The economic health of the value chain David Clark MIT CFP November, 2012

A more specific question: What is the incentive for ISPs to continue to invest in upgrading their service offerings? Is there a chance that the cycle of expansion and innovation might stall? A hot and very contentious topic – Look at the discussion of my last blog. – Divergence of views at the basic level.

What is the problem? (Assuming that there is one…) Those who use the Internet (either as app developers or end-users) have benefitted from a continuous improvement in capacity, peak rate, and penetration of access over the last 10 years. There is a strong consensus that these sorts of improvements should continue. What is the motivation that will drive investment?

Is there anything we agree on? ISPs make money. – Both wireline and wireless. Loads on the Internet are increasing, largely due to video content. Wireline access networks work pretty well today, wireless is less satisfactory – At least in the U.S. Wireless works better elsewhere. U.S. regulatory policy is in disarray. – Highly variable situation across the globe.

Next? More dangerous… Justification for capital upgrades are hard to make to investors. – Insert hand-wave argument that ROI is about zero, at least for wireline. Market in many parts of the world is starting to saturate. – Harder to justify investment than when one motivation was supporting new customers.

Where there is deep disagreement What is the cost of usage? – Do upgrades actually represent a material cost, or should we expect that ISPs will naturally upgrade as part of normal cost-reduction? Obvious answer is that it depends on the rate of upgrades. For wireless, are we managing spectrum well? – Are we using spectrum in ways that are: Efficient? Pro-innovation or pro-incumbent? – Is there a spectrum scarcity?

Going forward What is the business model for an ISP? – Triple play? But if everything is over the top? – Agent for license revenues? – Seller of enhanced (managed) services? – Seller of commodity, cost-reduced Internet access? Are wireline and wireless the same? – Same business? – Same constraints?

My “follow the money” approach What are the sources of revenues that could flow into ISPs? – The consumer (who pays an average of $45/month today in the US.) What will these look like in the future? – Government subsidies and incentives. – Payments from the “other side”: The sites with which the consumer interacts. Content, e-commerce, “browsing the web”. – P2P, etc. does not fit this model.

Who pays for the “other side”? The consumer. – Payment for content: NetFlix, NYT, iTunes, etc. Some content is purchased cross-channel. – E-commerce. About $202B in 2011, or $240/month /household Advertisers – Online: about $17.4B in 2H 2012 $38.60/month/household – TV: $75B in 2011.

Conclusions: adverts All the “free content” on the Internet is produced and hosted for less than we pay for access. – Or did I miss another source of funds? If ISPs tried to tap into this “other side” money, there is not much there.

Conclusions: consumer-pays Sellers in high margin businesses might be willing to pay for better QoS. – Example: priority traffic on wireless networks. 1% of gross wold be $2.40/month /household Providers of high-value content might willing to pay for better delivery. – Example: zero-rating (exempt from monthly quotas)

What is the difference? Between direct payment by the consumer and indirect payment via the “other side”? – In some cases, indirect payment may be easier for consumer to understand. – Indirect payment forces an ISP to set a price point for enhanced service. Hypothesis: high variation in value in different circumstances. – If consumer pays, will pay for enhancement of what is of highest value to specific consumer. Analog to bundling of content

Engage the consumer Sell enhancement to high-value applications. – Selling QoS Charge for usage? – Discuss tomorrow. What else? Have I missed other sources of funds?

More generally Moving on from my “follow the money” games. Do we agree what the problem is? Do we agree that there is a problem? Can we describe possible business models for ISPs? What constraints will regulators impose?

More tomorrow Two talks and a discussion about a research agenda.