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Margit Vanberg, A layered model of Internet services provision in:

Margit Vanberg

Competition and Cooperation Among Internet Service Providers, page 28 - 32

A Network Economic Analysis

1. Edition 2009, ISBN print: 978-3-8329-4163-5, ISBN online: 978-3-8452-1290-6 https://doi.org/10.5771/9783845212906

Series: Freiburger Studien zur Netzökonomie, vol. 14

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28 then those functions necessary to provide Internet core services to the end-user can be bought from third-party suppliers.10 2.3 A layered model of Internet services provision A policy analysis of the market for Internet services provision will naturally focus on core Internet services. However, core Internet services cannot be analyzed in isolation. In order to understand the market for Internet services provision, it is important to pay attention to the vertical interrelations between the Internet core and the Internet periphery as well. Only then can potential sources of market power in Internet services provision be located and their influence on market performance be estimated. At the same time such an analysis can also disclose whether existing regulatory interventions in the Internet periphery - interventions that are present due to market failure in other sectors - need to be adapted or extended due to the functions these network elements perform in the context of Internet services provision. This subsection introduces a conceptual framework for the analysis of the market for Internet service provision that takes into account the demands formulated above. The starting point for this approach is the reference model of Open Systems Interconnection (OSI model) developed in 1978 by the International Standards Organization. This general model of communications networks was written for technicians and describes the interrelationships between the diverse protocols that are used on the different layers of communications networks from an engineering perspective. Figure 2.3 shows the seven protocol layers of the OSI model. Inspired by the OSI model, economic analysis of communications networks increasingly uses simplified layered models to describe the architecture of communications networks for the purpose of policy analysis (Werbach, 2002). As one observer puts it: “The Layered Model is a market policy mapped onto a technical conception” (Cannon, 2003: 195). The weight the OSI model places on the technical functions performed by any communications network directs the view towards the similarities between services that are based on these protocols rather than to the differences in these services. The simplified models used for competition policy usually differentiate between a physical (network-oriented), a logical (transportoriented), and an applications layer (service-oriented); sometimes a content layer is analyzed separately.11 10 Whenever it is not necessary for the present analysis to differentiate between the different core functions of Internet service provision, then, throughout the thesis, reference will generally be made only to an ISP. When the difference between the core Internet services is important for the analysis, then reference will be made to Internet access service providers or Internet backbone service providers etc. 11 The layered approach used in this thesis is based on Werbach (2002). For an overview of alternative layering models of communications networks see Whitt (2004). 29 Figure 2.3: The OSI model Source: Based on Comer (2006: 159) Initially developed in the academic literature on regulation economics, the layered model subsequently was applied by regulatory bodies, as they began to conceive of communications networks as a combination of successive vertical layers of production. In the early partial liberalization of the telecommunications sector, regulatory authorities in the U.S. and in Europe, for instance, differentiated between a network layer, a basic services layer (defined by the close relationship of the basic services to the underlying network infrastructure), and a layer of value-added services (Gabelmann, 2003: 25).12 The network layer and the basic services layer were said to be in 12 In the U.S. the differentiation between “basic” and “enhanced services” was introduced when computer communications became more common. In the so-called Computer Inquiries II, initiated in 1976 and completed in 1980, the Federal Communications Commission came to the conclusion that data processing, and the communication services provided over data processing equipment, are competitive. It therefore differentiated these “enhanced services” from the regulated “basic services” (Cannon, 2003: 183). In Europe, a differentiation between value-added services and underlying network and basic services in the telecommunications sector became apparent when terminal equipment and value-added services were liberalized a few years prior to the liberalization of network services. See chapter 9 for more details on the liberalization process in both, the U.S. and Europe. Physical Hardware Connection Transport Network Data Link (Hardware Interface) Session Application Presentation 1 2 3 5 4 6 7 Layer Functionality Networkoriented Transportoriented Serviceoriented 30 need of sector-specific regulation. With regard to the network layer the natural monopoly characteristics of the network led to this assessment, whereas in case of the basic services layer the need for universal service obligations was pointed out as the crucial factor. In contrast, for the layer of value-added services competition was considered possible (see Figure 2.4). In the era of fully liberalized telecommunications markets competition was pursued in all layers of telecommunications service