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IP: A Wall Street take on the metered pricing thing
From: Dave Farber <farber () cis upenn edu>
Date: Fri, 08 Nov 1996 12:39:03 -0500
From: "eunice" <eunice () ccgw Tudor Com> I thought members of the list might be interested in the following. Archives of Bill Gurley's newsletters can be found at www.upside.com Eunice Johnson Analyst Tudor Investment Corp. net: eunice () tudor com vox: 617-772-4642 fax: 617-737-9280 ______________________________ Forward Header __________________________________ Subject: ATC 96-18 Author: Bill Gurley <bgurley () abovethecrowd com> at ccgw Date: 11/05/96 03:29 AM Above the Crowd Deutsche Morgan Grenfell Technology Group Newsletter Issue: 96-18 J.William Gurley bill_gurley () dmgtech com 415-614-1159 USAGE BASED PRICING:NOT IF, BUT WHEN "And you let go, let go, let go, 'cause you know you're getting tired. Can you feel it getting down to the wire?" - Buffalo Springfield Regular ATC readers should know by now that we are not big fans of the unlimited-use pricing model currently in existence on the Internet. With each passing week, congestion problems continue to worsen. Pacific Bell (PAC, 34) now claims that at peak usage, one in six business calls do not get through as a result of jammed circuits in the central office switch. Also, an article last week on CNN Interactive declared, "Soaring Internet usage is bringing the United States' phone system perilously close to gridlock by tying up millions of local phone lines every evening." Lastly, our own futile attempts to connect to Netcom (NETC, 15) in Palo Alto, New York, and Austin would suggest that this ISP is running its systems right up against its limits. We need a fix, and we need it now. While we risk accusations of redundancy, we feel compelled to reiterate our position on pricing. We have a hard time understanding why so many people fail to understand the necessity and rationality of usage based pricing. When you offer unlimited use of a limited resource overcrowding is inevitable. Of course, this isn't rocket science, it's Economics 101. We think MCI's (MCIC, 30) Internet guru, Vint Cerf, sums it up best. "The hill is overgrazed, there's no more grass, and the sheep die." Once you accept the wisdom of usage based pricing, the next question is "how do we get there?" Intense competition in the consumer Internet market would seem to preclude a shift to clocked services. Nonetheless, we see three different ways where usage-based pricing could emerge without proactive action from your local ISP. The first and most obvious way we move to usage based pricing is if the FCC decides to levy a modest per-minute access charge (perhaps one-half cent per minute) on data service connections from the central office switch. As many of you know, the RBOCs receive a hefty 3.25 cents per minute access charge from long distance providers, but absolutely zilch from the ISPs. This is despite the fact that the average Internet "call" typically lasts ten times longer than the average phone call. A proposal from the FCC is expected in November with a ruling in May. Once thought to be "out of the question," the FCC now appears more amenable to a data service access charge. If the FCC votes down Internet access charges, we will likely achieve data-voice price parity in an alternate way -- through the absolute removal of access charges. While this decision would assuredly be "free-market" friendly, it would also start a chain reaction that would likely result in per-minute pricing for all telephone calls. The removal or reduction of long-distance access charges will unquestionably increase the demand for long-distance services as a result of significantly reduced long-distance pricing (once again, Econ 101). This increased usage would put even more pressure on the already congested central office switch. Once this happens, the RBOCs will be left with no alternative but to move to per-minute pricing on all calls as a way to throttle demand. Obviously, a move such as this would be particularly unpopular with consumers and would re-ignite political concerns regarding universal service. However, keep in mind two things. First, most countries outside the United States do indeed have per- minute pricing on local calls. Secondly, when we designed the U.S. telecommunications network, we made a decision to subsidize local service with hefty per-minute long distance access charges. Now, some want to remove the subsidy, but to continue to reap its benefits. You can't have your cake and eat it too. Even if the FCC fails to restructure access charges, we could still end up with usage based pricing as a result of the continuing evolution of ISP peering relationships. The Internet grew up in the altruistic world of academia, and the competitive effects resulting from commercialization have yet to fully materialize. As Hank Williams Jr. likes to point out "Old habits like these, are hard to break." Most ISPs interconnect with each other at the public peering points, also known as MAEs (Metropolitan Area Exchanges) and NAPs (Network Access Points). It is in these facilities that ISPs exchange data packets which are destined for each other's network. What is most interesting is that the "rules of engagement" for these public interconnect points are nebulous, dissimilar, and quite likely to change. Why are these peering relationships so likely to change? For starters, the public peering points are one of the key contributors to Internet congestion. As with any "tree and branch" architecture, the main trunk is likely to experience the most traffic. However, this is not the only problem. Some of the larger ISPs are unhappy with smaller ISPs that interconnect at only a few of the public peering points. Assume ISP A is a major provider with interconnections at all of the major peering points. Now let's say that ISP B only connects at MAE East and MAE West. If a customer of ISP B asks for data from a customer of ISP A located in Chicago, ISP A will have to carry those bits through San Francisco, even if ISP B has a presence in Chicago. This is not only inefficient, but ISP A resents the fact that if ISP B were bigger (i.e. had more peering points) that it would not have to carry these bits as far. The large ISPs have already taken a significant first step toward solving these problems. Through the use of what is known as private interconnect points, these vendors have created several 1-1 tunnels between each other's networks. Some people speculate that vendors such as MCI and AT&T (T, 35) may have as many as a hundred private interconnects between their two networks. When data passes between these two vendors, the public peering points never come into question. Moreover, data packets spend the majority of their time on the network of their own service provider, as each ISP can off-load packets to the alternate ISP at the earliest possible point. If you have not heard about private interconnect points, there is likely a reason. Out of fear of these arrangements being considered collusive by the public, the FCC, or the Justice department, most of these arrangements have been secured under NDA (non-disclosure agreement). As such, it is hard to find an executive that is willing to talk about them. Looking forward, we think the ISP world could change significantly. Once a player such as MCI can create private interconnect agreements with the five or ten largest ISPs, they could then abandon the public peering points altogether. This would obviously be a shocking move, but it would significantly improve the performance of the MCI backbone. Of course, this would isolate several smaller ISPs, their customers, and any content that was on those networks. However, MCI could simply state that these ISPs are not carrying their fair share of the backbone load and could encourage those ISPs to become customers of MCI. Once they became customers, they would then again have full access to the network, albeit with MCI in control of the cost of that access. Of course, we use MCI only as an example, as any of the larger ISPs could push forward similar action. Just in case you think this is all Oliver Stone-ish, we would like to provide you a quote from the prospectus of Digex (DIGX, 10 7/8) a smaller ISP which recently went public. "Although the company currently meets those requirements (regarding peering), there is no assurance that other national ISPs will maintain peering relationships with the Company. In addition, there may develop increasing requirements associated with maintaining peering with the major national ISPs with which the Company may have to comply." It is our impression that a major move such as the one speculated above would move us closer to usage based pricing. In such a world, more ISPs would become customers, allowing a few large players to dictate pricing. If you think that is interesting, we would like to leave you with one more thing to consider. We have heard from multiple sources that MTV (VIA, 35) conveyed to Netcom that it would need to pay $1 per customer per year, if Netcom wanted to ensure that Netcom customer's could access the MTV site. While we can certainly argue over whether or not MTV's site commands that much leverage, the idea of a content provider dictating access pricing is surely something new to think about. Above the Crowd is a bi-weekly publication focusing on the evolution and economics of the Internet. It is distributed through First Call, fax and email. To be placed on the distribution list contact your Deutsche Morgan Grenfell salesperson or send email to atc-request () abovethecrowd com with the word "subscribe" in the body. As always, feedback is both welcomed and encouraged. ABOVE THE CROWD is a service mark of J. William Gurley.
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