Economic Impact of Asymmetric Paid Peering: Implications of the Netflix vs. SK Broadband Dispute

Economic Impact of Asymmetric Paid Peering
Implications of the Netflix vs. SK Broadband Dispute
Toshiya Jitsuzumi, Chuo University
T. JITSUZUMI@TPRC50 (Washington D.C. , Sep. 17, 2022) 1

Summary and presentation agenda
Summary
◦ Recently, in order to cope with the growing video traffic
over the internet, network operators are required to expand
their network capacity, and start requesting content
providers to share part of their investment expenditures.
◦ In Korea, negotiations between SK Broadband and Netflix
have been ongoing since 2018, and last year, in 2021, the
Seoul Central District Court ruled in favor of such sharing.
Presentation Agenda
1. SK Broadband vs. Netflix
2. Related issues
3. Model analysis
4. Policy implications
5. Conclusion
SK vs. Netflix Case Related issues Model Implications Conclusion
◦ The results of the simple model analyses
1. Incentives to introduce paid peering is present when ISP’s behavior is constrained in some way, and that in
many cases, the introduction of paid peering will harm economic welfare of the overall ecosystem, in a short-
term framework.
2. If long-term externality is taken into account, it is possible that paid peering is beneficial and realize fair cost
distribution among ecosystem players.
◦ Policy implications
◦ Once a decision is made to intervene in the ISP market, there is a need for continued involvement.
◦ Transparency on peering agreements should be improved.
◦ Paid peering may be a tool that can be used to maintain universal broadband service.

Development of the case
Simply put, their dispute is over the eyeball ISP's demand for
CAPs to bear the cost of expanded network infrastructure
that was essential to guarantee smooth delivery of Netflix
content to Korean subscribers.
◦ According to SK, there is a dramatic increase in Netflix usage
by SK users (35Gbps inApril 2018, 523Gbps in April 2020,
900Gbps in May 2021, and 1,200Gbps in September 2021).
Apr. 4, 2018 Netflix and SK Broadband have started
interconnection at Tokyo.
Oct. 22, 2018 SK Broadband demanded that Netflix pay
for its network.
Nov. 12, 2019 SK Broadband filed a ruling with the Korea
Communications Commission (the proceedings
for this ruling are currently suspended).
Jan. 1, 2020 Netflix and SK Broadband began
interconnection in Hong Kong.
Apr. 2020 Netflix filed suit in the Seoul Central
District Court seeking confirmation that
they are not obligated to negotiate or pay.
Jun. 25, 2021 Seoul Central District Court Decision
1. This case is not directly related to “net
neutrality”.
2. The action for non-existence of
obligation is dismissed.
3. The details of payment should be
decided by negotiations.
Nov. 5, 2021 Netflix appealed to the Seoul High Court.
Open Connect
TOKYO
Open Connect
Hong Kong

Similar discussions in the US and in the EU
Source: https://www.ft.com/content/1e99afea-acd4-4ee3-b655-ef60f8715f40,
https://etno.eu/news/all-news/717-ceo-statement-2021.html,
https://www.reuters.com/business/media-telecom/exclusive-france-italy-spain-call-tech-firms-pay-
telecoms-networks-2022-08-01/?fbclid=IwAR06gL0Loflt2sHx2Qor5jXmVhPKsEMfj9l2ByN-
5afiZBJG0P-02uGxM2I
Source: https://www.newsweek.com/ending-big-techs-free-ride-opinion-
1593696?fbclid=IwAR02HIsYNX7Fr-yfBAVYCzuIgtFM5HucGt5zAoJqwTKBKeaeupjeyxPp45g,
https://www.nexttv.com/news/fcc-seeks-hill-authority-to-add-edge-to-usf-
subsidies?utm_source=SmartBrief&utm_medium=email&utm_campaign=14B53D24-35C5-41D4-B190-
AC51C762248C&utm_content=D915256C-16A7-44F2-9C10-6D923D94695A&utm_term=8f67dc74-
788e-4218-8988-86a99224370f&fbclid=IwAR2JyPmodwxYkjxeAaA-
U3oOs0U_6A0EJf5iBOHR8ADfr1YidU6IqBMs4HU

