Margit Vanberg, Overview of the thesis in:

Margit Vanberg

Competition and Cooperation Among Internet Service Providers, page 21 - 23

A Network Economic Analysis

1. Edition 2009, ISBN print: 978-3-8329-4163-5, ISBN online: 978-3-8452-1290-6

Series: Freiburger Studien zur Netzökonomie, vol. 14

Bibliographic information
21 Internet service providers (ISPs) always have an incentive to interconnect with rival ISPs on non-discriminating terms, or whether there are market-share constellations in which larger ISPs have less incentive to interconnect than smaller ISPs. More recently the discussion on possible government intervention into Internet markets has turned to the question of network neutrality regulation.8 In this debate the competition policy concern is over whether the owners of the network infrastructure underlying Internet applications should be allowed to offer different service qualities at different prices for data transmission on their networks, or whether Internet traffic should be required to be treated equally by network owners, independent of the applications generating the traffic. The ongoing debate over this issue shows that Internet regulation concerns exist and that it is by far not certain that the Internet will remain unregulated. 1.3 Overview of the thesis The objective of this thesis is to develop an economic analysis of the supply-side and demand-side characteristics of Internet service provision with a view to answering the question of whether there is a role for sector-specific regulation in this market. The close relationship between Internet services technology and telecommunications services technology may lead those involved with the telecommunications industry to a false sense of familiarity with the Internet. There are, however, important differences in Internet technology and telecommunications technology, which in turn bring about significant differences in the relationship of the competing networks in these markets. Because understanding the specifics of the Internet is crucial for an analysis of the competitive forces that are present in the market, chapter 2 shall start out by describing the basic characteristics of Internet service provision. In this chapter the terms used throughout the thesis, to refer to different parts of the market for Internet service provision, are defined. Chapter 3 then provides an overview of the historical and technical background of the Internet. This description gives the reader detailed information on Internet technology and Internet interconnection. Chapter 4 lays the foundation for the economic analysis of the special competition policy and regulation concerns in the market for Internet service provision by presenting a conceptual framework that will be used for this analysis. Network economics needs a reference model for competition which allows for the typical characteristics of network industries that were discussed above without automatically equating these with market power. Chapter 4 introduces the theory of monopolistic bottlenecks as a reference model, which was designed explicitly to localize stable market power in network industries. The general understanding of sector-specific regulation in this theory is that regulation is more costly and associated with more 8 For an introduction to the network neutrality debate see Sidak (2007). 22 errors than general competition policy and that it therefore needs to be based on a special justification. The theory of monopolistic bottlenecks offers a criterion for justifying ex-ante sector-specific regulation in network industries. Chapter 5 applies the disaggregated regulatory approach, which uses the theory of monopolistic bottlenecks to identify network-specific market power as a justification for sector-specific regulation, to the market for Internet service provision. Sectorspecific regulation of Internet service provision would be justified if a disaggregated analysis of the network elements of the value chain for Internet service provision were to disclose monopolistic bottleneck network elements. The analysis concludes that network-specific market power can only be found in local access infrastructures belonging to the physical layer of Internet service provision. The analysis discovers no monopolistic bottleneck network elements in long-distance network capacity or in the logical layer of Internet service provision, which are at the center of the discussion on potential Internet regulation. Network externalities are often cited as the second possible cause for market failure in the market for Internet service provision. According to the theory of monopolistic bottlenecks, network externalities do not substantiate monopolistic bottlenecks and therefore cannot justify ex-ante sector-specific regulation. To support competition policy intervention as a means of internalizing network externalities requires strong evidence that, in particular cases, network externalities substantiate market power and that in these cases competition policy could achieve better welfare results in coordinating users and firms than free market processes can. Chapter 6 reviews relevant literature on network externalities in general and shows that in many realistic market environments the spontaneous market order has a comparative advantage in internalizing network externalities as compared to administered policy. Chapter 7 then analyzes the effect of the strong network externalities associated with Internet backbone services. The chapter reviews the economic analysis which were conducted in the context of prominent merger proceedings in the Internet backbone services market to see whether these analyses reveal stable market power. In the merger proceedings the competition policy concern was whether large ISPs can derive market power from network externalities and charge smaller rivals discriminatory prices for their services. It will be shown that competitive forces between ISP are strong and hinder a large ISP from discriminating against competitors. Chapter 8 summarizes the policy insights gained from the foregone analysis. The disaggregated analysis of the network elements of Internet service provision found that some parts of the local communications infrastructure must be considered monopolistic bottleneck network areas. Chapter 8 derives guidelines for the regulation of these monopolistic network elements using the principals of the disaggregated regulatory framework. Effective regulation of the monopolistic bottleneck network elements is a prerequisite for the functioning of competition in the remaining parts of the value chain of Internet service provision. Chapter 9 mirrors the actual regulatory policy in the U.S. and in Europe against these normative conclusions. It is shown that regulation legislation in the U.S., in theory, comes close to the regulation guidelines derived from the normative analy 23 sis. The practical implementation of regulation in the U.S., however, does not always conform to the legal standard. Most importantly, there is no open access regulation for broadband communications infrastructures, even when no second communications platform, next to the infrastructure of the telecommunications incumbent, exists. The lack of broadband-access regulation in the U.S. is at least partly responsible for the fear of network neutrality activists that vertically integrated incumbents may have an incentive to discriminate competitors in Internet service provision markets. In Europe, on the other hand, both the telecommunications regulation legislation as well as its practical implementation show a strong tendency to overregulation. The European regulatory framework for communications-markets regulation lacks a clearly defined limiting criterion for the implementation of ex-ante sector-specific regulation. Chapter 10 concludes the thesis with a summary of the main findings.

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Die Konvergenz der Netztechnologien, die dem Internet, der Telekommunikation und dem Kabelfernsehen zu Grunde liegen, wird die Regulierung dieser Märkte grundlegend verändern. In den sogenannten Next Generation Networks werden auch Sprache und Fernsehinhalte über die IP-Technologie des Internets transportiert. Mit den Methoden der angewandten Mikroökonomie untersucht die vorliegende Arbeit, ob eine ex-ante sektorspezifische Regulierung auf den Märkten für Internetdienste wettbewerbsökonomisch begründet ist. Im Mittelpunkt der Analyse stehen die Größen- und Verbundvorteile, die beim Aufbau von Netzinfrastrukturen entstehen, sowie die Netzexternalitäten, die im Internet eine bedeutende Rolle spielen. Die Autorin kommt zu dem Ergebnis, dass in den Kernmärkten der Internet Service Provider keine monopolistischen Engpassbereiche vorliegen, welche eine sektor-spezifische Regulierung notwendig machen würden. Der funktionsfähige Wettbewerb zwischen den ISP setzt jedoch regulierten, diskriminierungsfreien Zugang zu den verbleibenden monopolistischen Engpassbereichen im vorgelagerten Markt für lokale Netzinfrastruktur voraus. Die Untersuchung zeigt den notwendigen Regulierungsumfang in der Internet-Peripherie auf und vergleicht diesen mit der aktuellen Regulierungspraxis auf den Telekommunikationsmärkten in den Vereinigten Staaten und in Europa. Sie richtet sich sowohl an die Praxis (Netzbetreiber, Regulierer und Kartellämter) als auch an die Wissenschaft.