Scott Marcus, Director, WIK-Consult, "IP interconnection, traffic trends, and wholesale and retail prices"
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Scott Marcus, Director, WIK-Consult, "IP interconnection, traffic trends, and wholesale and retail prices"

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BEREC expert workshop on IP-Interconnection in cooperation with OECD ...

BEREC expert workshop on IP-Interconnection in cooperation with OECD
November 2nd, Bloom Hotel Brussels, 9:00-17:30

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  • 1. IP interconnection, traffic trends, andwholesale and retail prices J. Scott Marcus, Director BEREC/OECD expert workshop on IP Interconnection Brussels, 2 November 2011 0
  • 2. IP interconnection, traffic trends, and wholesale and retail prices• A.T. Kearney (2010): “Internet traffic is exploding in an unprecedented way due to increasing use of video. Costs for network operators are sky- rocketing, even under existing technology and even without considering the huge investments needed for fibre-based Next Generation Access. Due to market defects, there is no way to make consumers shoulder the cost of the increased bandwidth; thus, it will soon become necessary for firms that provide content to pay for the network for the first time, much as content and advertising typically pay for over-the-air broadcast television.”• Intuitive? Satisfying? Plausible? 1 BEREC/OECD IP Interconnection, Brussels, 2 November 2011
  • 3. IP interconnection, traffic trends, and wholesale and retail prices• I worked for GTE Internetworking (1990-2001) as Director of Capacity Planning, and later as Chief Technology Officer (CTO).• Intuitions that motivated this study: - Exploding traffic is not new! Ten-fold increase in 1995. • About 100% YoY increase in traffic in the late nineties. • Steady decline in YoY percentage growth widely documented. - Pressure on the fixed network due to traffic growth should be declining, not increasing, over time. - In most markets, prices respond rationally to underlying costs.• The study was commissioned by Google, but it is an independent, objective evaluation. All views in the study – and any errors – are WIK’s. 2 BEREC/OECD IP Interconnection, Brussels, 2 November 2011
  • 4. IP interconnection, traffic trends, and wholesale and retail prices• Peering, transit, Internet access in general• Traffic, costs, prices, and profitability• Deployment of Next Generation Access (NGA)• A two-sided market view• Recommendations 3 BEREC/OECD IP Interconnection, Brussels, 2 November 2011
  • 5. Peering, transit, and Internet access (1)• Transit - The customer pays the transit provider to provide connectivity to substantially all of the Internet. - Essentially the same service is provided to consumers, enterprises, ISPs, content provider or application service providers.• Peering - Two ISPs exchange traffic of their customers (and customers of their customers). - Often, but not always, done without charge.• Variants of both exist. 4 BEREC/OECD IP Interconnection, Brussels, 2 November 2011
  • 6. Peering, transit, and Internet access (2) Peering Peering ISP A ISP B ISP C 3 ISP A2 ISP B1 ISP C2 ISP A1 ISP C1ISP A1a ISP C1b ISP C1a ISP A1b ISP A2 5 BEREC/OECD IP Interconnection, Brussels, 2 November 2011
  • 7. Peering, transit, and Internet access (3)• A ladder of investment for content providers. - Small content providers: commercial third party hosting services, and possibly commercial services (such as Amazon) to provide general remote computing application services. - Larger content providers: deploy own web hosting capabilities, purchase transit services, possibly purchase commercial CDN to improve performance. - Still larger content providers: substantial investments in international networks, possibly qualifying for peering with some ISPs. Peering reduces their need for transit services. - Largest content providers: Deploy their own CDNs rather than using commercial CDN services.• With increasing scale, increasing investment and increasing vertical integration become cost-effective. 6 BEREC/OECD IP Interconnection, Brussels, 2 November 2011
  • 8. Peering, transit, and Internet access (4)• Findings: - Content providers make substantial payments for network connectivity, either through payments to Internet backbone providers, ISPs and CDNs or through investment in infrastructure. - Content providers connect to the Internet in principle in much the same way as other business users; however, large content providers are likely to climb their own “ladder of investment”, progressively internalising more and more of the functions of a network operator and/or a Content Delivery Network (CDN). - Their payments appear to be in reasonable balance with the costs that they cause. 7 BEREC/OECD IP Interconnection, Brussels, 2 November 2011
