Interconnection An Economic Perspective Peyman Faratin CSAIL Steven

Interconnection: An Economic Perspective Peyman Faratin (CSAIL) Steven Bauer (CSAIL) David Clark (CSAIL) Bill Lehr (CSAIL) Arthur W Berger (Akamai, CSAIL) Patrick Gilmore (Akamai) Tom Wilkening (Economics)

Interconnection Problem • • • AT&T - Carter phone & Hush-a-Phone (blocking) …. 2002: Madison-River - Vonage (blocking) 2005: Cogent-Level 3 (disconnecting) 2006: AT&T - Google (tiering) 2007: T-Mobile 2 (blocking) … ICE (Farrell and Weiser), Agency (Milgrom et. al), Entry Story -- because of lack of quality competition in interconnection § Two-Sided Markets (New Institutionalist Model) § A model of value-flows - demand information § Market failures • “middlebox”/overlays entry • Interconnection discrimination incentives (given cost-allocation mechanism)

Industrial Organization: Two-Sided Markets • Generative: Design aid • Business Model • Descriptive: future regulatory thinking

Causal Hypothesis of Interconnection Problems Outcomes Information & Behaviors IO & Contracts Architecture

The Trinity: Institution, Strategies and Outcomes Institution • architecture • contract • policy Strategic Agents Outcomes • Scalability, Resilience, Convergence • Fairness, Innovation, Profitability

Transfer Distribution Ambiguities (“we know how to route packets but not money”) AS 1 $ $ AS 2 content

Ambiguities Galore AS 1 $ $ $ AS 2 content AS 1 AS 2 content

Solution: Bi-lateral Volume-Based Contracts IO & Contracts • Retail market (bursty): § Flat-rate § Peak-rate tiered pricing Architecture • Wholesale market (better aggregation “deeper in”): § Full transit • Transfer level = non-linear • Transfer structure = asymmetric § Peering • Transfer level = 0 • Transfer structure = N/A § Emerging mechanisms: Paid-peering & Partial Transit • Distribution of Fixed and Usage pricing

End-Hosts Bear Cost of Transport AS $=0 $ AS $ MIT AS $ $=0 AS $ http: //www. google. com

No E 2 E Accounting for Tastes Eyeballs $ ISP $$$$ Growing Web. Server Eyeballs $$$$ ISP $$ Established Web. Server Eyeballs ? $ ISP ? $ Public Web. Server

Coordination Failures Has Led to E 2 E Market-Failures

Market-Failure Induced CDN Entry AKAM: 20, 000 servers, 900 networks, 70 countries, 750 cities, serving ≈ 15% of content

Strategies and Outcomes Information & Behaviors Contracts

The Trinity: Institution, Strategies and Outcomes Strategic Agents Institution • architecture • contract • policy Outcomes • Fairness • Growth • Profitability

Who Should Pay Who? Primitive = Value-Flows i Pi eyeball Pj ISP pj “Free Goods” IV I (0, 0) III II j Content Provider Q: what is the optimal price structure for ISP to maximize profits? pi

Value-Flow Discrimination i eyeball Pi ISP Pj j Content Provider Q: what is the optimal price structure? A: Depends on: • Relative size of value flows (cross-market externalities) pj • Fixed / Per transaction prices • Single v. s Multi-homing 45 o Established commercial web-server $$ ISP $$$ eyeballs pi

Complementarities/Interactions: Multi-Product Markets

Value-Flows/Externalities: Chicken-Egg Problems

Two-Sided Markets • But platform has to solve “chicken-egg” Problem: if there were more women, then more men would come, more women would come, more men would come, …. discrimination is welfare enhancing. “ladies nights”

Non-Discrimination Institution Strategic Agents Institution • “no ladies night” Outcomes • Fairness • Growth

Does Institution Implement Desired Outcome? • Rule (motivated by “fairness”): No bars can access discriminate based on sex • Q: Does rule implement a “fair” & innovative outcome in the presence of strategic actors? • A: No. Institution is “fair” but gives no growth incentives. Neutrality rule is not neutral with respect to growth tussle between objectives

Result of Rule: Closes Some Markets, Others Grow but Inefficiently

Strategic Preferences of Content Providers & Users Eyeballs $ ISP $$$$ Growing Web. Server Eyeballs $$$$ ISP $$ Established Web. Server Eyeballs ? $ ISP ? $ Public Web. Server

Strategic Agent Preferences: The Platform (in Presence of Externalities) • Platform (ISP/CDN) solves for efficient prices: § market price level ( ) and § price structure • Profit maximizing pricing structure in presence of externalities is often discriminatory (subsidize one side of the market to stimulate demand on other side - c. f. bar) § Strong incentives to discriminate

Network Neutrality Law or Current Architecture & Protocols Institution • “the architecture can’t / shouldn’t do that” • “no price discrimination for same service” Strategic Agents (1: Customer, 2: Content Provider) Outcomes • Fairness • Growth 3: Platform: ISP

