Interconnection: An Economic Perspective

1. Interconnection: An Economic Perspective Peyman Faratin (CSAIL) Steven Bauer (CSAIL) David Clark (CSAIL) Bill Lehr (CSAIL) Arthur W Berger (Akamai,CSAIL) Patrick Gilmore (Akamai) Tom Wilkening (Economics)

2. Interconnection Problem • AT&T - Carter phone & Hush-a-Phone (blocking) • …. • 2002: Madison-River - Vonage (blocking) • 2005: Cogent-Level 3 (disconnecting) • 2006: AT&T - Google (tiering) • 2007: T-Mobile2 (blocking) • … • ICE (Farrell and Weiser), Agency (Milgrom et.al), • Entry Story -- because of lack of quality competition in interconnection • Two-Sided Markets (New Institutionalist Model) • A model of value-flows - demand information • Market failures • “middlebox”/overlays entry • Interconnection discrimination incentives (given cost-allocation mechanism)

3. Industrial Organization: Two-Sided Markets • Generative: Design aid • Business Model • Descriptive: future regulatory thinking

4. Causal Hypothesis of Interconnection Problems Outcomes Information & Behaviors IO & Contracts Architecture

5. The Trinity:Institution, Strategies and Outcomes Strategic Agents • Institution • architecture • contract • policy • Outcomes • Scalability, Resilience, Convergence • Fairness, Innovation, Profitability

6. Transfer Distribution Ambiguities(“we know how to route packets but not money”) AS1 AS1 $ $ AS2 AS2 content

7. Ambiguities Galore AS1 AS1 AS1 $ $ $ AS2 AS2 AS2 content content

8. Solution: Bi-lateral Volume-Based Contracts • Retail market (bursty): • Flat-rate • Peak-rate tiered pricing • Wholesale market (better aggregation “deeper in”): • Full transit • Transfer level = non-linear • Transfer structure = asymmetric • Peering • Transfer level = 0 • Transfer structure = N/A • Emerging mechanisms: Paid-peering & Partial Transit • Distribution of Fixed and Usage pricing IO & Contracts Architecture

9. AS AS AS AS End-Hosts Bear Cost of Transport $=0 $ $ $=0 $ $ MIT http://www.google.com

10. $ $$$$ Growing WebServer Eyeballs ISP $$$$ $$ Established WebServer Eyeballs ISP ?$ ?$ Public WebServer Eyeballs ISP No E2E Accounting for Tastes

11. Coordination Failures Has Led to E2E Market-Failures

12. Market-Failure Induced CDN EntryAKAM: 20,000 servers,900 networks,70 countries,750 cities, serving ≈ 15% of content

13. Strategies and Outcomes Outcomes Information & Behaviors Contracts

14. The Trinity:Institution, Strategies and Outcomes Strategic Agents • Institution • architecture • contract • policy • Outcomes • Fairness • Growth • Profitability

15. Who Should Pay Who?Primitive = Value-Flows Pj i j Pi Content Provider ISP eyeball pj Q: what is the optimal price structure for ISP to maximize profits? IV I “Free Goods” (0,0) pi III II

16. Value-Flow Discrimination Pj i j Pi Content Provider eyeball ISP • Q: what is the optimal price structure? • A: Depends on: • Relative size of value flows (cross-market externalities) • Fixed / Per transaction prices • Single v.s Multi-homing pj 45o pi Established commercial web-server  $$  ISP  $$$  eyeballs

17. Complementarities/Interactions: Multi-Product Markets

18. Value-Flows/Externalities: Chicken-Egg Problems

19. Two-Sided Markets • But platform has to solve “chicken-egg” Problem: if there were more women, then more men would come, more women would come, more men would come,….  discrimination is welfare enhancing. “ladies nights”

20. Institution • “no ladies night” • Outcomes • Fairness • Growth Non-Discrimination Institution Strategic Agents

21. Does Institution Implement Desired Outcome? • Rule (motivated by “fairness”): No bars can access discriminate based on sex • Q: Does rule implement a “fair” & innovative outcome in the presence of strategic actors? • A: No. Institution is “fair” but gives no growth incentives. Neutrality rule is not neutral with respect to growth  tussle between objectives

22. Result of Rule: Closes Some Markets, Others Grow but Inefficiently

23. Strategic Preferences of Content Providers & Users $ $$$$ Growing WebServer Eyeballs ISP $$$$ $$ Established WebServer Eyeballs ISP ?$ ?$ Public WebServer Eyeballs ISP

24. Strategic Agent Preferences: The Platform (in Presence of Externalities) • Platform (ISP/CDN) solves for efficient prices: • market price level ( ) and • price structure • Profit maximizing pricing structure in presence of externalities is often discriminatory (subsidize one side of the market to stimulate demand on other side - c.f. bar) • Strong incentives to discriminate

25. Network Neutrality Law or Current Architecture & Protocols Strategic Agents (1:Customer, 2:Content Provider) • Institution • “the architecture • can’t / shouldn’t • do that” • “no price discrimination • for same service” • Outcomes • Fairness • Growth 3: Platform: ISP

26. $ $$$$ Growing WebServer Eyeballs ISP $$$$ $$ Established WebServer Eyeballs ISP ?$ ?$ Public WebServer Eyeballs ISP Unintended Outcome of Institution: Market Closures

