Internet Economics: Cost Structures and Interconnection Agreements

1. Internet Economics:Cost Structures and Interconnection Agreements Shi-Chung Chang Yi-Nung Yang

2. Lecture #8: Outline • Last Time • Bundling • Two-part Tariff • Non-uniform Pricing

3. Lecture #8: Outline • Today: • Costs of Internet Services • HW/SW • Customer Support • IP Transport • Information Content and Provision • Interconnection Agreements • Incentives • Architectures • Resale and Usage-Sensitive Pricing Reading Assignment: P. Srinagesh, “Internet Cost Structures and Internnection Agreements,” Internet Economics, eds. By McKnight, J. P. Bailey, MIT Press, 1997, pp. 121-154. J. P. Bailey, “The Economics of Internet Internnection Agreements,” Internet Economics, eds. By McKnight, J. P. Bailey, MIT Press, 1997, pp. 155-168.

4. Services offered by ISP • Offered Service • Hardware,software • customer support • IP transport • information content and provision • how customer get the services • access link to the nearest node of ISP • ISP arrange this connection ,and pass cost to customers

5. Costs of Hardware and Software Leased lines: eqp. Cost for 56kbps $2,500 for T1 $5,700 Variable Costs: computer memory, disk space, number of incoming telephone lines ==> substantial costs are borne by the user, not by ISP!!

6. Costs of Customer Support • ISPs incur support costs when • customer is acquired(service establishment) • ongoing basis during business relationship • service termination • Service establishment • credit check • consultation with customer on appropriate choice of service options • set up billing record • configuration of the ISP’s network to recognize the new customer • Analysis of the network structure for possible upgrade

7. Costs of Customer Support(Cont.) • Ongoing customer support: • Reconfiguration internet links or reassignment of IP address when large corporate customers upgrade their LAN • Network management and maintenance activity • Service termination: • final setting of accounts • reconfiguring routers and DNS

8. BARRNet Case Data • T1 Connectivity(1993) • Full service: $ 17,000 • Port-only: $ 13,000 • user provide router, does configuration, management and maintenance ==>$4,000 • Other unbundled options • basic internet connectivity package $1,500 • acquiring Internet number and domain name • platform specification of DNS server • configuration • one person training in maintenance • Deluxe internet connectivity package $3,000 • security, config. News server, config. Packet filters • consultation and training $125/hr

9. BARRNet 1996 Data • Connectivity (1996) • Full service: • Eqp. And Installation:$13,750, • Service: $22,800 for two-year, prepaid • for 14.4 kbps: $1,300 • T1 & 56 k Eqp. Install. > ongoing service charge • low speed service = 0.5 ongoing service • Consultation $175 /hr • Observations • account activation is significant to customer’s cost • Cost of standard support Customized advice

10. BARRNet 1996 Data • support cost reflect to charge • Nonrecurring charge(installation fee) for equipment and service activation • ongoing charge for a year’s service • different price policy for • different service • secure mail server ,package filter … • ownership and maintenance responsibility of hardware • port-only ,full service

11. Cost of Transporting IP Packets over Private line • IP Transport costs include: • leased-line tariffs • the cost of routing hardware and software • ongoing cost of monitoring the network • Cost structure • NSFNET:80% for leased line,7% for network operating center • Mid-Level ISP: 25~40% of total costs • Bandwidth a small portion of total costs ==> excess capacity in bandwidth

12. Sunk and Incremental Costs • Efficient BW use by statistical multiplexing • Cost of constructing fiber-optic links(Sunk cost) • major part: trenching and labor cost • small part :fiber cost • ==>install excess fiber (50-80% for Major Local Operating Co.) • incremental cost of providing private line service: • lighting up fiber • costs of customer acquisition • ongoing cost of maintaining a customer account

13. Private Line Cost and Tariff • Private line tariffs must • contribute to the sunk cost (by nonrecurring charge) • recover the incremental cost (by monthly charge based on airline mileage) • Q: What will you do? • at low incremental cost of usage • high sunk cost • excess capacity • ==> discount based on volume and term commitments e.g. AT&T 57% discount to > $1 million/mon. for 5 years

14. Volume discount: • large customers are desirable • Term commitment: • fixed costs of service activation and termination • ISP with leased-line backbones • size their needs over a three-to-five ear period • substantial excess capacity • the incremental cost is closed to zero • sunk cost of IP transport is substantial

15. Other Cost Structures • Examples: • Sprint Nation wide link with high sunk cost and high excess capacity • small ISP/reseller with small sunk cost and large incremental cost • no volume and term discount • =>different ISP with different cost structure and different pricing policy

16. Q:Impact of Fast Packet Technologies & Multimedia Apps. • Fast packet services: • Frame-Relay,SMDS,ATM • statistically multiplexing variable or fixed -size pkt • treat IP pkt as data unit,add own header • less multiplexing gain • Multimedia Applications • cost structure

