Internet Business Models and the

Competitive Dynamics of the Backbone

Market
Michael Kende

9 April 2001
 Introduction
Analysys is Europes leading independent
telecom strategy consulting and research
company, with 240 staff in 10 offices around
Europe, Asia, and the United States. Clients
include operators, policy-makers and regulators.
Authors have a wide range of experience in
analyzing the Internet backbone market in Europe
and the United States
Analysys was invited to discuss the competitive
dynamics of the Internet backbone market
 Agenda

Overview of the Internet

Peering
Entry into the backbone market
Competitive constraints on backbone market
Comparison with telephony
Analysis of Brazilian market
 Agenda

Overview of the Internet

Peering
Entry into the backbone market
Competitive constraints on backbone market
Comparison with telephony
Analysis of Brazilian market
Overview of the Internet

The Internet can be broken into four

types of players
Internet backbone providers
Internet service providers (ISPs)
Content providers (e.g. web sites)
End-users
Overview of the Internet

Internet service providers (ISPs) enable

end-users to access the Internet
ISPs have two types of customers
Dial-up customers using their personal computers
with modems
Businesses and other large organizations using
direct leased line connections
ISPs combine two inputs
Access facilities (e.g. modems)
Backbone services
Overview of the Internet

Internet backbone providers connect

end-users with each other and content

Transport Router

ISP
Web site

ISP Web site

Overview of the Internet

Internet backbone market has an impact

on ISPs costs
Internet backbones charge ISPs a monthly
fee for wholesale access to the Internet
Internet backbones require two inputs to
provide wholesale access to the Internet
Transport
Connectivity to other backbone providers
Overview of the Internet

Connectivity makes the Internet the

network of networks

ISP A Backbone 1
Web site C
A B C

Traffic from ISP A can

only reach Web site C.

ISP D

Web site B
D E F
Backbone 2
 Agenda

Overview of the Internet

Peering
Entry into the backbone market
Competitive constraints on backbone market
Comparison with telephony
Analysis of Brazilian market
Peering

Internet backbone providers have

opposing incentives
Backbones compete with one another for customers
Traffic exchange requires co-operation among
backbone providers
Connectivity is not regulated
In place of regulation, a system known as peering
has evolved
In the peering system, backbones connect when
it is mutually beneficial
Peering

In a peering relationship, backbones

only exchange traffic between their own
customers
ISP A Backbone 1
Web site C
A B C

Peering
connection

Backbone 2 Backbone 3
Web site D

ISP B
W X Y Z
Backbone 3 will not
pass traffic from
backbone 2 to
backbone 1
Peering

Peering is a mutually beneficial

relationship

Traffic is exchanged on a settlements-free basis

Peering is based on a perception of equality along
several measures
A measure of the flow of traffic at a point of
connection between networks
A comparison of the geographic size of networks
A comparison of the size and composition of
customer bases
Peering

Any analysis of the Internet backbone

market must be dynamic
Static focus on peering issues ignores
important forces
Dynamic nature of Internet constrains action
of any one backbone provider
Direct constraints from new entrants
Indirect constraints from input suppliers
and customers
 Agenda

Overview of the Internet

Peering
Entry into the backbone market
Competitive constraints on backbone market
Comparison with telephony
Analysis of Brazilian market
Entry into the backbone market Overview

Access to two inputs is required to enter

the Internet backbone market
Connectivity
peering is not the only option
Transport
long distance telecommunications
infrastructure (e.g. fiber or satellite)
Entry into the backbone market Connectivity

Peering may not always be mutually

beneficial
Peering may enable one backbone to
free-ride off the other
Peering can provide a smaller backbone
with free access to a larger backbone
Peering may require one backbone to
utilize more capacity than another
One backbone may refuse to peer with
another to prevent free-riding
Entry into the backbone market Connectivity

Example of free-riding between

networks of different size

ISP A Backbone 1
Web site C
A B C

Backbone 3
Web site D

Traffic from ISP A to Y Z

Web site B will pass
between points A and
B in both directions
Entry into the backbone market Connectivity

Transit is a comprehensive alternative to

peering
In a transit relationship, one backbone
agrees to route another backbones traffic to
all points on the Internet
The transit provider is paid for these services
Transit customer can provide backbone
services and grow to qualify for peering
Entry into the backbone market Connectivity

Example of a transit relationship

ISP A Backbone 1
Web site C
A B C

Transit Peering
Connection Connection

Backbone 2 Backbone 3
Web site D

ISP B
W X Y Z
Backbone 3 will take
traffic from backbone
2 to backbone 1
Entry into the backbone market Connectivity

Backbone providers have incentives to

compete on transit prices
Transit customers provide revenues for
backbones
Transit customers improve the bargaining
position of backbones in peering negotiations
Entry into the backbone market Infrastructure

Long distance infrastructure is the core

of a national Internet backbone provider
Long distance infrastructure markets can
support multiple competitors
Fiber optic technologies enable economical
overbuilds of existing networks
Regulations often enable entrants to lease
capacity from incumbents to complete
national build-out at affordable rates
Entry into the backbone market Conclusion