27. Externalities Create Surplus Expansion Opportunities (v.s. Capture) • Traditional (one-sided) Price discrimination • Discrimination increases the profits of the monopolist but may open some markets that would otherwise be closed. • … platform intermediaries in a TSM seek to maximize profit by transferring surplus from seller to consumer thereby growing the market • Growth on one side of the market induces growth on the other, creating surplus that can be captured

28. Market-Failure Induced CDN Entry:Akamai: 20,000 servers, 900 networks, 70 countries, 750 cities, serving ≈ 15% of content

29. Architectural Tools We Provide • The real question is how to architect for it: • Change in demand in i market / change in demand in j market • Source-destination discrimination • App discrimination • Per packet/per flow bit discriminate • Encryption • …. • There is a delicate tradeoff involved in how much information we provide and how much we lose/gain in objectives we are interested in Outcomes Information & Behaviors IO & Contracts Architecture

30. Conclusion • Interconnection • Not only a L2, L3 problem • Contract engineering and value-flows • Agents use mechanisms strategically • Tussle over outcomes • Open Questions: • Preferences over outcomes/objectives • CDN Tipping and Market-Power • 2 tiered Internet? • Externality Information for monitoring and regulation • Industrial Organization • A tool for architecture & policy

31. Future: ICWG • Data • War Stories/cases • Peering of video • Exclusivity contracts • Games being played • …. • Quantities and prices •  data to support theory •  data to build theory • Informative process to all • Designers • ISPs • Policy makers

32. Peyman@mit.edu

33. Auxiliary Slides (I) Information and Strategic Games

34. Competition: Peering+Transit Strategic Interactions • All compete to: • establish and • maintain peering • Competition over: • Eyeball Networks • Content • Colo CP (Apple iTunes, Microsoft,..) • Stub ASs (Yahoo, Google,…) • Non-stub Tier2 content (transit providers to content Stub AS)

35. LE LC “Normal” Business Strategy of LE-LC • Assume LE-LC interconnect under peering • LC’s problem is to keep ratios Strongest Peering Incentives

36. LE LC LE-LC Strategies • Observations: • Eyeballs are fixed, content can move (switching costs of content is lower)  perception of bargaining power by LE • LE doesn’t care about being out of balance & in fact wants to be out of ratios so it can demand payments (paid-peering)

37. “Equilibrium” in Establishing New Peering between Strategic Networks

38. LE LC LE-LC Peering Establishing Strategies • LE strategy: • LC asks to peer (or upgrade peering facilities to keep abreast of traffic flows) • LE refuses and demands higher settlements (paid-peering) because: • it is LC who is out of ratios and causing costs • Operational costs (AOL) • Precedence settings leads to economic loss on the long-run • Most LCs refuse to pay, but some do concede. Some content owners on LC who doesn’t concede switch to LCs that do.

39. tier1 tier1 LE LC LE-LC Strategies: Vertical + Horizontal • LC’s Counter strategy (“chicken”): • If LE refuses to peer/upgrade peering then LC sends some traffic via transit • Punishing strategy: LC bears P2 (which may even be above cost of P1), but LE has to pay P3 • Condition: Strategy only works if both LC&LE are transit customers of tier1. If LE has peering with tier1 & LC sent via transit then LC would in fact be helping LE because LE would look bigger to tier 1 P2 P3 P1

40. LE LC SE LC’s Strategy to Keep Ratios: Sell Low-cost Transit (Poaching: Vertical+Horizontal) • LC’s strategy: • Peering link is full-duplex and LC is mostly outbound • To keep ratios LC needs to pull  sell transit to SE • Poaching SEs by setting P2 at or even below cost •  LE P2P traffic to SE goes via LC P2

41. LE LC SE SE SE LC’s Strategy is Reactive and Proactive T P2

42. LE LC LC LC SE Ratio Balancing Needs Create Poaching Competition, Downward Pressure on Transit Prices and Quality • Margins of gain of poaching strategy to maintain peering shrinks as P2 falls • Excess reductions of P2 lowers quality/performance of transit because incentives of LC to manage are eroding? P2

43. Salient Economic Features • Dynamic efficiency (innovation) • Operator IO is highly complex (no clear upstream/downstream) • Behavioral: • Direct & indirect network Effects • Unobservability • Coordination failures

44. Auxiliary Slides (II) TSM Model

45. How ISP Determines its Optimal Price Structure: Geometry of the Problem Pj i j Pi Content Provider ISP eyeball pj Q: what is the optimal price structure for ISP to maximize profits? IV I “Free Goods” (0,0) pi III II

46. Value-Flow Discrimination Pj i j Pi Content Provider eyeball ISP • Q: what is the optimal price structure? • A: Depends on: • Relative size of value flows (cross-market externalities) • Fixed / Per transaction prices • Single v.s Multi-homing pj 45o pi Established commercial web-server  $$  ISP  $$$  eyeballs

47. Total Consumption i’s “native” demand demand of i due to demands of j

48. Total Consumption network externality term (how much purchases in j market affects purchases in the i market)

49. Benchmark: eji = eij = 0 pj pi(pj) Po = (1/2,1/2) pj(pi) 1/2 pi 1/2

50. pj pj pi(pj) eji=3/4 eji=0 pi pj eji=11/10 pi pj(pi)