Netflix throttling

A law prof discusses the Netflix class action suit and settlement in this column. Ramasastry says essentially the same things I've been saying about all this stuff. Even though a lot of the complaints people have been making against Netflix is that throttling is "unfair," the only thing that makes it illegal is that it is contrary to the service contract customers make with Netflix when they sign on. More specifically, it's that their description of terms in advertisements are inaccurate. Ramasastry doesn't mention it, but the strongest claim in the class action suit was statutory, authorized by the Lanham Act (a federal law that governs false advertising and other consumer protection issues) which authorizes private causes of action like this one, but also authorizes the kind of actions she suggests would have been better, like a suit from the California AG or the FTC. Given a choice between the two, I'd always prefer a state agency to sue on my behalf than hire a class-action plaintiffs' lawyer.

Now, Ramasastry isn't completely exhaustive in describing the legal issues surrounding this practice, but I can understand why not. You could characterize what Netflix is doing as a form of price discrimination, but backwards. Rather than charge different prices to different users, they provide different users paying the same price different services because of their estimate of the price elasticity and cost differential of those users. It's a combination of two forms of Pigovian price discrimination: second-order, in which prices are different based on the different costs of providing goods and services, and third-order, where providers estimate that certain users are more sensitive to marginal changes in price than others and act accordingly. As I read Netflix's justification of their shipping priority policy--and as Ramasastry reads it, apparently--Netflix calculates that providing high volume service is more costly than lower volume service, so high-volume service is limited, "throttled," in order to limit the volume of DVDs received to a certain per-unit cost. In addition, they estimate that low-volume users are more likely to drop their service if they don't get higher priority on popular titles and quicker turnaround when they do return discs, so the service is tailored to provide that.

That said, this kind of price discrimination (via service discrimination) is perfectly legal, which is why Ramasastry doesn't bring it up. Or, it's legal as long as it isn't flatly contradicted by Netflix's description of their services in advertising. I've spent the last few minutes trying to figure out how Netflix's price discrimination (or anything Netflix might do along these lines) could possibly run afoul of the Robinson-Patman Act (which prohibits certain kinds of price discrimination) and can't think of anything. You see these kinds of price discriminations whenever you buy a family pack of toilet paper at a lower per-unit price than a single roll or buy a discounted ticket to a movie theater.

On the other hand, I've read a couple of defenders of Netflix's priority policy online (low-volume users, assuredly) argue that the company is not only allowed to throttle users, regardless of stated and advertised terms, but should do so in order to fulfill their duty to stockholders. I read this stuff some time ago and can't find it now. I wish I could; it was really amusing. The argument is, if high-volume users cost too much to be profitable, the service they provide should be restricted to the point at which they provide an acceptable rate of return. This is like saying that, if I'm raising cattle and you pay me X dollars for 300 adult cattle to be delivered after they are fully grown, but my estimate of how much it'll cost to raise them is too low and I can only make a profit by giving you 200 cattle, then I should only give you 200 cattle, otherwise I'm violating my duties to my investors. Of course, recent corporate scandals have demonstrated that many people, inside and outside management circles, have come to believe that if increasing stock value and earnings means having to rip off customers, then by God it's the duty of management to rip off the customers.

It's worth pointing out that Netflix still describes their non-capped accounts as "unlimited" even though the throttling practice probably does impose greater limits on the number of discs one can rent beyond those imposed by the mail. As long as the policy works how they say it works, however, it's legal.