Unintended Outcome of Institution: Market Closures Eyeballs $ ISP $$$$ Growing Web. Server Eyeballs $$$$ ISP $$ Established Web. Server Eyeballs ? $ ISP ? $ Public Web. Server

Externalities Create Surplus Expansion Opportunities (v. s. Capture) • Traditional (one-sided) Price discrimination § Discrimination increases the profits of the monopolist but may open some markets that would otherwise be closed. • … platform intermediaries in a TSM seek to maximize profit by transferring surplus from seller to consumer thereby growing the market § Growth on one side of the market induces growth on the other, creating surplus that can be captured

Market-Failure Induced CDN Entry: Akamai: 20, 000 servers, 900 networks, 70 countries, 750 cities, serving ≈ 15% of content

Architectural Tools We Provide • The real question is how to architect for it: § Change in demand in i market / change in demand in j market § Source-destination discrimination § App discrimination § Per packet/per flow bit discriminate § Encryption § …. • There is a delicate tradeoff involved in how much information we provide and how much we lose/gain in objectives we are interested in Outcomes Information & Behaviors IO & Contracts Architecture

Conclusion • Interconnection § § Not only a L 2, L 3 problem Contract engineering and value-flows Agents use mechanisms strategically Tussle over outcomes • Open Questions: § Preferences over outcomes/objectives § CDN Tipping and Market-Power • 2 tiered Internet? § Externality Information for monitoring and regulation • Industrial Organization § A tool for architecture & policy

Future: ICWG • Data § War Stories/cases • • Peering of video Exclusivity contracts Games being played …. § Quantities and prices § data to support theory § data to build theory • Informative process to all § Designers § ISPs § Policy makers

Peyman@mit. edu

Auxiliary Slides (I) Information and Strategic Games

Competition: Peering+Transit Strategic Interactions • All compete to: § establish and § maintain peering • Competition over: § Eyeball Networks § Content • Colo CP (Apple i. Tunes, Microsoft, . . ) • Stub ASs (Yahoo, Google, …) • Non-stub Tier 2 content (transit providers to content Stub AS)

“Normal” Business Strategy of LE-LC Strongest Peering Incentives LE • Assume LE-LC interconnect under peering • LC’s problem is to keep ratios LC

LE-LC Strategies LE LC • Observations: § Eyeballs are fixed, content can move (switching costs of content is lower) perception of bargaining power by LE § LE doesn’t care about being out of balance & in fact wants to be out of ratios so it can demand payments (paid-peering)

“Equilibrium” in Establishing New Peering between Strategic Networks A < E, B > F G > C, H < D P LE P LC P P (A, B) (C, D) (E, F) (G, H)

LE-LC Peering Establishing Strategies LE LC • LE strategy: § LC asks to peer (or upgrade peering facilities to keep abreast of traffic flows) § LE refuses and demands higher settlements (paid-peering) because: • it is LC who is out of ratios and causing costs • Operational costs (AOL) • Precedence settings leads to economic loss on the long-run § Most LCs refuse to pay, but some do concede. Some content owners on LC who doesn’t concede switch to LCs that do.

LE-LC Strategies: Vertical + Horizontal tier 1 P 2 P 3 P 1 LE • LC’s Counter strategy (“chicken”): § § • LC If LE refuses to peer/upgrade peering then LC sends some traffic via transit Punishing strategy: LC bears P 2 (which may even be above cost of P 1), but LE has to pay P 3 Condition: Strategy only works if both LC&LE are transit customers of tier 1. If LE has peering with tier 1 & LC sent via transit then LC would in fact be helping LE because LE would look bigger to tier 1

LC’s Strategy to Keep Ratios: Sell Low-cost Transit (Poaching: Vertical+Horizontal) LE LC P 2 SE • LC’s strategy: § § Peering link is full-duplex and LC is mostly outbound To keep ratios LC needs to pull sell transit to SE Poaching SEs by setting P 2 at or even below cost LE P 2 P traffic to SE goes via LC

LC’s Strategy is Reactive and Proactive LE T SE LC P 2 SE SE

Ratio Balancing Needs Create Poaching Competition, Downward Pressure on Transit Prices and Quality LC LC LC LE P 2 SE • Margins of gain of poaching strategy to maintain peering shrinks as P 2 falls • Excess reductions of P 2 lowers quality/performance of transit because incentives of LC to manage are eroding?

Salient Economic Features • Dynamic efficiency (innovation) • Operator IO is highly complex (no clear upstream/downstream) • Behavioral: § Direct & indirect network Effects § Unobservability § Coordination failures

Auxiliary Slides (II) TSM Model

How ISP Determines its Optimal Price Structure: Geometry of the Problem i Pi eyeball Pj ISP pj “Free Goods” IV I (0, 0) III j Content Provider Q: what is the optimal price structure for ISP to maximize profits? pi II

Value-Flow Discrimination i eyeball Pi ISP Pj j Content Provider Q: what is the optimal price structure? A: Depends on: • Relative size of value flows (cross-market externalities) pj • Fixed / Per transaction prices • Single v. s Multi-homing 45 o Established commercial web-server $$ ISP $$$ eyeballs pi

