Economic study on IP interworking

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Prepared For: GSM Association 71 High Holborn London WC1V E6A United Kingdom

Economic study on IP

interworking

Prepared By:

Bridger Mitchell, Paul Paterson, Moya Dodd, Paul Reynolds, Astrid Jung of CRA International Peter Waters, Rob Nicholls, Elise Ball of Gilbert + Tobin

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EXECUTIVE SUMMARY

Telecommunications networks are on the verge of profound generational change. Century-old circuit-based networks are being replaced by packet-switched “next-generation networks” (NGNs) using Internet Protocols (IP). With quality of service parameters (QoS) built in, NGNs will be far more reliable than today’s IP-based public Internet, capable of delivering telephony, television, data and a plethora of new services at much lower marginal costs than would be possible on today’s networks. Large gains in efficiency and welfare will be possible; and if captured, they will be immensely valuable to society.

IP interconnect is a critical lever to achieving economic efficiency. The GSM Association (GSMA) has commissioned this study to consider the merits of various interconnect charging models, including the impact of particular models on investment, innovation, QoS and competition. And in particular, to consider the implications of a QoS environment where more sophisticated retail and interconnect services both enable and require more complex commercial arrangements.

Economically efficient interconnect (wholesale) charging depends on efficient retail charging. Given the large range of services that will be carried by QoS-enabled NGNs, a wide variety of retail pricing models will emerge. To be efficient, an associated variety of pricing models will be necessary at the wholesale level.

Consequently, there is no “one-size-fits-all” IP interconnect charging model that will deliver superior efficiency outcomes in all situations. Each model examined has different strengths and weaknesses, depending on the situation. Imposing a single model risks significant harm to efficiency and consumer welfare. Regulators should therefore proceed cautiously in recommending or favouring any particular model. Regulatory certainty can be achieved by issuing explicit assessment criteria – based on whether market outcomes would be advanced – rather than prescribing solutions to interconnect arrangements when the services to be carried and the networks over which they will be carried are undergoing significant change.

Large efficiency and welfare gains beckon

IP interconnection is not a new phenomenon – it underpins the public Internet today. But today’s IP-based networks are burdened with inefficiencies, and offer only “best-efforts” quality. They send each message as a series of packets, each bearing the destination address. These packets can take multiple, independent paths, carried by an indeterminate set of operators, and must be re-compiled at their destination into a coherent message.

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Interconnection arrangements in the public Internet are somewhat crude. Traffic is generally only measurable at the handoff points between each successive pair of networks. Pricing arrangements at each network handoff point are struck largely in isolation from each other and from the ultimate retail pricing models, resulting in a range of payment models: some sending networks pay to send, others receive a payment for sending packets, yet others treat interconnect as free. In an economically efficient world, the nature of customer demand would affect the structure and level of retail charges; and in turn, these retail services would be supported by an appropriate structure and level of wholesale interconnection charges. But currently, IP interconnection charges are largely determined by the tier status of operators and the balance of traffic flows between them, with no ability to attribute an appropriate value at the wholesale level to the contents of a particular packet or series of packets. This acts to inhibit the efficient recovery of costs. These inefficiencies are a direct result of the technical limitations of today’s Internet. But technological changes are transforming IP services and networks. Future NGNs (which will coexist alongside the public Internet) will be able to carry packets at a specified quality level (or QoS). This will have far-reaching consequences for both the retail services that can be offered, and the interconnect services that will be enabled and required. Multiple services will be simultaneously provided with differential, guaranteed service levels1_{. Packets with different quality settings will be able to be differently priced.}

This brings with it the ability to enhance consumer welfare by matching the type and quality of services demanded by consumers with the supply of these services in a least cost manner, or by giving consumers the ability to select the level of service for which they are willing to pay. For example, voice over Internet Protocol (VoIP) services could be delivered using a high-priority network “path” to ensure call clarity, while email services could use a cheap, low-priority path.

The requirements of end-to-end QoS will fundamentally change how IP networks interconnect. Current IP interconnection does not have to distinguish between different classes of traffic. But NGN networks will enable a model where one party takes responsibility for establishing a “QoS path”, maintaining the right quality level through the various networks between the sender and receiver. This model is consistent with the IPX arrangements being considered by the GSMA.

1 The International Telecommunications Union defines an NGN as “a packet-based network able to provide services, including telecommunications services, able to make use of multiple broadband, QoS-enabled transport technologies, and in which service-related functions are independent from underlying transport-related technologies. It offers unrestricted access by users to different service providers. It supports generalised mobility, which will allow consistent and ubiquitous provision of services to users.”

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Interconnect charging arrangements will need to evolve considerably from today’s models in order to support QoS. The network resources consumed will vary with the quality of service required, and these costs must be taken into account in interconnect arrangements if the cost burden is to be appropriately shared between operators and their respective customers. Further, because NGNs permit more centralised control over messages, interconnect charges can be set in light of a coherent view of the end-to-end service, including who pays the retail charges. As a result, the interconnection model can be firmly linked to the retail charging model, and where appropriate, applied end-to-end (instead of each segment applying its own model).

The current “best efforts” interconnection model may continue to apply to retail services for which QoS is not required. But, as we explain in more detail below, to simply transpose these models into the NGN world would stifle the development of more efficient models, and prevent efficiencies from being full realised.

Relatively few network operators have yet committed to full NGN upgrades. Typically, core networks are upgraded, with upgrades to the access networks to follow at some future point. Services to take advantage of QoS-based end-to-end IP are still being comprehended and developed – with supporting wholesale and retail commercial models as yet uncertain. But the imminent migration of services to NGNs, and the enormous potential for gains to society, have already sparked a regulatory and intellectual debate about the charging model that should be applied to IP interconnection.