  • 9. Traffic, costs, prices, and profitability (1)• Key findings: - Traffic volumes for Internet Protocol (IP) traffic are increasing, both for fixed and for mobile networks, but the percentage rate of increase is declining over time. - Traffic growth is partly a function of an increase in the number of subscribers, and partly a function of an increase in traffic per subscriber. - The number of fixed broadband subscribers continues to increase, as does the number of mobile users who use data services. - Unit costs for relevant network equipment (including routers and optoelectronics) are declining at a rate equal to that of Internet traffic increase per user in the fixed network. This can be viewed as an example of Moore’s Law. 8 BEREC/OECD IP Interconnection, Brussels, 2 November 2011
  • 10. Traffic, costs, prices, and profitability (2) Fixed Data Traffic 40000 Traffic is indeed increasing in both 35000 30000 the fixed and the mobile networks.Data traffic/month (PB) Middle East and Africa 25000 Latin America Japan 20000 Asia Pacific 15000 North America Central Eastern Europe 10000 Western Europe 5000 0 2006 2007 2008 2009 2010 2011* 2012* Mobile Data Traffic 1400 1200 Source: Cisco (2011), WIK calculations. D at a t raffic/ m o n t h  (P B) 1000 Middle East and Africa Latin America 800 Japan Asia Pacific 600 North America 400 Central Eastern Europe Western Europe 200 0 2006 2007 2008 2009 2010 2011* 2012* 9 BEREC/OECD IP Interconnection, Brussels, 2 November 2011
  • 11. Traffic, costs, prices, and profitability (3)• However, the rate of growth in percentage terms is declining over time. Source: Cisco (2011), WIK calculations. 10 BEREC/OECD IP Interconnection, Brussels, 2 November 2011
  • 12. Traffic, costs, prices, and profitability (4)20,000 $25.0018,00016,000 $20.00 Here we have the shipment14,00012,000 $15.00 quantities in Mbps and the price10,000 8,000 $10.00 per Mbps (USD) for high end 6,000 4,000 $5.00 routers and for long haul DWDM 2,000 0 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 $0.00 optoelectronic equipment. Worldwide high end router capacity shipped (Mbps) Price per Mbps (USD) These are among the key cost drivers for Internet core and 7,000 $7.00 aggregation networks. 6,000 $6.00 5,000 $5.00 The growth in shipments generally 4,000 $4.00 tracks the Cisco projections. 3,000 $3.00 2,000 $2.00 The growth in shipment volume 1,000 $1.00 does not equate to a growth in 0 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 $0.00 costs, because the decline in unit Worldwide long haul DWDM capacity shipped (Mbps) Price per Mbps (USD) costs is nearly in balance with it. Source: Dell’Oro (2011), WIK calculations. 11 BEREC/OECD IP Interconnection, Brussels, 2 November 2011
  • 13. Traffic, costs, prices, and profitability (5)• The core network is about 7% of total cost, the concentration network about 6%.• Both benefit from these technological enhancements. Source: German BNetzA (2009). 12 BEREC/OECD IP Interconnection, Brussels, 2 November 2011
  • 14. Traffic, costs, prices, and profitability (6)• Meanwhile, the number of fixed subscribers is growing, both globally and in Western Europe.• This rate of growth in percentage terms is also declining over time. 120 000 000 35.00% 111 925 627 number of fixed broadband subscriptions 30.00% 100 000 000 103 576 452 92 458 451 25.00% 80 000 000 76 061 730 20.00% 60 000 000 Western Europe 15.00% Growth rate 40 000 000 10.00% 20 000 000 5.00%   0 0.00% 2006 2007 2008 2009 Source: OECD (2011), WIK calculations. 13 BEREC/OECD IP Interconnection, Brussels, 2 November 2011
  • 15. Traffic, costs, prices, and profitability (7) Western European fixed IP data traffic   5 000 Internet traffic growth is partly a  4 500  4 000 response to increased use of  3 500 Actual Internet applications and content, PB/month  3 000  2 500 Holding constant the volume  2 000  1 500 per subscriber Holding constant the number and partly a result of increase in the  1 000   500 of subscribers number of subscribers.   0 2008 2009 2010 It is possible to distinguish between these two effects. Global fixed IP data traffic  The effects on network operator  25 000 profitability can be quite different.  20 000 Increases in the number of Actual subscribers equate to increasedPB/month  15 000 Holding constant the volume  10 000 per subscriber Holding constant the number of subscribers revenues.  5 000   0 2008 2009 2010 Source: Cisco (2011), OECD (2011) WIK calculations. 14 BEREC/OECD IP Interconnection, Brussels, 2 November 2011
