Transcript Performance

Internet Economics
John Chuang
School of Information Management & Systems
UC Berkeley
[email protected]
The Big Picture
Demand
Market
Structure &
Mechanisms
Supply
Price(s)
Welfare (surplus)
John Chuang
Producer Surplus
Consumer Surplus
Social Surplus
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Why Study Internet
Economics?
 Internet has interesting economic properties
 Resource allocation
- Rule-based vs. pricing-based
 Market structures
- Interconnections
- Horizontal mergers and vertical integration
- Bandwidth markets
 Policymaking
- Sustainable competition
- Universal access
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Outline
 Economic characteristics of the Net
 Resource allocation and pricing
 Interconnection and industrial
organization
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Economic characteristics
of the Net




Public vs. private good
Economies of scale
Economies of scope
Network externalities
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Public vs. Private Goods
 Private good
- depletable and excludable
- e.g., toothpaste, automobile
 Public good
- non-depletable and non-excludable
- e.g., national defense, clean air, lighthouses
 What about roadways, information, and
the Internet?
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Public vs. Private Goods
 Roadways:
- non-depletable (until congestion) and non-excludable
 Information:
- Encapsulated: depletable and excludable
- Non-encapsulated: non-depletable, but is it
excludable?
 Internet:
- non-depletable (until congestion), but is it
excludable?
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Economies of scale
 Average cost declines as output level increases
 Internet exhibits strong economies of scale
 High fixed cost
- e.g., trenching cost, up-front capital investment
 Low/zero marginal cost
- of sending an additional packet
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Traditional Goods &
Services
$
 Q* is optimal firm output
 Can support N firms if market
size (QTOT) >= NQ*
AC
Q
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Q*
QTOT
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Infrastructure Goods &
Services
$
 High FC, low MC  declining AC
curve (economies of scale)
 Therefore it is socially optimal to
have the entire market served by a
single firm (“natural monopoly”)
AC
Q
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QTOT
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 A monopolist:
- is a price-setter, not a price-taker
- maximizes producer surplus (profit), not consumer
surplus
 Alternatives: public utility or regulated monopoly
- e.g., AT&T historically treated as regulated natural
monopoly
- rate regulation
- structural regulation
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Competition
 In a perfect competition:
- all firms are price-takers
- P = MC in the long run
- inefficient firms with high MC will exit
market
- long term profits = 0
- consumer and total surplus maximized
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Technological Change
$
 Natural monopoly may not last
forever
 Technological change may
result in new cost curve: same
market may now be optimally
served by multiple firms
 e.g., long distance telephony
and the breakup of AT&T in
1984
Q
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QTOT
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Economies of Scope
 Significant joint costs of production for multiple
goods/services
 Examples:
- GM plants produce sedans, SUVs, and minivans, etc.
- Amazon.com sells books, music, and lawn-mowers,
etc.
- Internet supports multiple traffic types previously
carried over different networks (telephony, radio,
CATV, …)
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Service Differentiation
email
voice
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Best Effort
QoS Aware
Internet
SLA
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Network Externalities
 Externality: value (including costs and
benefits) of a good/service not fully
reflected in its price
- e.g., the price of an automobile does not
include the economic impact of its potential
to pollute
 Network externality: value of the network
is a function of the network size
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Positive Network Externalities
 Value of network increases with network
size
- e.g., telephones, fax machines, email clients
- Metcalfe’s Law: the value of a network is
proportional to the square of the number of
users (N^2)
- Reed’s Law: the value of network grows with
the number of possible sub-groups that can
be formed (2^N)
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Negative Network Externalities
 Value of network decreases with network
size
- e.g., due to increased likelihood of network
congestion
- During network congestion, each data packet
incurs a social cost to other packets (e.g.,
delay, packet-drop)
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Summary
 The Internet as a public good (?)
 High fixed cost, low marginal cost (strong
economies of scale)
 Significant joint costs (strong economies
of scope)
 Positive/negative network externalities
(demand-side economies/diseconomies of
scale)
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Outline
 Economic characteristics of the Net
 Resource allocation and pricing
 Interconnection and industrial
organization
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Resource Allocation Goals
(Objective Functions)
 Technical efficiency
- Performance (latency, throughput) vs. cost
- Survivability (availability, redundancy) vs. cost
not necessarily
aligned
 Economic efficiency
- Social surplus
- Pareto efficiency
 Other objectives
- Profit (producer surplus)
- Penetration/usage s.t. cost recovery (e.g., universal service)
- Equity, stability, predictability, etc.