Capturing gains by efficient IP interconnect

The key IP interconnect models under debate are examined in this report. They operate on a continuum of who pays whom for the delivery of a message (a phone call, SMS, MMS, IM, email or a download of a data file, streaming video or a web page). At one end, the initiating party’s network pays (IPNP) for termination on the destination network; at the other end of the continuum, the initiating party is paid by the receiving network for having originated the message (RPNP). At a midpoint between them is a model known as bill-and-keep (BAK) where no interconnect payment is made at all. A variant of IPNP and RPNP is known as “settlement-based interconnection” (SBI) where the packets in each direction are offset before payment is made. Transit interconnection arrangements (where an intermediate network takes the message part of the way between the originating and the terminating network) can be classified along similar lines, depending on which network pays for transit.

An assessment of these alternative interconnection charging models should be based on criteria of economic efficiency, because efficiency is a precondition to maximising welfare. In most practical circumstances, consumer welfare is also enhanced by increasing efficiency. With efficiency gains, prices fall, quality improves (to the extent consumers are willing to pay for it), costs are recovered (so investment incentives are preserved), and all messages carried have a value that is no lower than the cost of delivering them.

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Economic efficiency is defined as the best use of resources (allocative efficiency), least cost production (productive efficiency) and incentives for innovation and investment (dynamic efficiency). These dimensions of efficiency can conflict so that determining the optimal charging model may requiring balancing differing impacts.

In this report, we develop the thesis that efficient interconnect pricing can only be derived in light of the efficient retail pricing arrangements, and an understanding of the costs incurred by each network (with some very specific exceptions).

Understanding the efficient retail prices for messages brings some special challenges, because (unlike many services) messages are jointly consumed by sender and receiver. Efficient retail prices, as well as interconnection fees, must therefore serve the role of optimally distributing the charges paid by two types of end customers (in addition to the other economic roles of pricing, such as ensuring that costs are recovered with minimal distortions to demand).

Hence, the economic role of interconnection fees is to encourage the originating and terminating networks to charge their retail customers in a way that ensures that the retail prices faced by each customer sends signals for efficient consumption of messages. If this is achieved, messages will only be initiated if they are efficient - that is, if their aggregate value to both customers exceeds the total costs of service provision.

For these reasons, the efficient wholesale pricing model cannot be identified in isolation from the efficient retail charges. In an NGN world, QoS-based interconnection enables this link to be established (similar to that which exists in the telephony world today between wholesale and retail pricing). This is because the technical limitations of today’s IP interconnect – such as the lack of central control or billing information – will be overcome by more sophisticated arrangements that support the requirements for guaranteed QoS priorities. Retail services that promise a particular QoS (e.g. VoIP) will be backed up by wholesale deals that deliver on that promise and charge accordingly. Because of this close link between wholesale and retail charges in a future QoS environment, it is not possible to say that one particular interconnect model will always meet efficiency criteria better than another interconnect model. The large range of services that will be carried by QoS-enabled NGNs, and the wide variety of retail pricing models employed, will need to be linked to a similarly wide variety of pricing models at the wholesale level. As a result, there is no “one-size-fits-all” interconnect model that is most efficient in all situations. Indeed, it is likely to be most efficient to employ a range of different IP interconnect models, co-existing for different networks, customers or other situations.

It follows that consumer welfare will be harmed if an inefficient interconnect model is imposed (e.g. by a regulator mandating that a perceived ‘winning’ model be applied across the board). Services may not be provided to their fully optimal extent; investment incentives can be damaged; and innovation stifled at both retail and wholesale levels. In other words, inefficient IP interconnect could inhibit the realisation of many of the anticipated benefits of NGNs, with potentially very large efficiency and welfare gains simply “left on the table”.

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Examining particular interconnect models

A significant part of the public regulatory debate has been devoted to the question of whether BAK2_{is a more efficient charging model for interconnection than alternative}

approaches, and whether it should be imposed as a charging model in at least some interconnection situations. Based in part on the incorrect assumption that BAK is the predominant charging model in the current Internet environment, the argument has been made that as other services and networks converge to an IP standard, BAK could (or should) become the prevailing interconnection pricing model of the future.

Indeed, we find that BAK is only efficient under a limited set of specific circumstances. These are:

• where traffic is evenly balanced between peers (that is, networks with similar traffic levels and geographical diversity), and cannot be taken out of balance by strategic behaviour (in this situation all models would yield the same interconnect fee as BAK, that is, zero); or

• where traffic is stable but not evenly balanced and where the imbalance in traffic generates benefits to the different end-customers that just coincide with the costs incurred by each customer’s network.

In situations where traffic is not balanced and operators can avoid costs (e.g. by ‘hot potato routing’ whereby traffic is handed over as close as possible to a network’s own retail customers)3_{the introduction of a zero-fee BAK model tends to distort the operators’}

incentives to provide interconnection services, even in the retail situation specified above. This is because the inherent inflexibility of interconnection fees under BAK (they are always equal to zero) invites strategic behaviour in order to reduce costs. This incentive would lead to widespread distortions - likely to be amplified in the context of QoS provision - at the expense of consumers. BAK’s inflexibility is also likely to impede the development of QoS-based interconnect, as would occur where terminating networks would require a higher price for terminating a service at a higher quality.

For transit interconnection, some applications of BAK (e.g. in a chain of transit providers) raise even greater problems as they leave no prospect of cost recovery for transit providers and will therefore discourage the provision of transit services.

2 While the terms bill and keep and settlement-based interconnection are sometimes used interchangeably, there is an important difference between BAK and settlement-based interconnection. Settlement-based

interconnection involves an offset of traffic in each direction so that the operator sending more traffic pays for the net imbalance. BAK involves no payment for interconnection in either direction, irrespective of whether the traffic is in balance or not. See our discussion on this point in Appendix A.