Total Consumption i’s “native” demand of i due to demands of j

Total Consumption network externality term (how much purchases in j market affects purchases in the i market)

Benchmark: eji = eij = 0 pj pi(pj) Po = (1/2, 1/2) pj(pi) 1/2 pi

pj pj eji=3/4 eji=0 pi pj eji=11/10 pi(pj) pj(pi) pi

Architectural Guide • eij a potential candidate for value-flow proxy

Value-Flow and Structural i usr Pi ISP 1 ISP 2 j Pj Google pj Q: what is the optimal price structure? A: Depends on: • Relative size of cross-group externalities • Fixed / Per transaction prices 45 o • Single v. s Multi-homing pi

Assumptions • Network’s tariff: § Charges to i market for subscription § Charges to j market for traffic termination • i market single-homed § Makes single either-or decision competition between platforms for i market § i chooses network that maximizes its surplus • j market multi-homed § Makes independent join decisions no competition between platforms for j market § j puts more weight on network benefits of being in contact with widest population of i market than transaction costs of multiple platforms

Equilibrium Tariff (M. Armstrong) pj IV I pi III II • Low subscription charges to i market and high termination charges to j market § Equilibrium termination charges to j market maximizes i market and network’s profits and ignores j market welfare.

Multi-homing Reduces Competition and Welfare • Single-homing side is treated well, mhoming side’s interest are ignored at equilibrium (i is even cross-subsidized) • “Competitive bottleneck”: even if market for content users is highly competitive, so that profits of networks are lowered, there is no competition for providing services to content providers.

Engineers Provide Tools to Firms: Design-Evaluate Cycle • IO methodology: § puts economics (back) into the design consideration, but after protocol design § Allows “comparative statics” - “what happens to welfare if we change the institution” § Build testable models to ask “what-if” questions on efficiency-fairness tradeoff

Future • Competition for ideas and incentives § Strategic agents will use technical & regulatory tools to their economic advantage • FIND (2006): § 3/10 economic (CABO, Virtualization, Architecture of all fiber networks) § Highly recommend talking to economists & regulators § SIGCOMM 08 Workshop? • MIT’s Interconnection Working Group § David Clark, Steven Bauer, Bill Lehr, Peyman Faratin, Akamai

Markets i usr Pi qi Pj ISP qj j Google

Geometry of the Price Discrimination Problem i has relatively more externality impact on j p j MC pi j has relatively more externality impact on i

Demand • Each market has a continum of consumers willing to buy one discrete unit of good (transport service) • Let v be arbitrary willingness to pay of an individual • Then D(p) is the market demand

CU’s Market Demand Maximum service value (in absence of network externalities) D(pi) Vi Maximum market size (in absence of network externalities) v v p d. Ddpi Qi

Total Consumption i’s “native” demand of i due to demands of j

Total Consumption network externality term (how much purchases in j market affects purchases in the i market)

Measures Spill-over/TS network externality = cross-price (i to j) contribution to sales in j market.

Measures Importance of the spill-over effects

Externality of CPs to CUs D(pi) • As CPs use more transport then CUs max. service value for transport increases Vi Qi

Externality of CPs to CUs • CU value increase Vi Qi

Consumer Surplus Vi Vi Sji = (eji Qj)Vi /2 = Q i. V i / 2 S i = Q i. V i / 2 Qi Qi

Surplus Division v. s. Capture • Third-Degree Price discrimination § Firms offer nonlinear prices to mixed markets force heterogeneous consumers to self select (Peakrate pricing? ) § Mechanism differentially extract consumer surplus and transfer it to the seller • … platform intermediaries in a TSM seek to profit by transferring surplus from seller to consumer § Growth on one side of the market induces growth on the other, creating surplus that can be captured

Monopoly Pricing in Absence of Network Externality (Po) (monopoly sets prices in the two markets independently, implicitly assuming eij = eji = 0)

Monopoly CUs Profits Vi Vi / 2 Qi

Monopoly Pricing with Network Externality (P*) (monopoly sets prices in the two markets interdependently, eij eji > 0)

• Assume: § j market (CPs) demand for transport is inelastic § i market (CUs) demand for transport is elastic § eji eij > 0 § qi / pj > 0 (Positive TS, spillover, effect)

eji eij > 0, i > j - pi + - pj qi=Di(pi) + qj=Dj(pj) + + q =e D (p ) j ij i i - qi=eji. Dj(pj) +

- pi pi + qj=Dj(pj) pj qi + qi=Di(pi) pj - + + q =e D (p ) j ij i i qi=eji. Dj(pj) + pj qj pi qi

Asymmetricity in Externalities • Now vary the relative influence of CP CU –eji eij > 0

Benchmark: eji = eij = 0 pj Po = (1/2, 1/2) pi(pj) pj(pi) 1/2 pi

pj II pi(pj) I pj(pi) 1/2 pi 1/2 III IV

eij = 1/3 pj pj eji=3/4 eji=0 pi pj eji=11/10 pi(pj) pj(pi) pi