interconnection: an economic perspective peyman faratin (csail) steven bauer (csail) david clark...

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-Mobile2 (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

Architecture

IO & Contracts

Information & Behaviors

Outcomes

The Trinity:Institution, Strategies and Outcomes

InstitutionInstitution• architecture• contract• policy

OutcomesOutcomes• Scalability, Resilience, Convergence• Fairness, Innovation, Profitability

Strategic Strategic AgentsAgents

Transfer Distribution Ambiguities (“we know how to route packets but not money”)

AS1AS1

AS2AS2

contentcontent

$

AS1AS1

AS2AS2

$

Ambiguities Galore

AS1AS1

AS2AS2

contentcontent

$

AS2AS2

$

AS1AS1

contentcontent

AS2AS2

$

AS1AS1

Solution: Bi-lateral Volume-Based Contracts

• Retail market (bursty): Flat-rate Peak-rate tiered pricing

• 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

Architecture

IO & Contracts

MIT http://www.google.com

End-Hosts Bear Cost of Transport

AS

AS AS

AS

$

$

$

$

$=0

$=0

No E2E Accounting for Tastes

ISP $$Eyeballs EstablishedWebServer

$$$$

ISP ?$Eyeballs PublicWebServer

?$

ISP $$$$Eyeballs GrowingWebServer

$

Coordination Failures Has Led to E2E Market-Failures

IAP1

IBP2

CUi

CPj

CPm

CUk

Pi1

Pj1

Pk2

Pm2

P12

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

CDN

IAP1

IAP2

CUi

CPj

CPm

CUk

Pi1

Pj1

Pk2

Pm2

P2

P1

PjCDN

PmCDN

IBP2

P12

P22

PC2

Pj2

Strategies and Outcomes

Contracts

Information & Behaviors

Outcomes

The Trinity:Institution, Strategies and Outcomes

InstitutionInstitution• architecture• contract• policy

OutcomesOutcomes• Fairness• Growth

• Profitability

Strategic Strategic AgentsAgents

Who Should Pay Who?Primitive = Value-Flows

ISP

i jPi

Pj

pi

pj

I

IIIII

IV

(0,0)

“Free Goods”

Q: what is the optimalprice structure for ISP to maximize profits?

eyeball Content Provider

Value-Flow Discrimination

Q: what is the optimal price structure?A: Depends on:

• Relative size of value flows (cross-market externalities)• Fixed / Per transaction prices• Single v.s Multi-homing

pi

pj

45o

ISP

i jPi

Pjeyeball Content

Provider

Established commercial web-server $$ ISP $$$ eyeballs

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

InstitutionInstitution• “no ladies night”

OutcomesOutcomes• Fairness• Growth

Strategic Strategic AgentsAgents

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

ISP $$$$Eyeballs GrowingWebServer

ISP $$Eyeballs EstablishedWebServer

$$$$

ISP ?$Eyeballs PublicWebServer

?$

$

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

P*

[Pi*,Pj

*]

Network Neutrality Law or Current Architecture & Protocols

InstitutionInstitution• “the architecture can’t / shouldn’t

do that”• “no price

discrimination for same service”

OutcomesOutcomes• Fairness• Growth

Strategic Strategic AgentsAgents

(1:Customer, 2:Content Provider)(1:Customer, 2:Content Provider)

3: Platform: 3: Platform: ISPISP

Unintended Outcome of Institution: Market Closures

ISP $$Eyeballs EstablishedWebServer

$$$$

ISP ?$Eyeballs PublicWebServer

?$

ISP $$$$Eyeballs GrowingWebServer

$

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

CDN

IAP1

IAP2

CUi

CPj

CPm

CUk

Pi1

Pj1

Pk2

Pm2

P2

P1

PjCDN

PmCDN

IBP2

P12

P22

PC2

Pj2

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 Architecture

IO & Contracts

Information & Behaviors

Outcomes

Conclusion• Interconnection

Not only a L2, L3 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 iTunes, Microsoft,..)• Stub ASs (Yahoo, Google,…)• Non-stub Tier2 content (transit providers to content Stub AS)

“Normal” Business Strategy of LE-LC

LCLE

Strongest Peering Incentives

• Assume LE-LC interconnect under peering• LC’s problem is to keep ratios

LE-LC Strategies

LCLE

• 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

LC

P P

LE

P(A,B)

(C,D)

P(E,F)

(G,H)

LE-LC Peering Establishing Strategies

LCLE

• 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

LCLE

• LC’s Counter strategy (“chicken”): If LE refuses to peer/upgrade peering then LC sends some traffic via transit Punishing strategy: LC bears P2 (which may even be above cost of P1), but LE has to pay P3

• Condition: Strategy only works if both LC&LE are transit customers of tier1. If LE has peering with tier1 & LC sent via transit then LC would in fact be helping LE because LE would look bigger to tier 1

tier1tier1 tier1tier1

P1

P2P3

LC’s Strategy to Keep Ratios: Sell Low-cost Transit (Poaching:

Vertical+Horizontal)

SE

LCLE

• 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 P2 at or even below cost LE P2P traffic to SE goes via LC

P2

LC’s Strategy is Reactive and Proactive

SE

LCLE

P2T

SESE

Ratio Balancing Needs Create Poaching Competition, Downward Pressure on

Transit Prices and Quality

SE

LCLE

• Margins of gain of poaching strategy to maintain peering shrinks as P2 falls

• Excess reductions of P2 lowers quality/performance of transit because incentives of LC to manage are eroding?