Related issues
Although not admitted in the district court decision, Netflix argued the following two issues as grounds for no obligation.
Zero price rule (ZPR)
◦ ZPR prohibits network operators from charging content
providers that are not their direct customers.
◦ While having no official legal basis, this “rule” is widely
adopted in order to prevent dominant ISPs from abusing
their superior bargaining power.
◦ Whether this zero price rule would improve economic
welfare or not depends on the parameters of the market.
(Easley et al., 2018 and and Briglauer, 2019).
◦ ZPR functions as a subsidy program from network
operators to content providers.
◦ Lee and Wu (2009), Chettiar et al. (2010) and Chettiar
and Holladay (2010).
Paid peering
◦ Free peering (a settlement-free interconnection agreement)
has been a norm in the past. However, with the recent
proliferation of high-quality video, highly asymmetric traffic
exchange patterns have emerged, making it difficult to
maintain settlement-free arrangements.
◦ Some parties have begun requiring reasonable data
transfer fees to be paid by traffic senders in the name of
"paid peering." The agreement SK is seeking from Netflix is
one of those examples.
◦ In theory, it remains undetermined whether such paid
arrangements could improve welfare.
◦ Little and Wright (2000), Faratin et al (2008), Shrimali
(2010), Besen and Israel (2013), and Coucheney et al.
(2014) support paid peering, while Roson (2003), Choi
and Kim (2010), and Economides and Hermalin (2012)
are against it.
Considering the existence of CDN firms, ZPR does not
guarantee the level playing field. In this sense, ZPR
effectively contributes to the maintenance of market
dominance by large CAPs by narrowing the range of
strategies that can be employed by smaller players.

Four assumptions for model building
Two assumptions that may be unique to this study’s model:
1. CAPs rely on subscription fees rather than advertising revenues.
◦ Relying on subscription fees has the same effect as allowing side payments in the two-sided market model, allowing us to use a
simpler combined goods model.
◦ Most of previous attempts (such as Shrimali and Kumar [2008] and D'Annunzio and Russo [2015]) assume that CAPs employ
an advertising model and proceed the analysis following the wo-sided market structure. In contrast, in Gaivoronski et al. (2017)
and Hau et al. (2011), CAPs are assumed to employ a SVOD model.
2. CAPs will not conduct price discrimination depending on the ISPs through which end-users watch their content.
◦ ISPs can set their own prices for their own users.
Additional assumptions for simplification:
3. Network size and content quality are treated as given
in the short-term model.
◦ The decisions regarding capital investments themselves are
already made and inoperable in the short term.
4. Content providers cannot exit from the market.
◦ The termination of the contract with SK would not be an option
for Netflix, whose market valuation started declining as a result
of declining subscriber growth.

Short-term model settings
The analytical models treated in this study can be categorized into the following four.
◦ The situation where the payment from Netflix to SK (pa) is fixed at zero is the ZPR or free peering situation, and SK requested Netflix
to set that level to a positive value during the debate.
◦ It is also considered the situations where there is regulation of broadband usage fees.
Hotelling model with hinterland
Models (ii) and (iv) assume competition in the ISP
market. For the retail market covered by two ISPs, each
with market dominance, a Hotelling model with
hinterland is employed, assuming two types of user sets.
◦ For competition in the ISP market, the
example of Bourreau and Lestage (2019) is
followed.

Short-term model settings in a simplified shape
Models (iii) and (iv) can be simplified as follows:
◦ It is possible to treat the pricing related to the provision portion of the basic broadband service and the pricing related to the provision
of Netflix content separately.
◦ The net neutrality constraint can be expressed as pSK=pot=0.

Results of short-term model analyses
Ignore inter-CAP competition Consider inter-CAP competition
Ignore
inter-ISP
competition
i) Double Monopoly Model (DMM)
In the absence of price regulation, the effect of
introducing paid peering (PP) is neutral with respect to
resource allocation.
• SK's marginal cost is passed on to Netflix for the
amount of 𝑝𝑝𝑎𝑎. The total price faced by users
remains unchanged.
When ISP rates are regulated, introduction of PP
worsens resource allocation efficiency.
• SK's profit increases, while Netflix and users'
welfare worsens.
iii) DMM with Netflix unsubscribers
In the absence of price regulation, the effect of
introducing PP is neutral with respect to resource
allocation.
Under net neutrality constraints, introduction of PP may
worsen resource allocation efficiency.
• SK's profit increases, while Netflix and users'
welfare worsens.
Consider
inter-ISP
competition
ii) Duopoly Model (DM)
In the absence of price regulation, PP is introduced
symmetrically and is neutral in resource allocation.
• If PP stays asymmetric, welfare of SK and SK users
improves, but welfare of the rest worsens.
• If PP adoption requires additional costs, social
welfare deteriorates.
When ISP rates are regulated, PP is introduced
symmetrically, and resource allocation efficiency
worsens.
• If asymmetric PP stays, only SK's profit improves.
• In symmetric PP, both ISPs' profits improve while
Netflix and users’ welfare worsen.
iv) DM with Netflix unsubscribers
In the absence of price regulation, PP is introduced
symmetrically and is neutral in resource allocation.
• With asymmetric PP, only SK and its users benefit,
and social welfare deteriorates.
Under the net neutrality constraints, PP is introduced
symmetrically, and resource allocation efficiency
deteriorates.
• Only SK and ISP2's profit improves under both
asymmetric and symmetric PP.
• Impact on total surplus under asymmetric PP cannot
be determined.