3 The practical effect of hot potato routing is that a network uses the network of other operators to avoid both the cost of building its own backbone capacity or acquiring transit services from another operator who provides that

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The problems resulting from applying BAK in the wrong situations can also arise where IPNP (or RPNP) is applied using a particular interconnection charge that is far from the efficient charge for that situation. Further, as with BAK, where the level of interconnection charge is held constant, despite market developments, there would also be a risk that operators would engage in strategic behaviour to minimise costs.

Thus, a general advantage of IPNP and RPNP is simply that they encompass a range of interconnection charges compared with BAK (which implies an interconnect charge of precisely zero). Accordingly, as general charging models they are more likely to be able to accommodate the range of interconnection charges that are efficient in particular situations. Whether a particular level of interconnection charge is efficient will depend on factors such as how retail customers share in message benefits, whether there are means by which they can reward each other for initiating useful messages, and their respective networks’ costs.

In many circumstances, IPNP is likely to be efficient. For a significant share of messages, the initiating party will be the primary beneficiary and IPNP facilitates those messages being transported. While there will also be a large share of messages in which both parties benefit, IPNP can nonetheless support efficient message exchange through repeated calling arrangements and/or compensation arrangements. IPNP also has the property of discouraging unsolicited messages (spam) better than any other model by imposing an economic cost on the network of the customer originating the spam. It helps to limit the volume of spam through raising the cost of sending messages. IPNP can lead to termination charges that contribute to not only the cost of the individual message but also to the receiving party’s general cost of being connected. This provides a means to efficiently internalise subscriber externalities.

On the other hand, concerns have been raised that IPNP creates a termination monopoly that results in protracted regulatory inquiries into determining the efficient level of termination charges. Any market power in relation to the setting of termination charges is likely to diminish in an IP world, taking into account that there can be a large number of paths between IP addresses and that content can be multi-homed. Moreover, even where it is considered necessary for a regulator to continue to be involved in the setting of termination charges, this would involve a relatively small welfare cost compared with mandating a zero termination charge in situations where efficiency requires a significant positive termination charge. The welfare costs of mandating the wrong interconnection model across the industry are likely to greatly exceed any administrative savings from the simplicity of BAK.

We also find that there are likely to be other specific situations where RPNP will be appropriate. In particular RPNP facilitates messages being sent which primarily benefit the receiver and which may otherwise not occur under BAK or IPNP.

Policy conclusions

Based on our analysis, we have drawn the following regulatory and policy implications for IP interconnection:

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• Proceed cautiously: Regulators should be very cautious in mandating IP

interconnection charging models for the unfolding NGN IP environment. While regulators may be called upon to determine interconnection arrangements in particular circumstances, at this stage there is no justification for regulatory intervention to mandate a single IP interconnection model. It is too early to tell what model or models will prevail commercially and regulatory intervention to prescribe a particular model, such as BAK, is likely to be pre-emptive and risky.

• Don’t mandate a single charging model. Even if a particular charging model develops

considerable commercial currency, it does not follow that this model would be an appropriate “one-size-fits-all” model for regulators to mandate. Adopting the ‘wrong’ interconnection model in inappropriate circumstances will lead to significant market distortions, which ultimately reduces consumer benefit. The evidence is that the industry is working out appropriate IP interconnection models that correspond to the variety of market circumstances in the absence of ex ante regulatory intervention. Hence, mandating particular interconnection charging arrangements in the current environment may inhibit the development of inherently more effective and efficient IP operating models. It is useful to note that global connectivity was achieved for the current internet without regulatory intervention.

• Don’t 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 currently perceived bottlenecks (which in places have led to termination regulation as well as any-to-any connectivity requirements) will be replicated in an NGN environment.

• Use existing regulatory frameworks. In any event, existing regulatory frameworks

based on objective tests of market power are likely to be adequate to resolve problems should they arise. Current sector-specific and competition powers exist which permit regulators to intervene if bottlenecks emerge in IP Interconnection. For example, some potential upstream bottlenecks in the access network are already addressed through requiring the wholesaling of unbundled local loops and bitstream services.

• Employ consumer welfare analysis. However, in circumstances where regulators

identify market failure or are requested to resolve disputes, their intervention should be applied only as broadly as necessary to solve the problem. Regulators should therefore not identify a single charging model that would be the ‘fall-back’ option, but rather should employ a clearly defined assessment framework that appropriately reflects the drivers of consumer welfare and broader economic efficiency.

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1. INTRODUCTION

1.1. A

IM AND SCOPE

IP-based NGNs are being developed and deployed by a wide range of

telecommunications network operators to complement or replace existing circuit switched networks. As a result, the subject of IP interconnection is receiving increasing regulatory attention in Europe, at the European and Member State level, and in other regions.4

The mobile industry has taken a leading role in the development of NGNs. The IP Multimedia Subsystem (IMS) core architecture around which NGNs are being designed was originally developed as part of GSM standards. The GSMA and its members are currently developing network, operational and commercial models for IP interconnection (called the IPX).

These developments have led GSMA to commission CRA International and Gilbert + Tobin to undertake this study to:

• consider the key issues arising out of current regulatory debate about IP interconnection, focussing particularly on interconnection charging principles; • evaluate the advantages and disadvantages of various interconnection and service

charging models that could be employed in the market;

• consider the impact that particular interconnection models may have on

investment, innovation, quality of service and competition in the mobile industry; • assess the implications if regulators were to enforce a “one-size-fits-all” approach

to IP interconnection; and

• consider how the European regulatory framework can foster the development of efficient and competitive IP interconnection technology and its use in the provision of a range of services across the mobile, fixed telecommunications and Internet industries.

4 The European Regulator’s group has issued a consultation document on IP interconnection, See ERG Project Team on IP Interconnection and NGN, Consultation Document on IP Interconnection, ERG (06) 42, available at: http://erg.eu.int/doc/publications/erg_06_42_consult_doc_ip_interconnection_rev.pdf; the German regulator has set up an advisory group on the subject of IP interconnection and has commissioned a number of reports; Ofcom’s consultations on NGNs and its telecommunications strategic review consider issues relevant to NGN interconnection; and the Hong Kong regulator has issued a consultation on fixed to mobile convergence which focuses on interconnection charging models.

