shipping when they send stuff by FedEx?

More to the point, what’s really the alternative? One-price-fits-all Internet service is like one-size-fits-all clothing. All right in a pinch, but you wouldn’t want to live with it.

(This post was also published in San Jose Mercury News.)

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.)

No surprise there. But there are some interesting insights to be mined from the data. Household valuations of speed and reliability differ substantially, and are linked to how much time a household has spent online. While the average household is willing to pay $59 per month for basic Internet service, one with less than twelve months of online experience and a slow connection is willing to pay only $31. The willingness-to-pay data thus suggest that training in digital literacy, easy public access to broadband and discounted installation, if accurately targeted, could succeed in getting inexperienced users to take the plunge.

Interesting policy question: If they are right, and if there are positive social externalities in extending broadband penetration, would it make sense to lure new users with temporary subsidies?

They decided to outsource the process, commissioning an “independent” report [Download Here] on the subject, by a group led by Professor Yochai Benkler of the Harvard Law School.

Now, it happens that the report’s conclusions are out of synch with our own views [Download Here] as well as those of many other economists. For example, Bronwyn Howell, the head of the New Zealand Institute for the Study of Competition and Regulation and a noted authority on broadband, concluded [Download Here] that the “literature surveyed [by Benkler] is highly selective,” and that “negligible attention is given to the relative benefits of cross-platform competition versus access regulation…”

But we raise a different issue here: When should the government commission independent reports? In our opinion, only when the government lacks adequate in-house expertise. And, if the expertise is indeed lacking, only when outsiders are likely to improve the government’s decision-making process.

Neither of these conditions was apparently met in this case. The FCC staff (not to mention staff at other federal agencies) has been working on the issue for years. Besides, a simple call for comments would have allowed Professor Benkler and econotypes like us to fire away.