Long-term model
In a long-term framework, taking into account investment decisions by each players, we need to evaluate the ripple
effects of network quality and content variations to the entire ecosystem.
◦ Capital investment in ISP's networks will have a positive spillover effect on CAPs, and CAP's investment in content
will have a positive spillover effect on ISPs.
◦ A paid peering can be used as a means to internalize the externality and restore the efficiency of resource allocation.
However, whether ISPs will be on the
billing side depends on the magnitude of
the externalities they exert on each other.
pa>0
pa<0
Rich variation
of content
Better quality
of network

Policy implications
And, if we consider a long-term externality between network capacity and content quality/variety, the introduction of
paid peering can be beneficial to the overall society, yielding fairer cost distribution among ecosystem players.
◦ Especially when a government wants to expand the scope of “universal service,”…
The model concluded that
incentives to introduce paid
peering arise when ISPs' free
activity is constrained in some
way, or when there is a market
failure, and in many cases, the
effect is to harm social welfare.
Once a regulation on ISPs is initiated, additional rules are always
required in order to prevent evading regulations.
◦ In order to maintain the welfare improvements that were realized as a result of
rate regulation or net neutrality requirements, paid peering must also be
prohibited.
◦ Given the limited resources which are available to regulators, it is prudent to first
consider the use of the market mechanism as much as possible and to try to
avoid regulation as long as possible.
In Models (ii) and (iv), where
the ISP market is in duopolistic,
the model predicted a situation
that ends up with welfare
deterioration, as each ISP tries
to outbid the other.
How to resolve this bad–end scenario is best left to future studies, but it
would be useful to disclose terms and conditions of the peering
agreement and increase transparency of the deal.
◦ The greatest contribution that this lawsuit can make to academic research might
be that it has revealed information about the mutual negotiations between Netflix
and SK Broadband.

In order to expand the scope of universal service,…
On June 13, 2022, an amendment to the Telecommunications Business Act was enacted in Japan to make fixed-line
broadband newly eligible for universal service.
◦ In this case, the paid peering mechanism, discussed in this study, can be seen as a means of collecting the
necessary contributions from OTT beneficiaries.
Universal service fund for broadband services
Source: Created from https://www.soumu.go.jp/main_content/000821000.pdf,
https://www.soumu.go.jp/main_content/000791565.pdf
Fixed
broadband
provider
Mobile
broadband
provider
Eligible operator
Operators providing fixed
broadband services in
unprofitable areas
Part of the deficit in service
provision (currently
approximately 23B yen) will be
covered by grants provided
through the proposed USF.
Approx. 8 yen per
line per month
(current estimate)
OTT provider
“OTT providers are also beneficiaries in
the sense that the number of users of
their services will increase as a result
of ensuring the provision of broadband
services throughout Japan including
unprofitable areas. However, the
possibility of beneficiary sharing from
this perspective is still under debate in
the overall discussion on how network
costs should be borne.” (MIC’s report)

Conclusion
◦ Recently, in order to cope with the growing video
traffic over the internet, network operators are
required to expand their network capacity, and start
requesting content providers to share part of their
investment expenditures.
◦ In Korea, negotiations between SK Broadband and
Netflix have been ongoing since 2018, and last year,
in 2021, the Seoul Central District Court ruled in
favor of such sharing.
◦ The results of the simple model analyses
1. Incentives to introduce paid peering is present when ISP’s behavior is constrained in some way, and that in
many cases, the introduction of paid peering will harm economic welfare of the overall ecosystem, in a short-
term framework.
2. If long-term externality is taken into account, it is possible that paid peering is beneficial and realize fair cost
distribution among ecosystem players.
◦ Policy implications
◦ Once a decision is made to intervene in the ISP market, there is a need for continued involvement.
◦ Transparency on peering agreements should be improved.
◦ Paid peering may be a tool that can be used to maintain universal broadband service.

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