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1.2. S

TRUCTURE OF THE REPORT

A description of the basic concepts of interconnection in the telephony environment and in the internet environment is set out in Appendix A. In that Appendix we also consider the interconnection models currently used in the provision of telecommunications services. We describe the way in which messages5_{are routed across networks using Internet}

Protocol and how individual Internet Protocol networks interconnect together to form the internet. We also consider the aspects of network management that differ between fixed and mobile environments.

Section 2 introduces the technology of Internet Protocol networks by using traditional circuit switched networks as a reference point to describe how data is transmitted in digital form using packet switching.

Section 3 describes current IP interconnection models and how these models developed within the technical and operational constraints of the current internet.

Section 4 considers future technological changes in the IP environment, which will narrow the differences between switched and fixed networks, without introducing switched network architecture on IP networks. These impending changes include the ability to provide retail and wholesale services with different quality of service and to establish cascading charging relationships at the interconnection level. A more detailed analysis of the technical requirements for implementing quality of service parameters in an IP

environment is also set out in Appendix A.

Section 5 sets out the economic framework for determining efficient interconnection models.

Section 6 then uses this framework to assess and compare of alternative charging models (BAK, IPNP, RPNP, settlement-based interconnection).

Section 7 considers the policy implications arising from our analysis.

5 Throughout this report we use the term “message” in a broad sense. A message can, for example, be a phone call, SMS, MMS, instant message (IM), email or a download of a data file, streaming video or a web page. While the various types of messages differ in important aspects, all messages included in our definition can be described as a flow of data between the party that initiates the message and another party, which can be

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2. IP INTERCONNECTION IN THE CURRENT PUBLIC

INTERNET

2.1. I

NTRODUCTION

This section lays the foundation for the next chapter, which discusses IP interconnection pricing principles. In this section we:

• provide an overview of the key differences between circuit switching and packet switching;

• describe how individual Internet Protocol networks interconnect together to form the internet; and

• address some key aspects in relation to the concept of any-to-any connectivity. As further background to this section, Appendix A contains a description of how: • traditional circuit switch works to provide a reference point for the transmission of

information in digital form;

• information is transmitted in digital form using packet switching compared to traditional circuit switching; and

• the internet functions and the way in which messages are routed across it using Internet Protocol.

2.1.1. Implications of packet switching and circuit switching

From our discussion of circuit switching and packet switching in Appendix A, we can draw three key distinctions between circuit switched networks and packet switched networks. These are summarised in Table 1 below.

Table 1: Comparison of key features

Issue Circuit switched Packet switched

Path Single path established for the duration of a session or call

Multipath with variable paths for each packet

Signalling system Connection-oriented system with signalling network providing central control and billing information

Connectionless system with no central control and no central generation of billing information

Network interconnection knowledge

Central control by signalling system requires that all networks used for the call are known to the originating and terminating parties’ networks and have a commercial agreement to

interconnect

Network partners are not known, other than the possible next network along a packet’s pathway

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These three crucial distinctions are discussed in Appendix A and in section 3.6 as part of the analysis of the differences in interconnection of IP networks and circuit switched networks.

2.2. I

NTERCONNECTING

IP

NETWORKS

As the internet is comprised of so many networks, interconnection arrangements are fundamental to its success.

Networks comprising the internet may interconnect either:

• directly with each other (often called peering, at least where it occurs between similar sized networks). In turn, direct interconnection may be achieved over a private peering link or by public peering; or

• indirectly with each other by transiting one or more intermediate networks (called transit).

2.2.1. Direct interconnection

Where networks directly interconnect, they generally use a border gateway protocol (BGP), and in these circumstances it is an exterior Border Gateway Protocol (eBGP). The eBGP is a routing protocol used on the edge of autonomous systems (AS). It calculates loop-free (or direct) paths across the internet by tracking the path in terms of which AS it passes through. However, it does not track the “route” through individual routers within an AS. To use eBGP, an operator must have a router that supports BGP and a registered public AS number.

Routes learned via BGP use associated properties to determine the best route to a destination. These properties are referred to as BGP attributes, and are used in the route selection process.

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Private peering involves the two networks establishing a dedicated link between their two networks (see Figure 1). Public peering involves more than two operators connecting at a public peering point. Operators connecting at a public peering point are connected by a shared transmission network (see Figure 2).

Figure 2 – Public peering

The advantage of private peering over public peering is that the two privately peered operators are in a better position to agree on capacity upgrades needed on the link to avoid congestion, compared with multiple operators that interconnect at a public peering point.

2.2.2. Indirect interconnection

As there are so many networks comprising the internet, it is impractical for networks to directly interconnect with each other. As a result, larger networks may choose to offer a “transit service”. This is a service for the delivery of packets across a network to IP addresses which that network can “see”. A transit service provider configures the routing table of the BGP router to advertise the IP addresses of the network to which it is

interconnected.

As set out in Figure 3 below, Network 4 has elected to be a transit network. It advertises routes to Network 1, which include the IP addresses on Network 4 as well as the IP addresses on Network 2. This means that Network 1 can “see” the IP addresses on Network 2 and does not need to directly connect to Network 2 or enter into a commercial arrangement with Network 2. On the other hand, Network 3 only advertises the IP addresses on its own network to each of Network 1 and Network 2. Network 3 does not offer a transit service.

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Figure 3 – IP transit

2.3. A

NY

-

TO

-

ANY CONNECTIVITY

The internet permits any-to-any connectivity using IP addresses to locate internet users from time to time. The domain name server system provides for word-based addressing (for example, email addresses and web addresses), rather than users having to

remember large numbers of IP addresses. However, it is important to recognise that any-to-any connectivity does not require direct interconnection. The multipath nature of the internet means that any-to-any connectivity can be achieved without a requirement for direct interconnection of any particular pair of networks. That is, a combination of direct interconnection and transit achieves any-to-any connectivity.

