Internet Economics:

Cost Structures and Interconnection Agreements

Shi-Chung Chang Yi-Nung Yang

Lecture #8: Outline• Last Time

– Bundling

– Two-part Tariff

– Non-uniform Pricing

Lecture #8: Outline• Today:

—Costs of Internet Services– HW/SW

– Customer Support

– IP Transport

– Information Content and Provision

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.

— Interconnection Agreements– Incentives

– Architectures

– Resale and Usage-Sensitive Pricing

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

Costs of Hardware and SoftwareCustomer ISP

Dial up:Shell Account

1.Computer2. Modem3.Comm. software

1. Telephone lines2. Terminal Server (*)3. Modem pools(*)

Dial up:PPP or SLIP

1.Computer2. Modem3.Comm. software

1. In bound telephone lines2. Dial-up router (*)3. Links from router to

network(*)Leased line 1. Channel Service Unit

(CSU)/Data ServiceUnite(DSU)

2. Router

4. matchingCSU/DSU

5. internal links(*)6. additional port on router or

new router(*)

Variable Costs: computer memory, disk space, number of incoming telephone lines

==> substantial costs are borne by the user, not by ISP!!

Leased lines: eqp. Cost for 56kbps $2,500 for T1 $5,700

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

• Ongoing customer support:– Reconfiguration internet links or reassignment of

IP address when large corporate customers upgrade their LAN

– Network management and maintenance activity

Costs of Customer Support(Cont.)

• Service termination:– final setting of accounts

– reconfiguring routers and DNS

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

BARRNet 1996 Data

– T1 & 56 k Eqp. Install. > ongoing service charge

– low speed service = 0.5 ongoing service

• Observations– account activation is significant to customer’s cost

– Cost of standard support Customized advice

• Connectivity (1996)– Full service:

— Eqp. And Installation:$13,750,

— Service: $22,800 for two-year, prepaid

— for 14.4 kbps: $1,300

– Consultation $175 /hr

• 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

BARRNet 1996 Data

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

• Efficient BW use by statistical multiplexing

Sunk and Incremental Costs

• Cost of constructing fiber-optic links(Sunk cost)– major part: trenching and labor cost

– small part :fiber cost

• incremental cost of providing private line service:– lighting up fiber

– costs of customer acquisition

– ongoing cost of maintaining a customer account

• ==>install excess fiber (50-80% for Major Local Operating Co.)

• Private line tariffs must – contribute to the sunk cost (by nonrecurring charge)

Private Line Cost and Tariff

• Q: What will you do?– at low incremental cost of usage

– high sunk cost

– excess capacity

– recover the incremental cost (by monthly charge based on airline mileage)

==> discount based on volume and term commitmentse.g. AT&T 57% discount to > $1 million/mon. for 5 years

• 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

• 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

Other Cost Structures

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

– 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

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

Cost classification Cost type

service

Variable cost Step-wise Fix cost

Hardware and software support

Telephone line 1. router2. internal

link

None

Customer support Service creation ,duration ,termination

None None

Transport IPpackets(privateline)

incremental cost Routinghardware

Fiber-optic constructing

Informationcontent andprovision

Transporting &duplicationcost

None 1. Acquiring information content

2. Marketing sales administration

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

– 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

• 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

— 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

– 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

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

– 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

— 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

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

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

Interconnection Agreement

• New interconnection agreement considers– competitive business strategy

EX:provide unique content and not share

– government intervention:promote common carrier

• network provider decides how to interconnect with other networks

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

• 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

• 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

• 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