17. connectivity among ISPs need lower costs • once an ISP pay a flat rate to connect to a fast packet cloud • the incremental cost of virtual connections to multiple ISPs are very small • small ISPs can reach out to any one else on the backbone without investing backbone

18. Information content and provision • cost of online service • local and long-distance transport (8~10 %) • acquiring information content (40~45%) • sales,marketing and administration (45%) • Charge for connecting time or transported volume

19. Cost classification

20. Economics of Interconnection • 1986-1991 • NSFNET as single backbone • three layer hierarchy • use GGP (Gateway-to-Gateway protocol) • core gateway • contain full routes • non-core gateway • partial routes +default route to core gateway • core gateway +links formed the backbone

21. Problem of Multiple backbone and multiple connection • routing will depend on host address ,not only the network portion • routing according to traffic condition • routing table increase rapidly • which backbone should carry the traffic? • Settlements among interconnected networks • EGP: • notion of an autonomous system

22. 1991-1994 • from the very beginning • the key ISPs are inconsistent with each other • ANS provided a bundle of services • full routing,long haul transport • ISP should purchase transport or routing from ANS • for customer’s full access to all internet sites • after that • new backbones are constructed • interconnection agreement with ANS(bilateral) • ISPs argued should be settlement-free • benefit with each other • not apply to transit traffic

23. Formation of the Commercial Internet Exchange(CIX) • reason: • no transit traffic,no settlement • inability of the new entrants to obtain interconnection agreement with ANS • structure and mechanism: • funding members:CERFnet,PSI,and AlterNet • exchange traffic without regard to type and settlements • router is managed by PSI • other members leased private line from their network to the CIX router • ANS join the CIX after 1993 • for reseller • IN CIX,rules assured connectivity is direct • join CIX and pay $7500 annual membership fee • cost of reseller has gone up • otherwise blocked at CIX routers

24. AlterNet: • requires reseller to purchase wholesale connection • 3 times as much as retail connection • PSI • do not sell wholesale connection • Sprint • treat as customers • The formation of Metropolitan Area Ethernet-East (MAE-East) • developed by AlterNet,PSI,SprintLink • distributed Ethernet service spanning a wide geographic area • cloud service • low cost compared to that of a physical connect to a router • no multilateral agreement ,work out a set of bilateral agreement • no settlements • every provider accepts all traffic and delivers all traffic to any ISP with which a bilateral agreement exists

25. Analysis of Interconnection Agreements • Disadvantage of CIX architecture • congestion on XIX router • needless delay • smaller regional network (or reseller) with smaller cost can offer lower prices • solution: • setting up multiple interconnection points • smaller ISP pay settlement to larger ISPs

26. For reseller • prohibiting reseller • raising price to reseller • ISP using fast-packet services • ISP’s customers scattered different clouds • ISP use internet protocol to integrate its network • ISP provide customer support,some network management ,information content • not provide multiplexing function(for reducing the cost ofunderlying transport) • provided by the firms producing the underlying cloud • costs of interconnection become symmetric • every provider purchases access to the clouds • no sunk cost with ISP

27. This way ,CIX be an attractive model • As transport charges falls • price not proportional to their access speed • reseller need to fond another profitable business

28. Interconnection agreement • Interconnection agreement: • create network of networks • Before: • connect to a service provider who connect you to the NSFNET • Now: • Fragmentation of internet’s WAN service market • Each interconnection models have different technical,policy ,and economic costs and benefits • NAPs: points entering interconnection agreement for backbone providers

29. Incentive for interconnection • Network externality: • cost or benefit the user of a network derives from an additional person using the same network • positive for benefit • information provision,communication convenience,application interoperability • motivation factor for networks to interconnect • negative for cost • resource limit • application layer • Email

30. Interconnection Agreement • New interconnection agreement considers • competitive business strategyEX:provide unique content and not share • government intervention:promote common carrier • network provider decides how to interconnect with other networks

31. Four interconnection agreements models • Peer-to-Peer Bilateral Model • Ex:For two NSPs or ISPs with similar size and national reach • network externalities are symmetric • doubling the number of directly connected users through the interconnection point • Elements make two firms peers: • size:decrease intermediary network • experience:for successfully transport • customer base:network externalities

32. Hierarchical Bilateral Model • two party contract • customer-provider relationship • Ex:1.Internet Access Provider connecting to ISP2.small ISP connecting to a U.S backbone provider • firms with a smaller network • gets more network externalities • pays a large amount of the cost of connection

33. Third-Party Administrator Model • interconnection point consists of more than two networks • Ex:CIX • Third-party • operate the administration of the interconnection • firm not operating a network • route traffic between the interconnected networks • acts as a common carrier,offering consistent prices • Network Externalities • positive feedback • increase when connected network increase

34. Cooperative Agreement model • more than two parties sharing an interconnection point • administration is run by a committee of the interconnecting firms • not need to make a profit, only cost sharing is necessary