Further, any-to-any connectivity does not create a terminating access bottleneck in the same way that this occurs in fixed line networks. There are four reasons why there is not a bottleneck problem:

• in relation to content, much content is either multi homed (that is, there is connection between the web server and more than one IP network connected to the internet) or the content is “mirrored” (that is, the content is stored in more than one place and each web server is connected to a different IP network);

• the multipath nature of the internet means that there are a large number of potential paths between individual IP addresses. Although ultimately each address is associated with a single network, the multipath routing means that leveraging termination is practically impossible;

• as set out in the next section, the basic charging model of the internet is pay to download. This means that a significant change in internet charging would be required in order to benefit from any ability to leverage termination; and

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• the users of the internet are not restricted to using any one IP network provider to access services. This nomadicity contrasts with fixed line telephones and means that users can access applications regardless of their IP address from time to time.

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3. INTERCONNECTION PRICING MODELS IN CURRENT

INTERNET

In this section we set out the pricing models currently used in the IP interconnection arrangements for providing internet services. We begin by describing the hierarchy of internet access providers (IAPs) and internet service providers (ISPs) that exists in the internet environment. We then set out the different interconnection pricing arrangements between each of the participants in the internet value chain and illustrate how these arrangements come into play to illustrate how costs are likely to be allocated for a particular internet session.

3.1. O

PERATOR HIERARCHY WITHIN THE INTERNET

The internet is characterised by an informal hierarchy of operators. While the technical and operational arrangements for interconnection are reasonably standardised across the internet, the commercial arrangements between two operators will depend on where each of them falls within that hierarchy.

As a result, the direction of interconnection payments can switch as packets move along the path to their destination.

The hierarchy of internet operators is set out in Figure 4. This hierarchy is described by reference to tiers of operators:

• Tier 1 IAPs – Tier 1 IAPs (sometimes known as “backbone operators”) are large telecommunications operators which have internet networks covering large

geographic areas (countries, regions or the globe) and have significant numbers of points of presence (PoPs). Tier 1 IAPs interconnect with all other Tier 1 network operators and do not use transit providers.

• Tier 2 ISPs – Tier 2 ISPs host some content and may have peering arrangements in place with other Tier 2 ISPs. They usually have some network of their own, although limited to a geographic region (e.g. the east coast of the USA) and they all rely on purchasing some level of transit from Tier 1 IAPs to exchange messages with out of region networks and content providers.

• Tier 3 ISPs – Tier 3 ISPs are purely re-sellers of internet access services, they provide retail services to end customers but do not provide any wholesale internet services. Tier 3 ISPs rely solely on interconnection arrangements to provide internet services. They purchase transit from Tier 2 ISPs.

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Page 16 Figure 4 – The hierarchy of the Internet

Retail customers purchase internet services from ISPs who may sit at any level in the tiered hierarchy.

Each operator sets the criteria by which it will assess whether another operator requesting interconnection is a peer. It does this in interconnection and wholesale

arrangements. However, the peer criteria set by individual operators at each level in each country tend to coincide.

The three main criteria that determine peer status, particularly at the Tier 1 level, are: • volume of traffic to be exchanged;

• geographic reach of network and number of PoPs; and • backbone capacity.

Equivalence of traffic volume is not considered enough to treat operators as peers. A regional operator in an urbanised area may have an equivalent volume of traffic to an operator with a nationwide network, but if the two were treated as peers, the regional operator would get access to nationwide transport for no or low charges.

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IP networks, which are directly connected, are not necessarily in the same tier. For example, a Tier 2 ISP may directly connect to a Tier 1 IAP. However, this does not elevate the Tier 2 ISP to Tier 1. All Tier 1 IAPs are directly connected to each other. Separate hierarchies exist at sub-national, national, regional and global levels. Separate hierarchies will exist within each country for domestic originated traffic to domestic hosted content. However, for domestic originated content to content hosted in other countries, which requires global internet connectivity, the national operators will interconnect within a different hierarchy covering a larger part of the internet. An operator may be regarded as a Tier 1 IAP in its own country but be considered a Tier 2 ISP within a regional or global hierarchy.

3.2. B

ASIS OF CHARGING

In principle, there are three potential bases for charging for IP based interconnection: • per port – which is a “take or pay” type of interconnection where the interconnection

bandwidth is agreed and the traffic actually transported is not counted;

• per packet – where the port is dimensioned to be greater than the forecast traffic requirements and the packets which pass through the port are counted; and • a combination of per port and per packet.

3.3. I

NTERNET PRICING MODELS FOR DIRECT INTERCONNECTION

The fundamental pricing principle at play in the current public internet environment is ”pay to download”.

An important difference to interconnection in circuit switched networks is that ”receiving” refers to packets of data in the internet, whereas it refers to a message in circuit switched networks. Accordingly, for the purposes of the following discussion:

• “receiving network” refers to each network that pays to receive a packet from the immediately preceding network along the path of a packet through the internet, and not to the final network which connects the end user or content server receiving the message; and

• “initiating network” (as in IPNP) refers to each network that pays to send a packet to the next network along a packet’s pathway, and not to the network connecting the end user or content server which sent the message.

As a packet moves forward along the path to its destination, each network that receives data is charged as illustrated in Figure 5.

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Page 18 Figure 5 – Receiving Party Network Pays

As we discuss below, the RPNP model is then overlaid with different approaches, which apply to packets travelling in the reverse direction between the same two operators, so that:

• between some pairs of operators, a settlement-based model is used to offset the packets in both directions (usually with an “out of balance” buffer before offset payments apply);

• between other operators, one operator, as well as paying to receive, also pays to send in the reverse direction (that is, pays to download and upload); and

• in most cases, regardless of the direction in which the packets are being sent, if those packets transit over multiple networks, transit will be paid for.