  • 16. Traffic, costs, prices, and profitability (8)3.00 2.50  Fixed broadband subscriber2.00  France revenue per subscriber (ARPU) is1.50  Germany Italy fairly steady, but total fixed1.00  Spain broadband subscriber revenue is UK0.50  increasing at a rate that reflects the ‐   2005 2006 2007 2008 2009 2010 growth in subscribership. This is as it should be. The retail1.4 unit price is stable because1.2 1 underlying costs are stable.0.80.60.40.2 0 2006 2007 2008 2009 2010 Source: IDATE data (2011), WIK calculations. France Germany Italy Spain UK 15 BEREC/OECD IP Interconnection, Brussels, 2 November 2011
  • 17. Traffic, costs, prices, and profitability (9)• Meanwhile, unit prices for global transit are declining rapidly.• This decline reflects not only equipment costs but also circuits (over land and under water).• Labour and other OPEX elements play only a small role, since they depend mostly on the number of subscribers. Source: Telegeography (2011), WIK calculations. 16 BEREC/OECD IP Interconnection, Brussels, 2 November 2011
  • 18. Traffic, costs, prices, and profitability (10)• The cost of carrying every bit of Western European Internet traffic, including growth, is declining (and small in any case).• Any self-supply is presumably cheaper than buying transit. $160,000,000 $140,000,000 $120,000,000 $100,000,000 $80,000,000 $60,000,000 $40,000,000 $20,000,000 $0 2008 2009 2010 2011 Source: Cisco (2011), Telegeography (2011), WIK calculations. 17 BEREC/OECD IP Interconnection, Brussels, 2 November 2011
  • 19. Traffic, costs, prices, and profitability (11)• This is consistent with the trend in underlying equipment costs, which tracks with subscribership and revenue, not with the volume of traffic. 2,000  1,800  1,600  1,400  1,200  1,000  800  600  400  200  ‐   2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 IP traffic Fixed BB subscribers SP Edge total revenue SP Core total revenue DWDM Long Haul total revenue WDM Metro total revenue Source: Dell‘Oro (2011), Cisco (2011), WIK calculations. 18 BEREC/OECD IP Interconnection, Brussels, 2 November 2011
  • 20. Traffic, costs, prices, and profitability (12)• We also find no support for the A.T. Kearney claim that prices for broadband are stuck at any particular level.• Andrew Odlyzko claimed in a 2003 paper that the consumer preference for flat rate would win out if underlying costs were low enough.• Prices in the fixed network have been stable because usage-based costs have been small, and in decline.• Data from multiple sources show that prices move in both directions.• Mobile network operators in the United States (including the largest, AT&T and Verizon) have just recently announced their intention to implement capacity caps on their services. There are many ways in which to implement a price increase. 19 BEREC/OECD IP Interconnection, Brussels, 2 November 2011
  • 21. Traffic, costs, prices, and profitability (13)• Financial indicators do not suggest major mis-matches between costs, prices, and profitability of fixed network operators.• In their recent analyst call, AT&T said: “… IP data now makes up half of our consumer revenue. U-verse has transformed our Consumer business. We have done an outstanding job of scaling this business from scratch just a few years ago to an annualized $6.5 billion business today. And its growing at a 57% clip year- over-year. This has helped stabilize Wireline Consumer revenues, which grew for the fourth consecutive quarter. And as we scale U- verse, margins will continue to improve, contributing to profitability.“• If profitability goes up with volume, where, pray tell, are the purportedly exploding costs? 20 BEREC/OECD IP Interconnection, Brussels, 2 November 2011
  • 22. Traffic, costs, prices, and profitability (14)• Total fixed network costs increase at a rate that is in balance with the increase in subscribers. This means that the cost per user is relatively stable.• Total retail revenue for fixed broadband has increased in proportion to the number of subscribers. Traffic growth driven by an increase in the number of subscribers should raise no concerns.• If costs had increased, prices would have increased. Retail prices tend to move up or down in response to underlying costs, in this market as in most healthy competitive markets.• The growth in mobile Internet traffic is quite stunning.• All indications are that mobile network operators can and will find ways to adjust their retail prices to keep them in balance with their costs, provided that regulators do not prevent them from doing so. 21 BEREC/OECD IP Interconnection, Brussels, 2 November 2011
