IP: Too cheap to meter? from the Economist

[Dave Farber <farber () central cis upenn edu>]

http://www.economist.com/issue/19-10-96/sf0774.html
 Too cheap to meter? 
Too cheap to meter?


The fact that the Internet seems free to many of its users has been one
reason for its success. Now it may have to change. But how? READ about the
Internet, and thrill to the notion of a world wired at the speed of light,
with all the information anyone could want just a mouse-click away. But
actually use the cursed thing, and a more prosaic picture quickly emerges.
Delay, break-downs and glacial transmissions are part of everyday Internet
life. New users are amazed: surely this tepid data trickle is not the
fabled "information superhighway"? Veterans shake their head wearily: the
Internet has always been swamped, and as long at it doubles in size each
year, it seems likely always to remain so.
True? That question--whether the Internet can grow out of stumbling
adolescence and become as delay-free and reliable as the telephone
network--ultimately comes down to one of economics. Today's Internet works
with a financial model that has hardly changed from the days, a decade ago,
when the network was a non-commercial communications link for universities
and research labs. Multi-million dollar networks still trade data on the
barter principle, or the roughest approximations of real cost. Not
surprisingly, these intersections between networks are usually where the
traffic backs up (see <sf1.gif>map). 
Bypassing these bottlenecks is not as easy as it might seem. The Internet
is made up of many networks, operated by many different firms. Customers
can pay a fortune for "industrial strength", rather than "student strength"
service, but that service only lasts as far as the firm's network reaches.
Sooner or later, Web surfers find themselves in some congested backwater,
where no amount of money can make a swamped Web server serve: the Internet
treats all transmissions alike, whatever their price.
No wonder, then, that more and more users are simply bypassing the public
Internet. Companies are setting up private "intranets" within single
locations and "extranets" with branches and partners. A group of American
research universities plan to build "Internet II", dedicated to academic
traffic and free of commercial users, much as the Internet itself was just
a few years ago. This month, President Clinton promised to seek $500m over
five years to help them.
Building a second Internet (and many smaller rivals) might seem an
expensive alternative to simply eliminating the economic failings of the
first. But the question of how--or whether--the Internet's economic model
should be changed is difficult. One of the reasons the Internet has been
able to grow so quickly is that its builder avoided the complex accounting
and time-and-distance charging of the telephone networks. Yet now that the
Internet is carrying as much traffic as the voice networks over some
routes, some charging by use is already taking place (when traffic was not
so heavy, the approximations of flat-fee charges and bartering were good
enough; now they can be expensive mistakes). 
So which model is best? Or, more fundamentally, what should it cost to
communicate? At present, the answer depends on how you do it. Pick up the
telephone, and you pay by the mile and the minute. Send a message across
the Internet to the same destination (or use special software to make an
Internet telephone call) and--even though the message will travel across
the same lines--you pay, at most, the price of a local telephone call.
In part the cheapness is because the Internet sends messages more
efficiently than local telephone networks: it breaks them down into small
digital "packets" that can then be slotted in with other packets travelling
over the same network. By contrast, a telephone call requires a whole
electronic circuit to itself for the duration of the call. 
But in long distance and international transmissions, the technology is
similar: both voice and data are sent as a digital stream along fibre-optic
cable. Indeed, nearly all of the Internet runs along lines leased from the
telephone companies.
Both telephone companies and the myriad firms that run the Internet
therefore have a similar pattern of costs: their big expense comes in
installing switches (or "routers") and providing lines. The cost of
carrying one extra item is as near to zero as makes no difference--"too
cheap to meter", as some would have it.  
 But if the costs of the telephone companies and the Internet are similar,
why are their methods of pricing different? The answer is that telecoms
charges bear little relation to costs. The telephone industry is regulated
nearly everywhere and in most countries prices are set by bureaucrats and
commissions; real costs are hidden by a layer of cross subsidies. The
Internet, on the other hand, is essentially unregulated.


