Level 3's de-peering of Cogent threatens the inter in Internet (fwd)

["David J. Farber" <dave () farber net>]

===== Forwarded message from Daniel Berninger <dan () tier1research com> =====

\From: Daniel Berninger <dan () tier1research com>
To: dave () farber net
Subject: Level 3's de-peering of Cogent threatens the inter in Internet
Date: Wed, 19 Oct 2005 18:26:57 -0400

Dave,

For IP if of interest.  The dispute between Level 3 and Cogent remains
unresolved with Level 3 planning to de-peer Cogent again on November 9,
2005.

Best regards,

Dan

............................................
Daniel Berninger
VP, Senior Analyst
Tier1 Research
v: 202.250.3838
e: dan () tier1research com
w: www.tier1research.com

> > > > > > > > > > > > > > > > > > > > > > > > > >

Level 3's de-peering of Cogent threatens the inter in Internet

The anti-competitive instinct that leaves the US a laggard in Internet
access arrived as a threat to the Internet backbone business with Level 3's
de-peering of Cogent on Wednesday, October 5, 2005.  Level 3's move against
Cogent marks an escalation of the tensions that threaten settlement free
peering.  It has the hallmarks of an anti-competitive strategy rather than
just a business decision about the merits of peering.  Businesses can
compete by improving the value proposition offered customers or they can
attempt to injure the ability of other businesses to make competing offers.
A wannabe monopolist accepts short term self injury as the price of reducing
competition and winning future monopoly profits.   Level 3's decision to
make at least 15% of the Internet unreachable did not improve the value
proposition it offers customers.

A world without settlement free peering is a world without an Internet.
Level 3's test of the restraint of trade option comes only six months before
SBC and Verizon come together with collective scale five times larger than
Level 3 and with far more experience in allocating markets.  The refusal to
interconnect has always represented the weapon of choice for companies
seeking reduce competition in the communication business.  AT&T used refusal
to interconnect to establish a monopoly over telephone service at the
beginning of the last century as did the Bell cartel at the beginning of
this century.  The antitrust remedy that led to the breakup of AT&T in 1984
arose to win interconnection for competing long distance companies.  The
story offered in Level 3's press release regarding Cogent comes straight out
of the monopolists handbook.  Level 3 disconnected Cogent to protect its
"investment" and end the "free ride" enjoyed by Cogent.

The increasing consolidation of Internet backbones inevitably brings out the
toll collecting instincts, but the move against Cogent was less about a size
and more about a disparity in business models.  Level 3 CEO Crowe
consistently laments the lack of pricing power during quarterly earnings
calls.  He seems to blame Cogent for this lack of pricing power, but he
should blame himself for debt and lavish spending on a network that prevent
him from remaining price competitive.  Punishing Cogent for keeping transit
prices low does not begin to solve Level 3's troubles.  Level 3 pays out in
interest 25% of every dollar in communication revenue, but the company would
still have a negative net income without interest payments.  Level 3 enjoys
an enterprise value equivalent to 75% of what Verizon plans to pay for MCI,
but MCI remains 10 times larger than Level 3 in communication revenue.
Level 3's problem remains the same as other backbones in the Internet access
bottlenecks that limit traffic growth.  Success in raising prices transit
prices will only reduce traffic volumes further.

The motivation for settlement free peering decreases as the disparity
between networks increases, but a concern for the long term health of the
Internet should remain a part of the decision making process.  Level 3's
toll collecting ambitions conflict with its embrace of companies like Skype
as the source of traffic to fill its network.  The promise of the Internet
depends on continuous cost performance improvements like every other area of
the info tech industry.  Level 3 benefits from cost performance improvements
in processing power, storage, Internet access, and everywhere else in the IT
value chain.  Any success Level 3 achieves in raising prices will throttle
the Internet's growth.  Rising costs will shrink the types of viable
applications and associated data traffic setting in motion a vicious cycle
where backbone companies will need to raise their prices still further.  The
replacement of settlement free peering with a toll collecting ethic means a
less connected and lower performing Internet.

Level 3's plan to raise backbone transport prices can't succeed by just
de-peering Cogent.  Level 3 needs SBC (AT&T) and Verizon (MCI) to de-peer
Cogent.  Qwest and Savvis (acquired C&W) look like the next most likely
candidates to lose their Tier 1 ISP credentials.  Level 3 might not even
make the cut if SBC and Verizon decide to embrace Sprint.  The smaller
backbones can use settlement free peering between each other to minimize
dependence on the Tier 1 cartel,  but Level 3's move against Cogent leads
inevitably to a period of arrested development.  The US government has
proven a friend of market power in the battles over Internet access.  A
cartel of US companies controlling the Internet backbone provides yet
another reason for the UN to assert a role in Internet governance.   If
Level 3 proceeds with the plan of de-peering again on November 9, 2005, they
should revise the empty sentiment of their "the network partner you can rely
on" motto.




===== End forwarded message =====

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