internet business models and the competitive dynamics of the backbone market

Internet Business Models and the Competitive Dynamics of the Backbone

Market

Michael Kende

9 April 2001

Introduction

Analysys is Europe’s leading independent telecom strategy consulting and research company, with 240 staff in 10 offices around Europe, Asia, and the United States. Clients include operators, policy-makers and regulators.

Authors have a wide range of experience in analyzing the Internet backbone market in Europe and the United States

Analysys was invited to discuss the competitive dynamics of the Internet backbone market

Agenda

Overview of the Internet

Peering

Entry into the backbone market

Competitive constraints on backbone market

Comparison with telephony

Analysis of Brazilian market

The Internet can be broken into four types of players

Internet backbone providers

Internet service providers (ISPs)

Content providers (e.g. web sites)

End-users


Internet service providers (ISPs) enable end-users to access the Internet

ISPs have two types of customers

Dial-up customers using their personal computers with modems

Businesses and other large organizations using direct leased line connections

ISPs combine two inputs

Access facilities (e.g. modems)

Backbone services


Internet backbone providers connect end-users with each other and content


Web site

ISP

ISP

Web site

Transport Router

Internet backbone market has an impact on ISPs’ costs

Internet backbones charge ISPs a monthly fee for wholesale access to the Internet

Internet backbones require two inputs to provide wholesale access to the Internet

Transport

Connectivity to other backbone providers


Connectivity makes the Internet the “network of networks”


Web site CISP A Backbone 1

A

FED

B C

Web site B

Backbone 2

Traffic from ISP A can only reach Web site C.

ISP D

Agenda


Peering





Internet backbone providers have opposing incentives

Backbones compete with one another for customers

Traffic exchange requires co-operation among backbone providers

Connectivity is not regulated

In place of regulation, a system known as peering has evolved

In the peering system, backbones connect when it is mutually beneficial

Peering

In a peering relationship, backbones only exchange traffic between their own

customersWeb site C

ISP B

ISP A Backbone 1

Backbone 2 Backbone 3

A

ZYXW

B C

Web site D

Peering

connection

Backbone 3 will not pass traffic from backbone 2 to

backbone 1

Peering

Peering is a mutually beneficial relationship

Traffic is exchanged on a settlements-free basis

Peering is based on a perception of equality along several measures

A measure of the flow of traffic at a point of connection between networks

A comparison of the geographic size of networks

A comparison of the size and composition of customer bases

Peering

Any analysis of the Internet backbone market must be dynamic

Static focus on peering issues ignores important forces

Dynamic nature of Internet constrains action of any one backbone provider

Direct constraints from new entrants

Indirect constraints from input suppliers and customers

Peering

Agenda


Peering





Access to two inputs is required to enter the Internet backbone market

Connectivity

peering is not the only option

Transport

long distance telecommunications infrastructure (e.g. fiber or satellite)

Entry into the backbone market Overview

Peering may not always be mutually beneficial

Peering may enable one backbone to “free-ride” off the other

Peering can provide a smaller backbone with free access to a larger backbone

Peering may require one backbone to utilize more capacity than another

One backbone may refuse to peer with another to prevent free-riding

Entry into the backbone market Connectivity

Example of free-riding between networks of different size

Web site CISP A Backbone 1

Backbone 3

A

ZY

B C

Web site D

Traffic from ISP A to Web site B will pass between points A and B in both directions


Transit is a comprehensive alternative to peering

In a transit relationship, one backbone agrees to route another backbone’s traffic to all points on the Internet

The transit provider is paid for these services

Transit customer can provide backbone services and grow to qualify for peering


Example of a transit relationship

Web site C

ISP B

ISP A Backbone 1

Backbone 2 Backbone 3

A

ZYXW

B C

Web site D

Peering

Connection

Backbone 3 will take traffic from backbone

2 to backbone 1

Transit

Connection


Backbone providers have incentives to compete on transit prices

Transit customers provide revenues for backbones

Transit customers improve the bargaining position of backbones in peering negotiations


Long distance infrastructure is the core of a national Internet backbone provider

Long distance infrastructure markets can support multiple competitors

Fiber optic technologies enable economical overbuilds of existing networks

Regulations often enable entrants to lease capacity from incumbents to complete national build-out at affordable rates

