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Margit Vanberg, Essential network elements of Internet service provision in:

Margit Vanberg

Competition and Cooperation Among Internet Service Providers, page 78 - 80

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

Bibliographic information
78 minimally invasive regulatory policy. For those network areas in which no monopolistic bottlenecks are found, it can be concluded that high market shares of particular carriers are not a sign of stable network-specific market power and cannot be used to justify regulation. 5.2 Essential network elements of Internet service provision The disaggregated analysis of the market for Internet service provision uses the layered model of Internet service provision developed in chapter 2. Table 5.1 classifies the most important network elements and the principle drivers of costs in this layered model. These elements are then analyzed in the subsequent sections. The content layer comprises goods and services offered via Internet applications services such as news, home-banking services, online-shopping opportunities, etc. Providers of Internet content are responsible for production of these goods and services, and for the sales and marketing activities for these goods and services. Online content is offered by a variety of firms, often with the major part of their business activities in conventional retail and services markets. Offering Internet content requires no specific Internet hardware or software; only the programming of an onlinepresence. Server capacity for the distribution of the web-page content within the Internet is bought from Internet applications providers. The applications layer comprises the applications ISPs offer to end-users of the Internet, such as E-mail services, file transfer, web-browsing, content hosting, portal services, etc. ISPs offering Internet applications operate servers on which data can be stored. Carriers offering these applications are responsible for product development, product design, and sales and marketing activities. The direct relationship with Internet end-users also encompasses functions in the area of customer support and billing activities. The logical layer comprises the network elements employed in Internet access services and Internet backbone services. These network elements support the transmission of data within and between networks on the basis of the network elements located on the physical layer. Network management functions are located on the logical layer and require the deployment of skilled personnel. Hardware elements of the logical layer are routers and switches installed at Internet exchange points and network nodes. The hardware is complemented by software for transport functions that is designed to establish logical connections, to manage the fragmentation and reassembly of data messages, the control of transmission errors and for maintaining and updating routing tables. A further critical element of the logical layer is the common address space used in Internet data transmission. 79 Table 5.1: Disaggregated view of the market for Internet Service Provision The physical layer of Internet service provision encompasses the local communications infrastructure and the long-distance communications infrastructure of the network. The local communications infrastructure on the physical layer of Internet service provision is made up of the transmission lines connecting end-user sites with the nearest Point of Presence (PoP) of an ISP’s network. These transmission lines can either be telecommunications cables, coaxial cables, wireless media such as satellites and/or radio transmission facilities. The long-distance communications infrastructure encompasses the transmission lines that make up the backbone networks of ISPs. Besides these transmission lines, the physical layer of Internet service provision further encompasses collocation spaces, in which transmission equipment is installed. Layers of Internet Service Provision Network Elements The content layer - production, sales and marketing for online products and services such as o News o Home-banking o Online-shopping, o etc. The applications layer - building and maintaining server capacity - sales and marketing for o E-mail services o VoIP services o web-portal services o web hosting services, o etc. - customer support functions billing functions The logical layer (= Internet access services and Internet backbone services) - network management functions - Interconnection negotiations with other networks - the operation of Internet Exchange Points - the operation of routers and switches implementation and use of TCP/IP protocol software maintaining routing tables management of IP-address space - the operation of DNS servers The physical layer (= local communications infrastructure and longdistance communications infrastructure) building and maintaining transmission lines (requires access to public rights of way) building and maintaining collocation space upgrading of network capacity - terminal equipment 80 5.3 Analysis of the cost characteristics of the network elements on the Internet applications and Internet content layers Given access to the network elements of the physical layer and the logical layer, entry into the Internet applications layer is similar to entry into competitive product markets of other conventional industries. The costs of providing Internet application services such as E-mail services, portal services, web-hosting, etc. are driven primarily by comparable cost pools of traditional markets such as product development costs, marketing costs, and costs for customer care. The proportion of fixed costs in these production and marketing costs are not so high as to give rise to substantial economies of scale or scope. Furthermore, as the relevant market size on which Internet applications are offered is large, any small economies of scale or scope will be exhausted in the relevant market. The same reasoning applies to the content layer of Internet service provision. The goods and services offered via the Internet are often closely related to similar goods offered on conventional markets. The adjustments necessary in sales and marketing activities for distribution of goods and services over the Internet do not give rise to substantial economies of scale or scope. Among the Internet-specific costs of Internet application provision are the costs for operating servers. Servers are required for web-hosting services, for E-mail services, and for caching of remote web-sites.66 The size and therefore also the costs of these servers are scaleable. The required server capacity can be bought to scale such that the incurred fixed costs do not substantiate economies of scale in the relevant range of output. Further Internet-specific costs of Internet application provision are associated with the billing of electronically generated data records. The billing of such data records requires powerful rating engines. The fixed investments for these rating engines could be the source of economies of scale in the relevant output region, since smaller ISPs are not likely to generate enough traffic to exhaust the economies of scale of the most cost-efficient billing technologies. However, there are companies specialized in offering billing solutions to ISPs, telecommunications carriers, cable providers, etc.67 Smaller Internet application providers therefore do not need to invest into expensive billing equipment which may not be reversible upon exiting the market. Rather, it is possible to outsource all billing functions such as the rating of call records and the printing and shipping of invoices. This decreases the investment risk for Internet application providers. In summary, because there are no network elements on the application level that substantiate economies of scale in the 66 Caching refers to the temporary storage of remote content closer to the user. ISPs use the caching of web-sites to lower interconnection costs and to enhance the performance of their network (download speed). 67 See, for instance, www.billcom.de or www.intec-telecom-systems.com/; both sites last visited on Feb. 15, 2008.

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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.