The competitive dynamics of the

Internet provide for numerous means of
entry
Entrants can connect to existing backbones
through different means
Peering
Transit
Infrastructure is increasingly available
Leasing of existing infrastructure is regulated
Technology enables new entrants to build their
own infrastructure
 Agenda

Overview of the Internet

Peering models
Entry into the backbone market
Competitive constraints on backbone market
Comparison with telephony
Analysis of Brazilian market
Competitive constraints Overview

Competitive constraints on backbones

Customer forces
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Competitive constraints Input suppliers

Input suppliers compete indirectly with

backbone providers
Local transport
As an increasing amount of Internet usage is
local, traffic can bypass national backbone
providers network
Local telcos can use market power over last mile
as leverage against national backbone providers
International transport
International traffic can bypass national backbone
providers network
Competitive constraints Customer forces

Customers are increasing their

bargaining power with backbones
Local content is increasing
Demand of end users for high-quality local content
bestows market power on providers
Local content providers can leverage this market power
in negotiations with backbone providers
ISPs have powerful brand names
Local telcos have entered the market, and other ISPs
have national and international presence
These ISPs can negotiate advantageous terms with
backbone providers
Competitive constraints Technical substitutability

Advanced storage and processing

technologies reduce the need for
backbone transport
Usage of servers near end users
content providers can push content out to
mirror sites
users can pull content in to cache sites
In both cases, content is only transported on
backbone network once
Competitive constraints Technical substitutability

Diagram of the use of mirroring and

caching
Content from Web site C
is pulled by ISP A to a
Cache
cache closer to its users

Backbone 1
Web site C
ISP A
A B C

Mirror

Web site B
ISP D
D E F
Backbone 2
Content from Web site
B is pushed to a mirror
site closer to ISP D
Competitive constraints Technical substitutability

End users can multi-home to reduce

reliance on backbone networks for
connectivity
Multi-homing involves an ISP or content
provider directly connecting to more than one
backbone provider
As a result, traffic goes directly to the
terminating backbone without passing
through a peering connection
Companies such as InterNAP sell multi-
homed connections to end-users
Competitive constraints Technical substitutability

Diagram of multi-homing

Backbone 1
Web site C
A B C

By multi-homing to both
backbones, ISP A is
directly connected to
ISP A Web site C and ISP D,
without any peering
ISP D

D E F
Backbone 2
 Agenda

Overview of the Internet

Peering
Entry into the backbone market
Competitive constraints on backbone market
Comparison with telephony
Analysis of Brazilian market
Comparison with telephony

Comparison of Internet and telephony

Internet and telephony share the same basic
infrastructure
Local
Long distance
International
Telephony services are typically regulated while
Internet services are not
Input availability
Competitive dynamics of Internet markets
Comparison with telephony Internet not regulated

Input availability for Internet backbones

reduces need for regulations
Transport
Telephony regulations provide access to existing
transport capacity
New technologies lower cost of building new transport
capacity
Connectivity
Peering is one option
Peering policies increasingly being made public
Transit access makes entry and growth possible until
smaller backbones qualify for peering
Comparison with telephony Internet not regulated

Dynamism of Internet services reduces

need for regulation
Basic telephony services are static
Voice call between two users is live
There is no means to reduce reliance on network
for end-to-end call
Internet services are dynamic
Internet content can be stored
Storage technology (mirrors and caches) increase
competitive pressures on Internet backbone
providers
 Agenda

Overview of the Internet

Peering models
Entry into the backbone market
Competitive constraints on backbone market
Comparison with telephony
Analysis of Brazilian market
Analysis of Brazilian market

Analysis of Brazilian Market

Market Overview
Analysis of Entry
Competitive Constraints
Analysis of Brazilian market Market overview

Brazilian Internet market is growing

Wave of investment since market

restructuring in 1998
Number of lines has risen from 14.8 million in
1996 to 33.2 million in 2000
Number of dial-up Internet users has risen
from 471,000 in 1996 to 3.7 million in 2000

Source: Economist Intelligence Unit (2000)

Analysis of Brazilian market Analysis of entry

Necessary infrastructure is available

Incumbents must make infrastructure available to

Internet companies
Entrants building facilities
Local entrants include MetroRed, Diveo, and
AT&T
Long distance entrants include Intelig, Global
One, and Impsat
International entrants include 360networks and
Global Crossing
Analysis of Brazilian market Analysis of entry

Connectivity options are available

Embratel sells dedicated access to its

backbone to customers and competitors
alike
Peering is taking place
Embratel and RNP
Regional backbones connecting to
increase their coverage
Analysis of Brazilian market Competitive constraints

Existing backbone providers face

competitive constraints
Input providers
ISPs such as Terra are growing and moving into
backbone markets
Local incumbents will be free to provide national
backbone services soon
While existing national backbone providers grow,
utilities are beginning to enter the market with their
own facilities
ISPs are beginning to multi-home and use content
storage technologies to reduce reliance on backbones
Analysis of Brazilian market

Conclusion

There are increasing signs of competition

between backbone providers
Investments in infrastructure
Internet usage is growing
Competition is likely to increase in the future
when local telcos enter the market
This competition provides for affordable
Internet access services from ISPs