 At present, telephone companies typically make less than half their
revenue from fixed charges rather than from the price of each call. Tim
Kelly, of the International Telecommunication Union in Geneva, reckons that
the share of revenue from connection charges and monthly rentals has risen
in the past decade from about 33% to 40%; he expects an increase to around
60% over the next ten years.
The companies are not keen on such "rebalancing", since it usually involves
reducing lucrative call charges rather than increasing fixed charges. But
without it, they are vulnerable to competition, including competition from
the Internet, which can offer rival services far less expensively.
The competition, however, may have its silver lining: the Internet
encourages telephone use, and in most countries this is charged by the
second for local calls--including the ones, sometimes lasting for hours,
made by the net-surfers. Add to that the income from installing extra
lines, ordered by a surfer's frustrated relations in their desire to make
ordinary telephone calls. Add lastly the prospect that the telephone
companies will start offering services in competition with the Internet--
once the Internet has tested the prices consumers are willing to pay.
What seems reasonably certain, however, is that the impact of the Internet
and the spreading deregulation of the telecoms industry will bring prices
closer to real costs. The telephone companies will have the biggest pricing
adjustment to make. But the Internet too may have to change--perhaps by
moving closer to the method of the telephone companies, namely a mix of
fixed tariffs and ones based on usage. Economists such as Hal Varian, from
the University of California at Berkeley, and Jeff Mackie-Mason, of
Michigan University, fret that the present structure of Internet pricing
does not reflect its "social costs". 


World Wide Wait
Those are not, as you might think, the conversation-deadening impact of
hours spent surfing, but the congestion that periodically occurs on the
network. My Internet video call may hold up your electronic mail, imposing
a cost on you that I do not notice. Use-based pricing, they argue, is
essential to encourage the rational allocation of scarce transmission
capacity.
The dangers of congestion have undoubtedly increased in the past year or
two, as the Internet has moved from being a government-financed playground
for academics to a cornucopia of entertainment, commerce and information.
As a result the use of the Internet is growing faster than the number of
subscribers: traffic through one of the main connection points has been
doubling every six months, says Tony Rutkowski, once head of the Internet
Society and now with General Magic, a software firm, while the number of
subscribers is doubling only every year.
Moreover, the Internet is no longer being used almost exclusively to send
text. Instead, thanks partly to the development of the World Wide Web,
people can listen to music, make telephone calls and look at film clips.
These uses, which are the ones growing most quickly, gobble up far more
capacity than text: to send 15 seconds of high quality video munches as
much bandwidth as the text of a 700-page book.
A second change means that the costs of congestion are becoming higher. It
may not matter if some parts of an electronic letter take a second or two
longer than the others to reach their destination. But more and more of the
material sent over the Internet needs to arrive immediately to be
effective. If some of the bits that make up a video call or a telephone
conversation are held up en route, the results are jerky and garbled.
Do these congestion-driven arguments imply the need for new settlement
mechanisms? In the case of telephone companies, a system exists so that the
company with which a call starts--which bills the caller-- can hand some of
the proceeds to the company through which the call ends. 
Such settlements are a source of endless argument: America's long-distance
carriers complain that local telephone companies overcharge them. Moreover,
they transfer huge sums of money between countries: in 1994, carriers based
in the United States handed over a net $4.3 billion to foreign carriers.
Because countries in which telephoning is cheap (such as America) tend to
ring countries where calls are dearer, American carriers grumble that they
are subsidising the inefficient and uncompetitive. Gradually, therefore,
telephone companies are moving towards a "sender-keeps-all" system, where
they will charge each other a flat fee for access to a certain amount of
transmission capacity, rather than bill each other on the basis of use.
That would bring them increasingly into line with what happens on the
Internet, where settlement is rudimentary. There are payments between each
of the Internet's hierarchy of links: access providers pay their regional
network and regional networks pay the companies that operate the
high-capacity long-distance parts, the backbone of the system. But such
payments are mostly based on the availability of capacity, not its use:
service providers simply agree to carry each other's traffic without
totting up precise bills.
This encourages a "hot-potato" approach: Internet access providers hand
traffic on as quickly as possible to the carrier taking it to its ultimate
destination. That benefits small service providers and irritates big ones,
who say they get little reward for the effort of carrying the traffic for
most of its journey. In turn, this lessens their incentive to invest in new
capacity. 
The problem of settlement is worse for access providers outside America.
Led by Singapore Telecom and Australia's Telstra, they complain that they
have to pay all the cost of leasing lines between their country and the
United States. "The rest of the planet subsidises the United States,"
argues Barry Greene, who works for Cisco, a maker of routers, but was
previously with Singnet, the Internet arm of Singapore Telecom. The high
cost of leasing international lines means that upgrading them to ease
congestion can cost a non-American company ten times more than in America.


