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Internet Business Models and the Competitive Dynamics of the Backbone Market

Internet Business Models and the Competitive Dynamics of the Backbone Market. Michael Kende 9 April 2001. Introduction.

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Internet Business Models and the Competitive Dynamics of the Backbone Market

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  1. Internet Business Models and the Competitive Dynamics of the Backbone Market Michael Kende 9 April 2001

  2. Introduction • Analysys is Europe’s leading independent telecom strategy consulting and research company, with 240 staff in 10 offices around Europe, Asia, and the United States. Clients include operators, policy-makers and regulators. • Authors have a wide range of experience in analyzing the Internet backbone market in Europe and the United States • Analysys was invited to discuss the competitive dynamics of the Internet backbone market

  3. Agenda • Overview of the Internet • Peering • Entry into the backbone market • Competitive constraints on backbone market • Comparison with telephony • Analysis of Brazilian market

  4. Agenda • Overview of the Internet • Peering • Entry into the backbone market • Competitive constraints on backbone market • Comparison with telephony • Analysis of Brazilian market

  5. Overview of the Internet The Internet can be broken into four types of players • Internet backbone providers • Internet service providers (ISPs) • Content providers (e.g. web sites) • End-users

  6. Overview of the Internet Internet service providers (ISPs) enable end-users to access the Internet • ISPs have two types of customers • Dial-up customers using their personal computers with modems • Businesses and other large organizations using direct leased line connections • ISPs combine two inputs • Access facilities (e.g. modems) • Backbone services

  7. Overview of the Internet Internet backbone providers connect end-users with each other and content Transport Router ISP Web site Web site ISP

  8. Overview of the Internet Internet backbone market has an impact on ISPs’ costs • Internet backbones charge ISPs a monthly fee for wholesale access to the Internet • Internet backbones require two inputs to provide wholesale access to the Internet • Transport • Connectivity to other backbone providers

  9. Overview of the Internet Connectivity makes the Internet the “network of networks” ISP A Web site C Backbone 1 A B C Traffic from ISP A can only reach Web site C. ISP D Web site B D E F Backbone 2

  10. Agenda • Overview of the Internet • Peering • Entry into the backbone market • Competitive constraints on backbone market • Comparison with telephony • Analysis of Brazilian market

  11. Peering Internet backbone providers have opposing incentives • Backbones compete with one another for customers • Traffic exchange requires co-operation among backbone providers • Connectivity is not regulated • In place of regulation, a system known as peering has evolved • In the peering system, backbones connect when it is mutually beneficial

  12. Peering ISP A Web site C Backbone 1 A B C Peering connection Backbone 3 Backbone 2 Web site D ISP B W X Y Z Backbone 3 will not pass traffic from backbone 2 to backbone 1 In a peering relationship, backbones only exchange traffic between their own customers

  13. Peering Peering is a mutually beneficial relationship • Traffic is exchanged on a settlements-free basis • Peering is based on a perception of equality along several measures • A measure of the flow of traffic at a point of connection between networks • A comparison of the geographic size of networks • A comparison of the size and composition of customer bases

  14. Peering Any analysis of the Internet backbone market must be dynamic • Static focus on peering issues ignores important forces • Dynamic nature of Internet constrains action of any one backbone provider • Direct constraints from new entrants • Indirect constraints from input suppliers and customers

  15. Agenda • Overview of the Internet • Peering • Entry into the backbone market • Competitive constraints on backbone market • Comparison with telephony • Analysis of Brazilian market

  16. Entry into the backbone market Overview Access to two inputs is required to enter the Internet backbone market • Connectivity • peeringis not the only option • Transport • long distance telecommunications infrastructure (e.g. fiber or satellite)

  17. Entry into the backbone market Connectivity Peering may not always be mutually beneficial • Peering may enable one backbone to “free-ride” off the other • Peering can provide a smaller backbone with free access to a larger backbone • Peering may require one backbone to utilize more capacity than another • One backbone may refuse to peer with another to prevent free-riding

  18. Entry into the backbone market Connectivity Example of free-riding between networks of different size ISP A Web site C Backbone 1 A B C Backbone 3 Web site D Y Z Traffic from ISP A to Web site B will pass between points A and B in both directions

  19. Entry into the backbone market Connectivity Transit is a comprehensive alternative to peering • In a transit relationship, one backbone agrees to route another backbone’s traffic to all points on the Internet • The transit provider is paid for these services • Transit customer can provide backbone services and grow to qualify for peering

  20. Entry into the backbone market Connectivity Example of a transit relationship ISP A Web site C Backbone 1 A B C Peering Connection Transit Connection Backbone 3 Backbone 2 Web site D ISP B W X Y Z Backbone 3 will take traffic from backbone 2 to backbone 1

  21. Entry into the backbone market Connectivity Backbone providers have incentives to compete on transit prices • Transit customers provide revenues for backbones • Transit customers improve the bargaining position of backbones in peering negotiations

  22. Entry into the backbone market Infrastructure Long distance infrastructure is the core of a national Internet backbone provider • Long distance infrastructure markets can support multiple competitors • Fiber optic technologies enable economical overbuilds of existing networks • Regulations often enable entrants to lease capacity from incumbents to complete national build-out at affordable rates