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Rule-Based Resource
Allocation
 Example: TCP Congestion Control
- All hosts reduce transmission rate when there
is congestion
- Some TCP-unfriendly implementations ignore
congestion signal
0.5Mb/s
0.5Mb/s
1Mb/s
0.5Mb/s
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The Role of Prices
 Allocate resources to maximize economic
efficiency
 Serve as feedback signals
- Help users make efficient consumption
choices
- Help provider make optimal capacity
expansions
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Pricing Network Services
 Criticism of flat-rate pricing
- Tragedy-of-the-Commons
 Usage-based pricing
- Metering costs
- Users prefer predictable bills
 Marginal cost pricing
- MC=0 most of the time
 Congestion-based pricing
- Packets bid for service
- Too costly to implement
 Back to flat-rate?
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QoS and Pricing
 QoS Pricing
- Multi-class network requires differential
pricing scheme
- Otherwise all users select best service class
 How about use differential pricing to
implement QoS itself?
- Paris Metro Pricing
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Desirable Properties of
Pricing Schemes
 Service provider’s
perspective
- Encourage efficient
resource usage (incentive
compatibility)
- Low cost (implementation,
metering, accounting and
billing)
- Competitive prices
- Cost recovery
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 User’s perspective
- Fairness
- Predictability
(reproducibility)
- Stability
- Transparency
(comprehensibility)
- Controllability
(Delgrossi and Ferrari 1999)
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Outline
 Economic characteristics of the Net
 Resource allocation and pricing
 Interconnection and industrial
organization
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Inter-exchange
Carrier (IXC)
Point of
Presence
LongDistance
Network
Customer Premises
Internet Service Providers
Telephone Network
Internet backbones
Backbone
Provider 1
Router
Tandem
Switch
Local
Exchange
Carrier
(LEC)
Local
Ingress
Switch
Local
Egress
Switch
Dial-Up
ISP
DNS
Router
Remote ISP
Server
Content
Provider
xDSL
Modem
Cable
Modem
JohnCustomer
Chuang Premise
Backbone
Provider 2
Router
Exchange
Point
Local Loop
Analog
Modem
INTERNET
Router
Firewall
Headend
Cable Network
Corporate
LAN
Source: M. Sirbu 31
Industrial Organization
 Horizontal merger
 Vertical integration/disintegration
 Determinants:
- Technological efficiencies
- Transactional efficiencies
- Market imperfections
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Vertically Related Markets
 Upstream/downstream relationship
 Examples:
-
Detroit: steel v. automobile
Software: OS v. applications
Telephony: local v. long distance
Internet: physical transport v. access v.
content/services
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Vertical Integration
 Good:
- economies of scope savings
- internalize transaction costs
- reduce prices & increase total welfare
 Bad:
- if one component is monopolistic
- foreclose competition in other component
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Vertical Integration: Telephony
 Telephony was vertically-integrated industry
 AT&T (Ma Bell) offered end-to-end solution
 Divestiture in 1984
- Local service (the seven baby bells)
- Long distance service (AT&T)
- Customer premise equipment (CPE)
 Removes hidden subsidies between local service
(monopoly) and long distance (competitive)
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Vertical Integration: Internet
 Different vertical components of Internet [Lehr98]:
- Local access transport (LAT): PacBell, TCI (AT&T)
- Retail Internet access provision (ISP): AOL, @Home
- Wide area transport (WAT): AT&T, MCI-WorldCom,
Sprint, Qwest, Level3
- Backbone Internet service provision (BSP): UUNET,
AT&T, BBN
 Note: AT&T vertically integrated across all four
components
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Downstream Goods/Services






Internet data centers
Content distribution networks
Application service providers
Certificate authorities
Billing and payment services
Content providers
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Unbundling the Local Loop
 RBOCs (e.g., Pacific Bell) own the local loop
infrastructure and offers local phone/DSL service
 Telecom Act of 1996 requires RBOCs to
unbundle services from local loop access
 Motivation: allow competitive local exchange
carriers (CLECs, e.g., Covad, Northpoint) to
compete against the incumbents
 Difficult to implement/enforce; not sustainable
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Unbundling the Cable Plant
 TCI owns/operates cable infrastructure (LAT)
 @Home offers broadband Internet access over
cable (ISP)
 TCI and @Home are now one integrated entity:
AT&T Broadband
 Enters AOL…
- wants to offer retail ISP service over AT&T’s cable
infrastructure, in competition with @Home service
- demands unbundling and open access to cable plant
 Who wins?