Free lunches all round
Economists, famously sceptical about free lunches, have thought up various
ingenious schemes to charge Internet users in ways that more accurately
reflect costs. Several versions will appear in a forthcoming tome on
Internet Economics, edited by Lee McKnight and Joseph Bailey of MIT. The
main suggestion is to attach to messages some indication of their priority
(high for a film clip, low for an e-mail message and so on). Users might
pay in advance for high priority traffic; or their payments might vary with
the level of congestion. 
The means for such fancy solutions will increasingly become available. A
new protocol, or standard, called RSVP will soon allow people to specify
the quality of service they want and, in theory, to be billed for it.
Asynchronous transfer mode, or ATM, a technology that breaks the Internet's
many sorts of digital signals into packets of a standard size, will allow a
reliable quality of service and make it easier to keep accounts, if it ever
becomes widely used. 
Undoubtedly, charges would have an effect on the way the Internet is used.
A study of "Information Infrastructure Convergence and Pricing: The
Internet" by the OECD, published in June, showed that Internet access was
far greater in competitive telecommunications markets than in uncompetitive
ones. The reason is almost certainly that the average price for leased
lines in countries with monopolies was 44% higher than in competitive ones
(see <sf2.gif>chart). There was also a close correlation between Internet
use and the structure of local call charges: surfing for hours is free or
almost free in the United States and Canada, but most OECD countries charge
local callers for the time they spend on the line. 
Fearful that use-based pricing would be a dampener, many Internet
aficionados cross their fingers that the Internet can muddle on with its
present, mostly flat-fee structure. After all, the capacity of the
Internet's backbone has increased more than 10,000 times in the past
decade; and that has been financed by the enormous increase in the number
of subscribers. 
In addition, various technical solutions have emerged to slow the growth in
traffic, such as the practice of "caching": storing material that one
person has looked at close to the point of use, so that the next user need
not go all the way to the original site to look at it.
Flat-raters point also to the low cost of a flat-rate sender-keeps-all
system. After all, for some telecoms companies to bill a customer for a
call costs more than to transmit it. Moreover, the present system suits the
idiosyncracies of the Internet. Each message may hop across a dozen
different carriers. Should each be paid something? And the person who
initiates an Internet "conversation" may send out a tiny message and
receive a huge one. How should the costs be divided? 
One way or another, as the Internet expands in both content and usage, a
change is surely inevitable. Some of the larger telecoms carriers, such as
BT/MCI, are building parallel global Internets of their own on which
customers, for a premium payment, will be guaranteed a more reliable
service than the public Internet can now offer. They will, says Barbara
Dooley, managing editor of CIXtra, a newsletter, have an incentive to carry
customers' traffic for as much of the way as possible, to keep control of
the quality of service. Once they carry traffic around the world, they will
have little incentive to make settlement payments; they will probably agree
to accept a certain volume of traffic from each other free.
And what of the public Internet? Its users will face a choice. If they want
to surf for free, they will have to put up with the occasional congestion.
This will be partly self regulating: if too many people try to hold video
conferences with their children, the quality will become so awful that the
youngsters will give up in disgust and congestion will lessen. The
wonderful thing about the Internet is that it still reflects what its users
want, not what some large telecommunications company believes they ought to
have.


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