  23. Entry into the backbone market Conclusion The competitive dynamics of the Internet provide for numerous means of entry • Entrants can connect to existing backbones through different means • Peering • Transit • Infrastructure is increasingly available • Leasing of existing infrastructure is regulated • Technology enables new entrants to build their own infrastructure

  24. Agenda • Overview of the Internet • Peering models • Entry into the backbone market • Competitive constraints on backbone market • Comparison with telephony • Analysis of Brazilian market

  25. Competitive constraints Overview Customer forces Content providers Technical substitutability Input suppliers Memory/ processing Local Backbone provider Multi-homing Inter-national ISPs Competitive constraints on backbones

  26. Competitive constraints Input suppliers Input suppliers compete indirectly with backbone providers • Local transport • As an increasing amount of Internet usage is local, traffic can bypass national backbone provider’s network • Local telcos can use market power over last mile as leverage against national backbone providers • International transport • International traffic can bypass national backbone provider’s network

  27. Competitive constraints Customer forces Customers are increasing their bargaining power with backbones • Local content is increasing • Demand of end users for high-quality local content bestows market power on providers • Local content providers can leverage this market power in negotiations with backbone providers • ISPs have powerful brand names • Local telcos have entered the market, and other ISPs have national and international presence • These ISPs can negotiate advantageous terms with backbone providers

  28. Competitive constraints Technical substitutability Advanced storage and processing technologies reduce the need for backbone transport • Usage of servers near end users • content providers can push content out to mirror sites • users can pull content in to cache sites • In both cases, content is only transported on backbone network once

  29. Competitive constraints Technical substitutability Diagram of the use of mirroring and caching Content from Web site C is pulled by ISP A to a cache closer to its users Cache Web site C Backbone 1 ISP A A B C Mirror Web site B ISP D D E F Backbone 2 Content from Web site B is pushed to a mirror site closer to ISP D

  30. Competitive constraints Technical substitutability End users can multi-home to reduce reliance on backbone networks for connectivity • Multi-homing involves an ISP or content provider directly connecting to more than one backbone provider • As a result, traffic goes directly to the terminating backbone without passing through a peering connection • Companies such as InterNAP sell multi-homed connections to end-users

  31. Competitive constraints Technical substitutability Diagram of multi-homing Web site C Backbone 1 A B C By multi-homing to both backbones, ISP A is directly connected to Web site C and ISP D, without any peering ISP A ISP D D E F Backbone 2

  32. Agenda • Overview of the Internet • Peering • Entry into the backbone market • Competitive constraints on backbone market • Comparison with telephony • Analysis of Brazilian market

  33. Comparison with telephony Comparison of Internet and telephony • Internet and telephony share the same basic infrastructure • Local • Long distance • International • Telephony services are typically regulated while Internet services are not • Input availability • Competitive dynamics of Internet markets

  34. Comparison with telephony Internet not regulated Input availability for Internet backbones reduces need for regulations • Transport • Telephony regulations provide access to existing transport capacity • New technologies lower cost of building new transport capacity • Connectivity • Peering is one option • Peering policies increasingly being made public • Transit access makes entry and growth possible until smaller backbones qualify for peering

  35. Comparison with telephony Internet not regulated Dynamism of Internet services reduces need for regulation • Basic telephony services are static • Voice call between two users is live • There is no means to reduce reliance on network for end-to-end call • Internet services are dynamic • Internet content can be stored • Storage technology (mirrors and caches) increase competitive pressures on Internet backbone providers

  36. Agenda • Overview of the Internet • Peering models • Entry into the backbone market • Competitive constraints on backbone market • Comparison with telephony • Analysis of Brazilian market

  37. Analysis of Brazilian market Analysis of Brazilian Market • Market Overview • Analysis of Entry • Competitive Constraints

  38. Analysis of Brazilian market Market overview Brazilian Internet market is growing • Wave of investment since market restructuring in 1998 • Number of lines has risen from 14.8 million in 1996 to 33.2 million in 2000 • Number of dial-up Internet users has risen from 471,000 in 1996 to 3.7 million in 2000 Source: Economist Intelligence Unit (2000)

  39. Analysis of Brazilian market Analysis of entry Necessary infrastructure is available • Incumbents must make infrastructure available to Internet companies • Entrants building facilities • Local entrants include MetroRed, Diveo, and AT&T • Long distance entrants include Intelig, Global One, and Impsat • International entrants include 360networks and Global Crossing

  40. Analysis of Brazilian market Analysis of entry Connectivity options are available • Embratel sells dedicated access to its backbone to customers and competitors alike • Peering is taking place • Embratel and RNP • Regional backbones connecting to increase their coverage

  41. Analysis of Brazilian market Competitive constraints Existing backbone providers face competitive constraints • Input providers • ISPs such as Terra are growing and moving into backbone markets • Local incumbents will be free to provide national backbone services soon • While existing national backbone providers grow, utilities are beginning to enter the market with their own facilities • ISPs are beginning to multi-home and use content storage technologies to reduce reliance on backbones

  42. Analysis of Brazilian market Conclusion • There are increasing signs of competition between backbone providers • Investments in infrastructure • Internet usage is growing • Competition is likely to increase in the future when local telcos enter the market • This competition provides for affordable Internet access services from ISPs

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