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Horizontal Merger
 Proposition: Economies of scale
 Example: Internet Backbone
- MCI-WorldCom (1998)
- WorldCom-Sprint (2000; abandoned)
 Objection: concentration leads to market power
- Larger network has less incentive to interconnect, or
to maintain a high quality interconnection
- Larger network has negotiation power over smaller
networks
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Fiber System Route Miles
1995
1997
Level 3
Williams
IXC
Qwest
WorldCom
MCI*
Sprint
AT&T
50,000
40,000
30,000
20,000
10,000
0
1999E
Source: Kende 2000
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Horizontal Merger
 Example 2: Local loop
 Seven Baby Bells Merging
-
SBC + PacBell + Ameritech
Nynex + BellAtlantic
Bell South
US West
 1996 Telecom Act: unbundling and open access
- competition in local exchange (e.g., Covad,
Northpoint and other CLEC’s )
 Facilities-based competition
- e.g., wireless, cable, satellite, …
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Network Interconnection
 Network externalities motivate network
operators to interconnect
 Different types of interconnection:
- Peering
- Multilateral
- Bilateral (or private)
- Transit
 Issue of settlement
- Peer = settlement-free = sender-keep-all (SKA)
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Peering
Backbone A
Backbone C
Backbone B
Peering
Source: Kende 2000
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Multilateral Peering
Backbone A
Backbone C
Backbone B
NAP
Source: Kende 2000
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Bilateral/Private Peering
Backbone A
Backbone C
Backbone B
Source: Kende 2000
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Transit
Backbone A
Backbone C
Backbone B
Transit
Source: Kende 2000
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Hot Potato Routing
Backbone A
ISP X
East
Coast
West
Coast
ISP Y
Backbone B
Source: Kende 2000
Request
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Response 48
Free Riding
Backbone A
ISP X
East
Coast
West
Coast
ISP Y
Backbone B
Source: Kende 2000
Request
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Response 49
UUNET Peering Policy
 Need to meet following requirements to peer
with UUNET (January 2001):
 Interconnection Requirements
-
Geographic scope (> 50% of UUNET scope)
Traffic exchange ratio (not exceed 1.5:1)
Backbone capacity (> 622Mbps)
Traffic volume (> 150Mbps per direction)
 Operational Requirements
- 24x7 NOC, fully redundant network, implement
“shortest-exit routing”, …
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Interconnection Issues
 Peer or transit?
- Size (market share) important
 Why multilateral peering fails?
- Tragedy-of-the-Commons
 What about advanced services?
- Inter-domain multicast, inter-domain QoS,
content peering, …
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Markets
 Bandwidth Markets
- Bandwidth is perishable
- Bandwidth as tradable commodity
 Contract terms
-
What: Diameter of pipe (Mbps)
Where: city A to city B
When/how long
Other: quality metrics (drop rates, latency, …)
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Bandwidth Exchanges
 Two basic functions
- Facilitate financial transaction
- Facilitate physical delivery of traded BW
 Three types of exchanges
- Sole seller of bandwidth (e.g., Enron, Williams)
- Neutral facilitator of member trading (e.g., Band-X,
RateXchange)
- Member-managed exchange (e.g., Bandwidth
Financial Corporation, Commerex)
John Chuang
Source: Mindel and Sirbu 2001
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Example: NY-London DS3,
US$/month, 1-year contract
Source: RateXchange
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Commoditization Trend Lines
Commodity
Timing
Crude Oil
OTC
Futures Market
Derivatives
Late 1970’s
1983
1985
Natural Gas
OTC
-Between Pipelines
-Intermediaries
Futures Market
Derivatives
Early 1970’s
Mid 1980’s
1990
1991
Electricity
OTC
-Between Utilities
-Intermediaries
Futures Market
Derivatives
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Late 1960’s
Early 1990’s
Mid 1990’s
Mid 1990’s
Source: RateXchange
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Commoditization Trend Lines
Commodity
Timing
Telecom
OTC
-Between Utilities
-Intermediaries
Futures Market
Derivatives
Late 1980’s
Mid 2000
TBD
TBD
Source: RateXchange
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Other Markets?
 Distributed processing (P2P)
- SETI@Home, entropia, Popular Power
 Distributed storage/caching
 Distributed object services
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