Economic study on IP interworking: Summary of findings

Paul Reynolds 3GSM World Congress 15 February 2007

Overview
The imminent migration to all-IP networks has raised a regulatory debate about appropriate IP interconnection charging models Key areas discussed: NGN all-IP networks create the potential for large efficiency and welfare gains IP interconnection arrangements are critical to realise these gains A number of policy implications flow from the analysis of IP interconnection

Economic study on the IP interworking: Summary of findings

Future NGN interconnect enables economic efficiency improvements over current arrangements
Todays IP interconnect
Best efforts quality Packets transported along multiple blind routes without regard for contents Packets can only be counted at network handoff points Interconnect pricing negotiated bilaterally at handoff, in isolation of retail pricing Unlike circuit switched services, no necessary link between retail charging model and interconnection model

Future NGN IP interconnect

Priority assigned by packet Quality of service (QoS) can be guaranteed, with different quality for different services Differential charging by priority Single party could provide virtual tunnel QoS path (e.g. IPX) for quality-critical services

LARGE ECONOMIC EFFICIENCY GAINS POSSIBLE BUT HOW CAN THEY BE CAPTURED?

VERDICT: INEFFICIENT
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Economic study on the IP interworking: Summary of findings

IP interconnection is a critical lever for efficiency

Interconnect fees have important market effects
They impact cost recovery, and hence investment & innovation incentives They impact retail prices, and hence consumer demand

IP interconnect therefore represents a critically important leverage point in improving efficiency, especially in capturing the potential gains enabled by NGNs
Simply transposing a partial version of the current (inefficient) IP interconnect arrangements into the NGN environment would be a massive lost opportunity, and would probably undermine the rationale for upgrading to NGN

Economic study on the IP interworking: Summary of findings

What is the efficient direction of interconnect payments?

The efficient direction of interconnect payments can be derived from two factors
The efficient retail pricing model Network costs
RETAIL PRICING MODEL

Efficient message Efficient message exchange exchange

Efficient allocation of Efficient allocation of charges among charges among customers customers Efficient direction of Efficient direction of interconnect fee interconnect fee

NETWORK COSTS

Cost distribution Cost distribution among networks among networks

Economic study on the IP interworking: Summary of findings

The efficient interconnect model can be deduced if the distribution of retail benefits and network costs are known

100% terminating network

Distribution of costs

IPNP
nt .I i. e er nn co

f ct e

ee

Deriving the efficient wholesale model from the retail model and network costs (assuming total cost of a message = total benefit)

K BA

100% originating network

RPNP
Distribution of benefits
100% initiating party 100% receiving party

Economic study on the IP interworking: Summary of findings

What happens if the wrong interconnection model is imposed?

If an inefficient model is imposed, services will not be provided to an efficient extent and costs may not be covered
Networks will seek to recover their costs by distorting their behaviour e.g. by targeting only low cost customers, changing network design decisions or by raising other prices These changes can lead to market outcomes that are far from efficient, including suboptimal network coverage and underinvestment in quality Ultimately service offerings may be limited (e.g. retail usage caps) and overall consumer benefits lower

Economic study on the IP interworking: Summary of findings

BAK is efficient in special circumstances only

BAK is only efficient under special conditions:
Where traffic is stable and balanced between peers (networks of similar size and cost) Where the distribution of costs among networks happens to align exactly with the distribution of benefits among retail customers

In most cases, BAK leads to market distortions and damages efficiency

By setting the interconnect price to zero, BAK requires a network to gain all of its revenues from its own retail customers, which usually leads to inefficiencies in retail pricing Because BAK is inflexible, it gives rise to network structure bias (the hot potato problem) and may lead to under-investment in quality and coverage of networks A rational firm will not provide transit services under a BAK pricing model

These inefficiencies are likely to be amplified in an all IP-world

QoS increases the costs that need to be covered by wholesale and retail revenues, leading to a larger cost gap if costs cannot be recovered This might prevent the introduction of QoS in any form

Economic study on the IP interworking: Summary of findings

IPNP can outperform BAK

IPNP will outperform BAK in most situations
The fee should not be locked in but should instead respond to market developments It is the model most commonly applied in telephony (already has wide consumer acceptance) For transit interconnection, it provides a means to cover transit costs that would otherwise be stranded by BAK

For the most part it encourages beneficial messages and discourages spam
Works well where the sender gains the most benefit Where the recipient gains the most benefit, repeated or returned calling patterns, or offline relationships, can sufficiently compensate so that beneficial messages are still sent

Economic study on the IP interworking: Summary of findings

RPNP can also outperform BAK

RPNP has the potential to outperform BAK on efficiency
Provided that the level of the fee responds to market developments For transit, RPNP provides a means to cover costs that would otherwise be stranded by BAK

However, if applied generally it would risk a massive growth in spam

The sending network and/or the sender would face zero costs, and the recipient may not be able to prevent the messages

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Economic study on the IP interworking: Summary of findings

There is no single best IP interconnect model; variety is necessary to optimise efficiency

Model
BAK

Advantages Apparently simple and low cost although requires monitoring of retail market conditions, operator costs and/or traffic balance

Disadvantages Leads to market distortions in most cases These are amplified in a QoS environment and when BAK is applied to transit

Implications Suitable only in limited situations (e.g. sustained traffic balance between peers) and is not flexible when circumstances change

IPNP

RPNP

Likely to perform well in many situations because it discourages spam but it does not significantly impede messages which benefit mostly the receiving party IPNP can provide efficient signals to operators RPNP can be efficient in particular circumstances and can adjust dynamically as conditions change

Regulators have been concerned in some cases that the level of termination charges may not be effectively constrained. Such concerns are likely to be less relevant in an all-IP world. Encourages spam

Likely to be the best performing model in most common situations

May be suitable in some situations, although dominated by IPNP in most cases

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Economic study on the IP interworking: Summary of findings

Policy conclusions
Proceed cautiously
Regulators should be very cautious in mandating IP interconnection charging models for the unfolding NGN IP environment This analysis shows that there is no justification for regulatory intervention to mandate a single IP interconnection model at this stage. It is too early to tell what model or models will prevail commercially Regulatory intervention to prescribe a particular model, such as BAK, is likely to be preemptive and risky

Dont mandate a single charging model

Even if a particular charging model develops commercial currency, it does not follow that this would be appropriate to mandate as it may inhibit the development of better models Evidence from the IP environment to date is that the industry can work out appropriate IP interconnection models without the need for ex ante regulatory intervention

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Economic study on the IP interworking: Summary of findings

Policy conclusions
(continued)
Dont assume bottlenecks will be replicated
The deployment of NGNs has the potential to change the way many services are delivered. A regulator should not assume that existing bottlenecks will be replicated

Use existing regulatory frameworks

Existing regulatory frameworks are generally sufficient to resolve problems should they arise (where they are telecom sector-specific and based on an objective assessment of market power and general competition powers)

Employ consumer welfare analysis

Should regulators feel a need to act, they should address the particular circumstances only When considering IP interconnection charging models that might be applied in any intervention, a clearly defined assessment framework that reflects the drivers of consumer welfare and broader economic efficiency should be employed

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Economic study on the IP interworking: Summary of findings

Economic Study on IP interworking: Summary of findings

Paul Reynolds CRA International 1 Undershaft London EC3A 8EE +44 (0)20 7664 3701 (ph) +44 (0)20 7664 3998 (fax) preynolds@crai.com

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Economic study on the IP interworking: Summary of findings