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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
—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.
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 Software
Customer
ISP
Dial up:
Shell Account
1.Computer
2. Modem
3.Comm. software
1. Telephone lines
2. Terminal Server (*)
3. Modem pools(*)
Dial up:
PPP or SLIP
1.Computer
2. Modem
3.Comm. software
Leased line
1. Channel Service Unit
(CSU)/Data Service
Unite(DSU)
2. Router
1. In bound telephone lines
2. Dial-up router (*)
3. Links from router to
network(*)
4. matching
CSU/DSU
5. internal links(*)
6. additional port on router or
new router(*)
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!!
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
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
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
• 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
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
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
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
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
• 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
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
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
Variable cost
Step-wise
Fix cost
Hardware and soft
ware support
Telephone line
1. router
2. internal
link
None
Customer support
Service creation ,
duration ,
termination
None
None
Transport IP
packets(private
line)
incremental cost
Routing
hardware
Fiber-optic constructing
Information
content and
provision
Transporting &
duplication
cost
None
1. Acquiring
information
content
2. Marketing
sales
administration
service
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 (MAEEast)
– 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
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 of
underlying 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 ISP
2.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