P2

LCLC

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

ISP

i jPi

Pj

pi

pj

I

IIIII

IV

(0,0)

“Free Goods”

Q: what is the optimalprice structure for ISP to maximize profits?

eyeball Content Provider

Value-Flow Discrimination

Q: what is the optimal price structure?A: Depends on:

• Relative size of value flows (cross-market externalities)• Fixed / Per transaction prices• Single v.s Multi-homing

pi

pj

45o

ISP

i jPi

Pjeyeball Content

Provider

Established commercial web-server $$ ISP $$$ eyeballs

Total Consumption

i’s “native” demand

qi Di(pi) e jiD j (p j )

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)

qi Di(pi) e jiD j (p j )

q j D j (p j ) eijDi(pi)

e ji q iq j

Benchmark: eji = eij = 0

pi(pj)

pi

pj

pj(pi)

1/2

1/2

Po = (1/2,1/2)

pj

eji=0

pi

pj

eji=3/4

pi

pj

eji=11/10

pi(pj)

pj(pi)

eij q jq i

1/3

Architectural Guide

• eij a potential candidate for value-flow proxy

Value-Flow and Structural

Q: what is the optimal price structure?A: Depends on:

• Relative size of cross-group externalities• Fixed / Per transaction prices• Single v.s Multi-homing pi

pj

45o

ISP1

ijPi Pjusr

GoogleISP2usr

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)

• 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.

pi

pj

I

IIIII

IV

Multi-homing Reduces Competition and Welfare

• Single-homing side is treated well, m-homing 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

ISP

i jPi Pj

qjqi

usr Google

Geometry of the Price Discrimination Problem

pi

pj

i has relatively more externalityimpact on j

j has relatively more externalityimpact on i

MC

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

vp dDdpi

-Vi

-Qi

D(p

i)

-

v

Maximum marketsize (in absenceof network externalities)

Maximum service value (in absenceof network externalities)

Total Consumption

i’s “native” demand

qi Di(pi) e jiD j (p j )

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)

qi Di(pi) e jiD j (p j )

q j D j (p j ) eijDi(pi)

e ji q iq j

Measures

q j D j (p j ) eijDi(pi)

q jpi

eijDi' (pi)

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

Measures

r

q jpi

qip j

Importance of the spill-over effects

qi Di(pi) e jiD j (p j )

q j D j (p j ) eijDi(pi)

Externality of CPs to CUs

• As CPs use more transport then CUs max. service value for transport increases

-Vi

-Qi

D(p

i)

qi Di(pi) e jiD j (p j )

Externality of CPs to CUs

-Vi

-Qi

qi Di(pi) e jiD j (p j )

• CU value increase

Di 1(e jiD j )

Consumer Surplus

-Vi

-Qi

-Vi

-Qi

Si = QiVi / 2

Sji = (eji Qj)Vi /2

= QiVi / 2

qi Di(pi) e jiD j (p j )

Surplus Division v.s. Capture

• Third-Degree Price discrimination Firms offer nonlinear prices to mixed markets

force heterogeneous consumers to self select (Peak-rate 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

-Qi

-Qi / 2

-Vi / 2

io

i piQi(1piVi

)

pio Vi2

,qio Qi2

io ViQi

4Si

4

(qi

o, pi

o)

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)

qi Di(pi) e jiD j (p j )

q j D j (p j ) eijDi(pi)

qj=eijDi(pi)

qi=Di(pi)

pi

qi=ejiDj(pj)

qj=Dj(pj)

pj

+

+

+

+

+-

-

-

eji eij > 0, i > j

qj=eijDi(pi)

qi=Di(pi)

pi

qi=ejiDj(pj)

qj=Dj(pj)

pj

+

+

+

+

+-

-

- pi

qi

qj

pj

qi

pi

pj

qi

pi

Asymmetricity in Externalities

• Now vary the relative influence of CP CU

–eji eij > 0

Benchmark: eji = eij = 0

pi(pj)

pi

pj

pj(pi)

1/2

1/2

Po = (1/2,1/2)

pi(pj)

pi

pj

pj(pi)

1/2

1/2

III

III IV

eij = 1/3pj

eji=0

pi

pj

eji=3/4

pi

pj

eji=11/10

pi(pj)

pj(pi)