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. 81 relevant output region paired with irreversible investments, there are no monopolistic bottlenecks in the market for Internet application services. In conclusion, both the content layer and the applications layer of Internet service provision are competitive. There are no substantial economies of scale in these markets that could give rise to monopolistic network elements. According to the disaggregated regulatory approach, sector-specific regulation cannot be justified in these layers of Internet service provision. 5.4 Analyzing the cost characteristics of the logical layer of the Internet A large part of costs on the logical layer of Internet service provision can be attributed to the skilled personnel employed for network management and interconnection negotiations. The wage costs of personnel are part of variable costs and consequently do not substantiate stable market power. Possible sources of large fixed investments on the logical layer are Internet Exchanges, routers, and software. Therefore, the cost characteristics of these network elements are important to look at in more detail. Operation of Internet Exchanges68 Internet Exchange Points (IXPs) are shared interconnection points, where carriers meet for the purpose of exchanging Internet traffic.69 The primary service provided by an Internet Exchange (IX) is a central switching platform and a pre-provisioned fiber mesh often comparable to a local area network, to which carriers can connect their own equipment in order to realize interconnections with other carriers. Secondary services of IXs include help in establishing contacts between carriers, for instance by establishing mailing lists of carriers present at the IX. Carriers can gain efficiency from interconnecting at IXs, because interconnection at IXs minimizes the cost for building fiber to the location of several peering points. Furthermore, an IX offers the opportunity for direct interconnection between networks when the amount of traffic between the two networks would not have warranted a bilateral interconnection. Smaller carriers also use IXs to bundle traffic in order to negotiate a joined agreement for interconnection with larger carriers and thereby better the commercial terms of the contract (Hussain, 2002). There are economies of scale in providing IX services. Firstly, the cost of the shared infrastructure at the IX falls with the number of carriers supplied by it. Secondly, a smaller number of IXs in a given area is more efficient because the benefit of 68 I am grateful to Arnold Nipper, the technical manager of the DE-CIX, in Frankfurt Germany, for an interview, which provided extensive background knowledge for this section on IXPs. The DE-CIX is an IX organized by the Association of the German Internet Economy (www.eco.de; site last visited on Feb. 15, 2008). 69 The European Internet Exchange Association has an informative website on Internet Exchange Points (www.euro-ix.net; site last visited on Feb. 15, 2008).