  • 23. Deployment of Next Generation Access (NGA) (1)• Through the EU 2020 strategy, Europe seeks to achieve availability of 30 Mbps broadband to all Europeans by 2020, with half of all broadband consumers served at speeds of 100 Mbps or more.• Consumers have only limited interest in NGA at present – incremental willingness to pay for ultra-fast broadband is only about € 5 per month, which is nowhere near enough to fund the initial investment needed in most parts of the national territory.• Most estimates of the investment needed are in the neighbourhood of € 200 – 300 billion. Network Cost per home accessed [in €] Type DE FR SE PT ES IT VDSL 457 n.v. 352 218 254 433 PON 2,039 1,580 1,238 1,411 1,771 1,110 P2P 2,111 2,025 1,333 1,548 1,882 1,160 Source: WIK (2008). 22 BEREC/OECD IP Interconnection, Brussels, 2 November 2011
  • 24. Deployment of Next Generation Access (NGA) (2)• There is a probable need for some combination of: - Public subsidies and public-private partnerships (PPPs), to the extent consistent with European State Aid rules. - Cooperation among providers, to the extent that this can be implemented in ways that do not distort competition. - Retail pricing for broadband and NGA that includes bandwidth caps and/or usage-based charges. - Retail pricing (to an ISP’s own customers) for broadband and NGA that differentiates (for instance) based on the Quality of Service (QoS) provided, subject to due regard for non- discrimination.• The focus to date has been on supply, not on the demand side. 23 BEREC/OECD IP Interconnection, Brussels, 2 November 2011
  • 25. A two-sided market view (1)• A fairly new body of economic theory deals with two-sided markets (broadcast televisions, singles bars).• The objective is to enhance societal welfare by maximizing particicipation and usage externalities. Google Yahoo User Commercial Broadband ISP ISP Bing 24 BEREC/OECD IP Interconnection, Brussels, 2 November 2011
  • 26. A two-sided market view (2)• Determining the right balance of payments in a two-sided market is complex. Many factors would need to be considered, including externalities and demand elasticities.• If one were going to take a two-sided market approach to NGA deployment, however, the flow of payments might well be in the opposite direction from that which has been suggested.• If consumers are not convinced that ultra-fast connectivity is worth what it would cost, there is a clear need for more high value high bandwidth content. 25 BEREC/OECD IP Interconnection, Brussels, 2 November 2011
  • 27. Recommendations to network operators• Costs in the fixed network are by no means exploding, and the costs that are alleged to be increasing would in any case be small compared to the overall costs of the business.• If costs were truly increasing for all market players (as may be the case for mobile networks), you would have no difficulty in raising your prices.• If your prices are constrained by competition to levels that are insufficient to cover your costs, it can only mean that your costs are high in comparison to those of your competitors.• We would respectfully suggest that you (1) re-examine your respective cost structures, and (2) reconsider your retail pricing arrangements. 26 BEREC/OECD IP Interconnection, Brussels, 2 November 2011
  • 28. Recommendations to policymakers• There is no market failure to “correct”.• The normal European preference is to rely on wholesale regulation where needed, but to avoid intervention in retail pricing arrangements other than in exceptional cases. Non-intervention in retail prices is generally the right approach here: Network operators need the flexibility to evolve their pricing plans.• It is possible that Internet pricing plans will move away from pure flat rate arrangements over the next few years, especially for mobile network operators. This should be viewed in general as a normal, healthy market adjustment, not as an aberration. 27 BEREC/OECD IP Interconnection, Brussels, 2 November 2011
  • 29. wik-Consult GmbHPostfach 200053588 Bad HonnefTel 02224-9225-0Fax 02224-9225-68eMail info@wik-consult.comwww.wik-consult.com