provision. Differentiating the vertical layers of production in this way has helped regulatory authorities to recognize that the services provisioned on the separate layers of an industry can be offered by independent service providers. Competition authorities in industrialized countries have used this insight to liberalize competitive market segments of network industries which were previously completely in the hands of private or state monopolies (e.g., electricity markets, transportation, postal services). They have come to the conclusion that it suffices to regulate smaller market segments when necessary, rather than regulating an entire industry. Traditionally, regulators use the layered model foremost to differentiate within an industry between those market segments that show natural monopoly characteristics and those market segments that are competitive. New regulatory approaches however urge the use of a layered model of communications networks to overcome inconsistencies in the sector-specific regulations across industries. In many countries, sector-specific regulation is imposed according to service categories. In the U.S., for instance, there continue to exist individual policies for fixed-line voice communications, for wireless voice communications, for cable-TV broadcasting, for computer communication networks, etc.13 This horizontal differentiation according to service category leads to inconsistencies when platforms, that were initially regulated according to an association with a particular service category, are used to offer services which fall into a different regulatory category. For instance, under U.S. telecommunications regulation, common carriers that traditionally were active in fixedline voice telecommunications, were obliged to open their physical network infrastructure to all ISPs wanting to offer Internet services to the attached end-users. Cable-TV networks were, however, not considered to be common carriers under this statute. Therefore, when they entered the market for Internet service provision, they were free to arrange an exclusive agreement with just one ISP to serve their endusers. As a result, the competitive situation for ISPs depended on the platform over which the end-user was attached to the Internet.14 13 The U.S. Communications Act differentiates Title II (telephony), Title III (TV and radio broadcasting as well as wireless services), and Title IV (Cable-TV) services. See Nakahata (2002: 100ff.). 14 This situation was reversed in 2005 when the obligation to common carriers to open their networks to ISPs was eliminated. See Section 9.1.2 for more details. 31 Figure 2.4: A layered model of electronic communications as used in telecommunications liberalization Source: Based on Gabelmann (2003: 27) If policymakers would consistently apply a layered model of communications networks, they would recognize, that the different communications networks are very similar on the layer of physical network infrastructure and on the layer of logical infrastructure. In fact, once network convergence is complete, a single network and a single logical infrastructure will be used to carry the data of voice, video, and other data services, and the differences between the communications sectors will therefore be located mainly on the applications and the content layers. Network convergence is central to the current Internet policy challenges. To be able to formulate a forward-looking Internet policy, the analysis ought to be based on a general layered model of communications networks. Attention can then be given to avoiding inconsistencies in the regulation of the different communications platforms that compete with one another, as network convergence progresses. Second, using the layered model will make it possible to differentiate market segments that are competitive and market segments in which sector-specific market power Value-added services - Premium numbers (i.e. 1-800-numbers) - E-mail - Fax… Basic services - circuit-switched data transmission - packet-switched data transmission - network management -… Physical network infrastructure - cables and wires - switches and routers - … Co m pe tit iv e la ye r M o n o po lis tic la ye r Partial liberalization Full liberalization C o m p etitiv e lay e rs O nly ele m e nts co n sid ered m o n op olistic 32 may be found. The layered model can thus serve as a starting-point for identifying the minimal basis for sector-specific regulation.15 Figure 2.5: A layered model of Internet service provision Figure 2.5 categorizes the Internet functions that were introduced in section 2.2 in a layered model of Internet service provision. The Internet core functions are located on the logical layer (Internet transport services) and on the applications layer. The Internet periphery functions are located on the physical layer and on the content layer. This categorization will be used throughout the thesis. 2.4 Conclusions This chapter has defined Internet service provision by differentiating between Internet core services and Internet periphery services. Internet application services and 15 Chapter 4 introduces the disaggregated regulatory approach (Knieps, 1997) which will be combined with the layered model to pursue the objective of minimal regulation. Applications layer - E-mail - Web-portal services - VoIP - … Logical layer (Internet transport services) - routers/switches - TCP/IP protocol - IP address assignment - network management - Interconnection with other networks - … Physical layer - local communications infrastructure - long-distance communications infrastructure - terminal equipment Content layer - news - online-shopping - home banking - …

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Zusammenfassung

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.