3.3.1. Interconnection between Tier 1 IAPs

The pricing arrangement between interconnected Tier 1 IAPs is usually settlement-based direct interconnection. Although not entirely accurate, the pricing model applied between interconnecting Tier 1 IAPs is often referred to as “settlement-free interconnection” on the basis that it usually involves no payment by either party.

The earliest forms of interconnection between Tier 1 IAPs used BAK pricing, because it was considered too hard to measure whether traffic was in fact balanced. As discussed in Appendix A, “true” BAK involves no payments in either direction, regardless of whether traffic is out of balance.

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Current pricing arrangements between Tier 1 IAPs rely on a measurement of the balance of traffic between the interconnecting Tier 1 IAPs. This is done by smart routers between the interconnected parties, which measure the amount of traffic flowing between the two IAPs per minute. The data is compared at the 95th_{percentile of results, to allow for}

spikes in traffic flow. The per minute data is then aggregated over a calendar month and traffic is considered to be balanced, if the total traffic flows to each IAP from the other IAP are equal or within 5% of each other. If traffic is balanced, then no party pays for

interconnection with the other party. If, however, traffic is not balanced, then the IAP that has downloaded more data from the other IAP pays an amount to cover the cost of the additional data downloaded, over and above what would otherwise have been a balanced amount. The interconnecting Tier 1 IAPs also often agree that an additional buffer to allow for an imbalance of more than 5% before payment will be required.

Effectively the payment obligations between the Tier 1 IAPs are still offset against each other and payments are only made for the traffic imbalance between the two Tier 1 networks. This charging model is illustrated in Figure 6 below.

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Page 20 Figure 6 - Settlement-based interconnection where imbalance is offset

3.3.2. Interconnection between Tier 1 IAPs and Tier 2 ISPs

In interconnection arrangements between Tier 1 IAPs and Tier 2 ISPs, the Tier 2 ISP will be able to offset the charge it would otherwise have recovered from the Tier 1 IAP (for uploading to the Tier 1 IAP) against the amount it must pay the Tier 1 ISP. This is in effect the same concept of offsetting payments based on imbalances in traffic as is applied to interconnecting Tier 1 parties. However the difference is that traffic is measured by counting all bytes, not just any imbalance at the 95th percentile, and no buffer for differences in traffic flow is applied.

In this scenario, an incentive therefore exists, for Tier 2 ISPs to host popular (and therefore valuable) content. The more users the Tier 2 ISP can attract to content hosted on its own network, the cheaper the cost of interconnecting with the Tier 1 IAP becomes. This, in turn, assists the Tier 1 operator to achieve balance with other Tier 1 IAPs.

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Figure 7 - Tier 1 and Tier 2 interconnection

3.3.3. Interconnection between Tier 2 and Tier 3 ISPs

As between Tier 2 and Tier 3 ISPs, the Tier 3 ISP will always pay for data it downloads from the Tier 2 ISP. This is the case regardless of the amount of traffic flow, although data flowing from the Tier 2 ISP to the Tier 3 ISP is always likely to exceed traffic flowing in the other direction, given that the Tier 3 ISP has no content to host, and merely sends retail customer requests for data or applications. For this reason, a Tier 3 ISP has no opportunity to offset charges for any data it uploads to the Tier 2 ISP, against its charges for downloading from the Tier 2 ISP. However, in the traditional internet environment, the Tier 3 ISP usually recovers the entire retail charge for the service from the retail

customer.

3.3.4. Initiating Party Network Pays (IPNP)

The IPNP model involves a payment from the network of a party that initiates a message to the network of the receiving party. The IPNP model is illustrated in Figure 8 below.

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Page 22 Figure 8 - Initiating Party Network Pays to Send

This interconnection model is only used in the traditional internet wholesale

interconnection environment in the case where a Tier 3 ISP uploads data to a Tier 2 ISP. However, this model is widely used in data messaging on mobile. In the mobile context, this model is usually linked to the retail charging model. The initiating party’s network will pay for interconnection services from the other networks over which a message passes to reach its destination. This IPNP model also resembles the standard termination model that applies in the fixed network and between fixed and mobile networks in most countries.

This model tends to apply between backbone network providers and ISPs providing the retail internet access service to end users. This model also tends to be used for interconnection between content providers or content farms and internet backbone providers. The content providers usually pay a flat capacity charge to connect to the IAP’s network.

3.4. W

HO PAYS FOR TRANSIT

?

Transit interconnection is required when packets traverse one network, in order to reach an IP address hosted on another network. Traditionally, transit providers have been paid by the sending network. Where there is a chain of transit networks, each network will pay the next network down the chain.

Settlement-based interconnection and settlement-free interconnection are not widely applied in the context of transit. Transit will usually be charged even between operators that regard themselves as peers (although some of the largest Tier 1 operators may also provide domestic transit on a settlement-free basis). International transit is usually charged, particularly for transit to the US, given the costs operators face in provisioning international capacity to allow access to US content (which continues to account for most content on the internet).

The transit network is providing a wholesale IP carriage service. Specialist backbone providers supply transit services to connect retail ISPs or regional IAPs to content providers or to other networks.

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3.4.1. Multiple charging models applied in a single internet session

While an end user is engaged in a single internet session, such as browsing the internet, packets will be flowing in both directions. When the end user clicks on a web link, outbound packets will be sent to the IP address and inbound packets will bring back the content to display the web page on the end user’s screen. This process occurs as a series of, what can be referred to as, hops between ISPs and ASPs and is outlined in Figure 9.

Figure 9 - Paths across multiple operators

It is in this scenario that all of the traditional internet interconnection pricing models come into play at different stages of the process. Figure 10 further illustrates this point.