Entry into the backbone market Infrastructure

The competitive dynamics of the Internet provide for numerous means of

entry Entrants can connect to existing backbones

through different means

Peering

Transit

Infrastructure is increasingly available

Leasing of existing infrastructure is regulated

Technology enables new entrants to build their own infrastructure

Entry into the backbone market Conclusion

Agenda


Peering models





Competitive constraints on backbones

Competitive constraints Overview

Customer forces

Content

providers

ISPs

Technical

substitutability

Mem

ory/

processing

Multi-

homing

Inpu

t sup

plie

rsLo

cal

Inte

r-na

tiona

l

Backbone

provider

Input suppliers compete indirectly with backbone providers

Local transport

As an increasing amount of Internet usage is local, traffic can bypass national backbone provider’s network

Local telcos can use market power over last mile as leverage against national backbone providers

International transport

International traffic can bypass national backbone provider’s network

Competitive constraints Input suppliers

Customers are increasing their bargaining power with backbones Local content is increasing

Demand of end users for high-quality local content bestows market power on providers

Local content providers can leverage this market power in negotiations with backbone providers

ISPs have powerful brand names

Local telcos have entered the market, and other ISPs have national and international presence

These ISPs can negotiate advantageous terms with backbone providers

Competitive constraints Customer forces

Advanced storage and processing technologies reduce the need for

backbone transport

Usage of servers near end users

content providers can push content out to mirror sites

users can pull content in to cache sites

In both cases, content is only transported on backbone network once

Competitive constraints Technical substitutability

Diagram of the use of mirroring and caching

Web site CISP ABackbone 1

A

FED

B C

Web site B

Backbone 2Content from Web site B is pushed to a mirror site closer to ISP D

ISP D

Mirror

Cache

Content from Web site C is pulled by ISP A to a cache closer to its users


End users can multi-home to reduce reliance on backbone networks for

connectivity

Multi-homing involves an ISP or content provider directly connecting to more than one backbone provider

As a result, traffic goes directly to the terminating backbone without passing through a peering connection

Companies such as InterNAP sell multi-homed connections to end-users


Diagram of multi-homing

Web site C

ISP A

Backbone 1

A

FED

B C

Backbone 2

By multi-homing to both backbones, ISP A is directly connected to Web site C and ISP D, without any peering ISP D


Agenda


Peering





Comparison of Internet and telephony Internet and telephony share the same basic

infrastructure

Local

Long distance

International

Telephony services are typically regulated while Internet services are not

Input availability

Competitive dynamics of Internet markets


Input availability for Internet backbones reduces need for regulations

Transport

Telephony regulations provide access to existing transport capacity

New technologies lower cost of building new transport capacity

Connectivity

Peering is one option

Peering policies increasingly being made public

Transit access makes entry and growth possible until smaller backbones qualify for peering

Comparison with telephony Internet not regulated

Dynamism of Internet services reduces need for regulation

Basic telephony services are static

Voice call between two users is live

There is no means to reduce reliance on network for end-to-end call

Internet services are dynamic

Internet content can be stored

Storage technology (mirrors and caches) increase competitive pressures on Internet backbone providers

Comparison with telephony Internet not regulated

Agenda


Peering models





Analysis of Brazilian Market

Market Overview

Analysis of Entry

Competitive Constraints


Brazilian Internet market is growing

Wave of investment since market restructuring in 1998

Number of lines has risen from 14.8 million in 1996 to 33.2 million in 2000

Number of dial-up Internet users has risen from 471,000 in 1996 to 3.7 million in 2000

Source: Economist Intelligence Unit (2000)

Analysis of Brazilian market Market overview

Necessary infrastructure is available

Incumbents must make infrastructure available to Internet companies

Entrants building facilities

Local entrants include MetroRed, Diveo, and AT&T

Long distance entrants include Intelig, Global One, and Impsat

International entrants include 360networks and Global Crossing

Analysis of Brazilian market Analysis of entry

Connectivity options are available

Embratel sells dedicated access to its backbone to customers and competitors alike

Peering is taking place

Embratel and RNP

Regional backbones connecting to increase their coverage

Analysis of Brazilian market Analysis of entry

Existing backbone providers face competitive constraints

Input providers

ISPs such as Terra are growing and moving into backbone markets

Local incumbents will be free to provide national backbone services soon

While existing national backbone providers grow, utilities are beginning to enter the market with their own facilities

ISPs are beginning to multi-home and use content storage technologies to reduce reliance on backbones

Analysis of Brazilian market Competitive constraints

Conclusion

There are increasing signs of competition between backbone providers

Investments in infrastructure

Internet usage is growing

Competition is likely to increase in the future when local telcos enter the market

This competition provides for affordable Internet access services from ISPs


internet business models and the competitive dynamics of the backbone market

Documents

backbone marketcomparison

backbone providersconnectivity

backbone providersoverview

backbone marketmichael

internetinternet backbones

peering system

internet business models

peering issues