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

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Presentation on theme: "Interconnection: An Economic Perspective Peyman Faratin (CSAIL) Steven Bauer (CSAIL) David Clark (CSAIL) Bill Lehr (CSAIL) Arthur W Berger (Akamai,CSAIL)"— Presentation transcript:

1 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)

2 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)

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

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

5 The Trinity: Institution, Strategies and Outcomes Institution architecture contract policy Outcomes Scalability, Resilience, Convergence Fairness, Innovation, Profitability StrategicAgents

6 Transfer Distribution Ambiguities (“we know how to route packets but not money”) AS1 AS2 content $ AS1 AS2 $

7 Ambiguities Galore AS1 AS2 content $ AS2 $ AS1 content AS2 $ AS1

8 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

9 MIT End-Hosts Bear Cost of Transport AS $ $ $ $ $=0

10 No E2E Accounting for Tastes ISP $$ Eyeballs Established WebServer $$$$ ISP ?$ Eyeballs Public WebServer ?$ ISP $$$$ Eyeballs Growing WebServer $

11 Coordination Failures Has Led to E2E Market-Failures

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

13 Strategies and Outcomes Contracts Information & Behaviors Outcomes

14 The Trinity: Institution, Strategies and Outcomes Institution architecture contract policy Outcomes Fairness Growth Profitability StrategicAgents

15 Who Should Pay Who? Primitive = Value-Flows ISP ij PiPi PjPj pipi pjpj I IIIII IV (0,0) “Free Goods” Q: what is the optimal price structure for ISP to maximize profits? eyeball Content Provider

16 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 pipi pjpj 45 o ISP i j PiPi PjPj eyeball Content Provider Established commercial web-server  $$  ISP  $$$  eyeballs

17 Complementarities/Interactions: Multi-Product Markets

18 Value-Flows/Externalities: Chicken-Egg Problems

19 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”

20 Non-Discrimination InstitutionInstitution “no ladies night”Outcomes Fairness Growth StrategicAgents

21 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

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

23 Strategic Preferences of Content Providers & Users ISP $$$$ Eyeballs Growing WebServer ISP $$ Eyeballs Established WebServer $$$$ ISP ?$ Eyeballs Public WebServer ?$ $

24 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

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

26 Unintended Outcome of Institution: Market Closures ISP $$ Eyeballs Established WebServer $$$$ ISP ?$ Eyeballs Public WebServer ?$ ISP $$$$ Eyeballs Growing WebServer $

27 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

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

29 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

30 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

31 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

32

33 Auxiliary Slides (I) Information and Strategic Games

34 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)

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

36 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)

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

38 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.

39 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 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 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 tier1 P1P1 P2P2 P3P3

40 LC’s Strategy to Keep Ratios: Sell Low-cost Transit (Poaching: Vertical+Horizontal) SELCLE 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 P2P2

41 LC’s Strategy is Reactive and Proactive SELCLE P2P2 T SE

42 Ratio Balancing Needs Create Poaching Competition, Downward Pressure on Transit Prices and Quality SELCLE 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? P2P2 LC

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

44 Auxiliary Slides (II) TSM Model

45 How ISP Determines its Optimal Price Structure: Geometry of the Problem ISP ij PiPi PjPj pipi pjpj I IIIII IV (0,0) “Free Goods” Q: what is the optimal price structure for ISP to maximize profits? eyeball Content Provider

46 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 pipi pjpj 45 o ISP i j PiPi PjPj eyeball Content Provider Established commercial web-server  $$  ISP  $$$  eyeballs

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

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

49 Benchmark: e ji = e ij = 0 pi(pj)pi(pj) pipi pjpj pj(pi)pj(pi) 1/2 P o = (1/2,1/2)

50 pjpj e ji =0 pipi pjpj e ji =3/4 pipi pjpj e ji =11/10 pi(pj)pi(pj) pj(pi)pj(pi)

51 Architectural Guide e ij a potential candidate for value-flow proxy

52 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 pipi pjpj 45 o ISP 1 i j PiPi PjPj usr Google ISP 2 usr

53 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

54 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. pipi pjpj I IIIII IV

55 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.

56 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

57 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

58 Markets ISP i j PiPi PjPj qjqj qiqi usrGoogle

59 Geometry of the Price Discrimination Problem pipi pjpj i has relatively more externality impact on j j has relatively more externality impact on i MC

60 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

61 CU’s Market Demand  v  p dDdp i - V i - Q i D(p i ) -v-v Maximum market size (in absence of network externalities) Maximum service value (in absence of network externalities)

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

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

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

65 Measures Importance of the spill-over effects

66 Externality of CPs to CUs As CPs use more transport then CUs max. service value for transport increases - V i - Q i D(p i )

67 Externality of CPs to CUs - V i - Q i CU value increase

68 Consumer Surplus - V i - Q i - V i - Q i S i = Q i V i / 2 S ji = (e ji Q j )V i /2 = Q i V i / 2

69 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

70 Monopoly Pricing in Absence of Network Externality (P o ) (monopoly sets prices in the two markets independently, implicitly assuming e ij = e ji = 0)

71 Monopoly CUs Profits - V i - Q i - Q i / 2 - V i / 2

72 Monopoly Pricing with Network Externality (P * ) (monopoly sets prices in the two markets interdependently, e ij  e ji > 0)

73 Assume:  j market (CPs) demand for transport is inelastic  i market (CUs) demand for transport is elastic  e ji  e ij > 0   q i /  p j > 0 (Positive TS, spillover, effect)

74 q j =e ij D i (p i ) q i =D i (p i ) pipi q i =e ji D j (p j ) q j =D j (p j ) pjpj e ji  e ij > 0,  i >  j

75 q j =e ij D i (p i ) q i =D i (p i ) pipi q i =e ji D j (p j ) q j =D j (p j ) pjpj pipi qiqi qjqj pjpj qiqi pipi pjpj qiqi pipi

76 Asymmetricity in Externalities Now vary the relative influence of CP  CU –e ji  e ij > 0

77 Benchmark: e ji = e ij = 0 pi(pj)pi(pj) pipi pjpj pj(pi)pj(pi) 1/2 P o = (1/2,1/2)

78 pi(pj)pi(pj) pipi pjpj pj(pi)pj(pi) 1/2 III III IV

79 e ij = 1/3 pjpj e ji =0 pipi pjpj e ji =3/4 pipi pjpj e ji =11/10 pi(pj)pi(pj) pj(pi)pj(pi)


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