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Page 24 Figure 10 - Current internet charging models

From this diagram it can be seen that the interconnection charging arrangements apply separately to the outbound and inbound streams. The red arrows show the flow of data that is sent when the retail customer clicks to download content from a particular source. The click, being an instruction to send data back to the customer, is itself data consisting of a minimal number of bytes that must be sent to the content source requesting delivery of the content. The blue arrows show the flow of data that is sent in response to the retail customer’s request. That is, the blue arrows indicate the path of the bytes of data

containing the content that the user requested. This will be a larger amount of data than the original request. While in this specific session this is likely to cause a traffic

imbalance, generally, balancing is done on an aggregate basis. However, this scenario illustrates how traffic imbalances occur if multiple transactions of this type occur regularly. The direction of interconnection payments also will change as a packet moves up one side and down the other side of the internet hierarchy, as depicted in Figure 5 and Figure 8. This is illustrated in Figure 11 for an instruction packet from an end user to a content server.

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Figure 11 - Payments for a data request in a packet switched environment

This is in contrast to the circuit switched environment, in which, once the retail provider is identified, interconnection payments all flow back in the one direction up the chain of interconnected networks to the retail provider, as illustrated in Figure 12. The illustration is based on an initiating party pays (IPP) model. In a receiving party pays (RPP) model, the flow of payments would be in precisely the opposite direction.

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3.5. W

HAT IS PAID FOR

?

Where a charge is payable for either interconnection between the originating and the terminating network or for transit, it may be calculated in a number of different ways.6

The charge may be on a per packet basis, which results in a traffic-sensitive payment. Alternatively, the payment may be a capacity fee, usually expressed as a port fee, which in effect is a “take or pay” arrangement. The interconnection fee also may be volume based.

3.6. C

URRENT TECHNOLOGY SHAPES INTERCONNECTION CHARGING MODELS

Applications of settlement-free interconnection (BAK) between the originating and the terminating network were mainly driven by the technical limitations of the current IP environment (that is, the internet a decade ago), because early interconnected networks were operated by research and academic institutions which had no billing systems. As a result, there was no demand for router manufacturers to facilitate counting of exchanged packets. Further limitations include:

• as the terminating network is only undertaking to deliver packets on a best efforts basis, the initiating network is reluctant to pay for a packet that may never be delivered or is delivered late;

• as the packets comprising a single message are routed over multiple paths, sending charging records back to the sending operator would be a complex exercise;

• as the pathway for packets is not set up in advance, the sending or receiving network will not necessarily know which other networks will be involved in providing interconnection services;

• as the internet only provides for a best efforts service quality, interconnection

charging would involve paying for packets which may be dropped or delayed. TCP/IP will make several attempts to resend failed packets and BAK means that operators do not pay multiple interconnection charges fro delivery of the same message content;7_and

• the internet is not capable of identifying the origin of packets or billing back up the chain to the originating operator or down the chain to the receiving operator.

6 The regulatory discussion often compares settlement-free interconnection (BAK) to “calling party network pays”, where two regulated versions of the latter model are considered: Element Based Charging (EBC) and Capacity Based Charging (CBC). Both EBC and CBC are based on cost-based charging. In commercially negotiated CPNP agreements, the parties are of course not constrained to use cost-based EBC or CBC.

7 As a practical matter, modern routers (even state of the art routers) count all packets exchanged between interconnected networks and do not differentiate between packets being sent for the first time and those being resent because of a failed attempt.

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Our discussion in Appendix A sets out some of the differences between circuit switching and packet switching.

Table 2 further summarises the differences between circuit switched and packet switched environments, which are key to understanding the differences in retail and wholesale services provided in each and to understanding the business models that underpin these services:

Table 2: Differences between circuit switched networks and packet switched networks

Circuit switched Packet switched

Retail charging model

Mainly initiating party pays, with some countries using receiving party pays for specialist fixed calls (e.g. 800). Receiving party pays applies to calls to mobiles in some markets

End user usually pays to upload (initiating party pays) and pays to download (receiving party pays).

Basis of retail charging

Each discrete ”session” by an end user, in the form of a call or SMS, is charged separately.

• End users charged on total volume of packets (e.g. megabytes) over a period of time, regardless of individual sessions.

• Some shift to session-based charging (e.g. rate per 30 minute usage period).

Type of interconnection

Direct interconnect with indirect interconnection/transit most limited to international services

Direct interconnection between peers but also substantial use of indirect

interconnect/transit as it is not feasible for the vast number of networks composing the global internet to directly interconnect with each other.

Interconnection charges

• Mainly IPNP (including settlement-based interconnection).

• RPNP for some services (e.g. 800). • BAK for some fixed services and in

some countries for calls to mobile.

Mainly RPNP (downloading charges), with settlement-based interconnection between peers.

Interconnection pathway

Single dedicated pathway comprising circuit through which signals pass in both directions

• Inbound and outbound packets travel in different streams.

• Packets comprising the inbound or outbound message usually will travel over multiple inbound or outbound

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Circuit switched Packet switched

Direction of wholesale charging

Messages flow in both directions (e.g. two way call), but interconnection charges flow in one direction. Interconnection charges flow up the chain of interconnected operators to the retail provider of the service

• The outbound and inbound packet streams are separately charged for interconnection purposes.

• Within each stream, there is no consistency in direction of interconnection charges. The direction of charges which apply between two adjacent networks along a packet’s pathway will depend on the commercial arrangements between the operators (and their relative positions in the hierarchy of the internet). When passing a packet onto a network, some operators along the packet’s pathway may pay to send, some may pay to receive and some may offset against packets received in the revenue direction. As a result, interconnection charges not set are passed back up the chain to the retail provider of the internet service.

Charges for transit, on the other hand, have been easier to implement in the current IP environment. Each network, at its Border Gateway, is able to recognise whether a packet presented by a directly interconnected network has an IP address that is hosted on its network or on another network. The receiving network can choose to refuse to accept packets to IP addresses not hosted on its network, or allow the packets to transit its network on the way to the ultimate address. If the receiving network does allow transit, it can charge the network that passed it the packet. This charge is imposed even if the destination network loses that packet and requests the packet to be resent.

The existence of signalling and inter-carrier billing systems in the circuit switched networks avoids many of these problems and provides more options for commercial charging arrangements between interconnected networks. The original designers of the internet intended to keep its architecture simple and therefore did not build in similar signalling superstructure. Therefore, to a large extent, interconnection models which currently prevail on the internet are shaped by its technical limitations.

While the current architecture of the internet was suited to its not for profit origins, as we discuss in the next section, technological developments will support the capability to support differential quality of service offerings and a more diverse range of retail and interconnection billing arrangements. This raises questions about whether current IP interconnection models will be appropriate going forward.

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4. THE CHANGING WORLD OF IP

4.1. I

NTRODUCTION

In this section we describe the features of a stand-alone NGN and then consider how NGNs may interconnect. The section will draw out the two main differences between IP interconnection in the current best efforts internet environment and in the future NGN world, these being:

• the additional demands of IP interconnection to support quality of service (QoS) on an end to end basis; and

• the capability to support inter-operator billing, that is, tracking and valuing where a packet travels and linking inter-operator billing to the value of the series of packets sent.

We use the IPX developed by the GSMA as an example of the developing models of a more sophisticated form of IP interconnection.

The increasing requirement for differential QoS transport arises from the variety of applications that will be provided over packet switched networks. For example, both voice and video require higher QoS than email or web surfing. On the other hand, it is technically inefficient to create networks which are solely QoS transport enabled, if the users of that network will have some needs which are met by a best efforts solution. Instead, the network must be responsive and adaptive to the consumer needs and, in many cases, without consumer intervention. That is, the QoS requirements will, in the main, be determined by the application and a subsequent consumer decision as to the service priority.

4.2. N

EXT

G

ENERATION

N

ETWORKS

4.2.1. Introduction

The International Telecommunications Union defines an NGN as follows:

A next-generation network (NGN) is a packet-based network able to provide services, including telecommunications services, able to make use of multiple broadband, QoS-enabled transport technologies, and in which service-related functions are independent from underlying transport-related technologies. It offers unrestricted access by users to different service providers. It supports generalised mobility, which will allow consistent and ubiquitous provision of services to users.

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Page 30 No single definition of NGN exists so far (and indeed is unlikely ever to exist), but

it is generally acknowledged that its architecture relies on a few general

principles: a shared core network for all access and service types, packet-based transport technologies, open standardised interfaces between the different network layers (transport, control and services), support for user-adaptable interfaces and variable access network capacities and types.

Importantly, the NGN is always a packet-based network and this means that the packet switched analysis set out in the previous two sections can be applied to NGNs. Further, an important aspect of the NGN is its support for quality of service enabled transport technologies.

While NGN will gradually replace circuit-switched networks, the public internet will exist alongside NGNs – and compete with NGNs for many services.

4.2.2. NGN architecture

NGN architecture supports a range of quality service parameters (discussed in

Appendix A) and consists of four planes which, in order from the end user interface, are the:

• access plane: this represents the direct interface between end-users and the rest of the network;

• transport plane: the IMS forms the core of the transport plane;

• control plane: this is analogous to the signalling system in a circuit switched net-work; and

• service plane: this contains services which can be applied to the lower planes in order to create products. This plane does not have an analogy in conventional networks but has some comparable functionality to the Intelligent Network. The access and transport planes form the next generation transport mechanism. The control and service planes form the next generation services. These are illustrated in Figure 13.

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Figure 13 - Planes

4.3. Q

UALITY OF SERVICE

The relevance of particular quality of service parameters to specific services is explained in further detail in Appendix A. The quality of service required in each case will depend on the application being used and or the consumer’s willingness to pay for increased priority.

Quality of service is achieved in an NGN through a process depicted in Figure 14 below. A QoS service path with consistent parameters is created through the network along which packets comprising the message with the QoS commitment then travel (see Appendix A.4 for a discussion of the key service parameters, such as jitter, latency and packet loss). This process comprises the following elements:

• packet labelling: packets to which a particular quality of service must attach are labelled, or assigned a priority. For example, for an IP television service, preventing jitter and packet loss is key to the consumer’s experience. Packets associated with this application will be given the highest level of priority;

• service plane and control plane communicating with routers to create QoS paths: the control plane and service plane in an NGN will create multiple QoS paths for packets with similar labels. The service plane provides the path module and the control plane instructs the routers along the QoS path to prioritise packets according to their priority labels. QoS paths are not dedicated capacity paths. They are only created for the duration of the transfer of labelled packets;

• customer premises equipment: the customer premises equipment (CPE) must be able to respect and apply packet labelling so that it can send packets, and label packets it sends, with particular QoS priority levels, and so that it can receive packets labelled a particular priority; and

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• billing for QoS: In an NGN environment, the networks involved in carrying the prioritised packets along their path are known and it is possible to establish

cascading billing arrangements that support either IPP or RPP charging models and recompense each network on actual, not estimated, averaged or balanced traffic flow.

Figure 14 - Establishing a QoS path

4.4. NGN

INTERCONNECTION

Typically, NGN interconnection will require specific applications to be associated with QoS parameters, to ensure that they are delivered both within a network and across networks in a uniform and predictable manner. That is, the mechanisms used to create QoS enabled transport paths within an NGN will need to be used between NGNs and respected by interconnecting NGNs to permit effective and efficient interconnection. In order to provide this level of predictability, IP interconnection will require routing and prioritisation of packets between networks on a consistent and seamless basis. That is, interconnected IP networks will need to agree on QoS parameters and also agree on the way in which they will respect the labelling of packets. The labelling provides the required parameters for QoS and these parameters will need to be respected by all of the

interconnecting networks. In turn, the interconnected networks will need to agree on an appropriate billing mechanism for the transfer of those QoS parameters.

Economic study on IP interworking