Network Interconnection: CPNP, Bill and Keep, and the Evolution to IP

1. Network Interconnection:CPNP, Bill and Keep, and the Evolution to IP J. Scott Marcus: Department Manager, NGN and Internet Economics CPNP versus Bill and Keep, ENCORE, The Hague, 22 April 2008

2. CPNP, Bill and Keep, and the Evolution to IP:Assessment and Conclusions • Network evolution: NGN, VoIP, IPTV • VoIP interconnection – the same as IP interconnection? • What does the migration to IP change? • Economic implications of the migration to NGN for interconnection • Conclusions and recommendations

3. CPNP, Bill and Keep, and the Evolution to IP : A clarification • This presentation is concerned with interconnection, not with access. The two are closely linked in popular perception and in the literature, but they are not the same thing. • Interconnection enables an operator to establish communications between its customers and the customers of another operator. • Access enables an operator to utilize the facilities of another operator in the furtherance of its own business and in the service of its own customers.

4. CPNP, Bill and Keep, and the Evolution to IP • Migration from PSTN to NGN “marries” it with the Internet. • Switched fixed and mobile networks – regulated arrangements. • Regulation to address market power. • Termination fees in the absence of regulation will tend to be very high, for both large and small operators. • Lack of interconnection implies a connectivity breakdown. • Internet – peering arrangements are typically “Coasean”. • Peering: two providers exchange traffic only for their respective customers, often (but not always) with no explicit charges. • Sharing of facilities costs for interconnection may be unequal. • In most countries, no regulation of peering. • Lack of interconnection usually does not imply a loss of connectivity, but may have implications for costs.

5. CPNP, Bill and Keep, and the Evolution to IP: The Evolution from PSTN to NGN • Historically, networks and services were closely interlinked. • Telecommunications networks delivered telephone service. • Mobile networks delivered telephone service. • Cable networks delivered television service. • Today, any transmission platform can deliver any service. Telecommunications networks Mobile networks deliver voice, video, and/or data. Cable networks • Independent providers (with no network at all) can also offer services. }

6. Network Data Link Physical The TCP/IP Reference Model Layers interact with peer layers Server Router Personal Computer Application Application Transport Transport Network Network Data Link Data Link Physical Physical Layers derive services from successively lower layers

7. The TCP/IP Reference Model • Physical Layer – the transmission facilities. • Data Link Layer – the logical management of physical transmission facilities. • Network Layer – forwarding and routing (Internet Protocol, or IP). • Transport Layer – provides applications with datagram (UDP) or virtual circuit (TCP) services, as needed. • Application Layer – provides services to the user. • Web • Email • VoIP • IPTV • Peer-to-peer file sharing

8. E-mail Client Web Browser VoIPClient IPTVClient Personal Computer Network Data Link+ Physical CPNP, Bill and Keep, and the Evolution to IP: The Evolution from PSTN to NGN Today, your broadband connection can support any combination of voice, video and data – provided that it is fast enough.

9. CPNP, Bill and Keep, and the Evolution to IP: The Evolution from PSTN to NGN • The migration to IP-based NGNs has the potential to break the strong historical linkage between the service and the network, thus enabling the emergence of independent service providers. • Data services • VoIP • Video (IPTV) • Implications for regulation in support of competitive entry: • IP-based NGNs might introduce new forms of competition. • Unfortunately, the move to IP does not necessarily eliminate traditional market power. • The migration might, moreover, enable the emergence of new competitive bottlenecks. • Which effect(s) will predominate?

10. CPNP, Bill and Keep, and the Evolution to IP: The Evolution from PSTN to NGN • Network costs are driven by capacity requirements. In future integrated IP-based networks, where voice represents only a small fraction of the traffic, total costs will have little to do with minutes of voice use. • Traditional interconnection arrangements historically represented an attempt to use wholesale payments (between network operators) to correct for imbalanced retail payments (between service providers). • To the extent that the network and service providers are different firms, and to the extent that voice is only a small fraction of the cost of the network, this system makes even less sense going forward than it did in the past. • We return to these points at the end.

11. The Future of IP Interconnection:VoIP interconnection versus IP interconnection • Does IP interconnection equate to voice interconnection? • Different answers are emerging for IP-based service providers, fixed incumbents, and mobile operators. • Independent VoIP service providers, cable operators who offer VoIP: Interconnection arrangements based on VoIP peering are emerging. This requires the ability to determine which service provider serves which telephone numbers (e.g. by means of carrier ENUM). • Fixed PSTN: As networks migrate to IP-based NGNs, IP peering does not automatically imply the ability to use VoIP to connect to the fixed incumbent’s voice services. • Mobile PLMN: The GSM-A already provides an IP backbone for interconnecting mobile operators, the GRX/IPX. All indications are that connectivity to the mobile operator’s inherent voice service will be available only to other mobile operators, and possibly to other service providers who agree to equivalent conditions.

12. The Future of IP Interconnection:VoIP interconnection versus IP interconnection • Evolution of GSM-A interconnection architecture from GRX to IPX • Migration from basic peering model to QoS-oriented approach • IPX internals will be on “public” IP addresses, but will not be externally accessible. • Key voice infrastructure, including carrier ENUM and SIP servers, will thus be accessible only to MNOs or (possibly) to firms that accept MNO pricing and quality arrangements. • Advantage: “Hubbed” architecture potentially overcomes transaction cost problems in getting QoS-capable services launched. (Although the value of differentiated QoS is not proven.) • Concern: “Hubbed” wholesale pricing could serve in effect to reinforce current arrangements not only for wholesale pricing, but also for retail pricing.

13. The Future of IP Interconnection:VoIP interconnection versus IP interconnection

14. The Future of IP Interconnection:VoIP interconnection versus IP interconnection

15. The Future of IP Interconnection:VoIP interconnection versus IP interconnection • Fixed incumbents, and even more so mobile operators, will likely resist external IP interconnection to their inherent voice service, except where charging arrangements mirror current arrangements. Mobile operators in particular have considerable means to resist. • Tentative conclusion: IP Interconnection ≠ VoIP Interconnection • The same might conceivably prove to be true for some applications other than voice, but we found no concrete indications to that effect.

16. The Future of IP Interconnection: Economic Implications • Network evolution: NGN, VoIP, IPTV • Economic implications of the migration to NGN for interconnection • Background on retail and wholesale arrangements, PSTN and Internet • Economic implications today • How does the migration to IP change these implications? • VoIP interconnection – the same as IP interconnection? • Conclusions and recommendations

17. Traditional Telephony Interconnection ModelsPSTN and PLMN • Bulk of revenues comes from telephony • However, sharply declining percentage of traffic • Retail arrangements • Calling Party Pays (CPP) • Traditional arrangement based on presumed cost causality and presumed internalization of call externalities • Receiving (Mobile) Party Pays (RPP/MPP) • Shared utilities from calls, receiver sovereignty • We know of no RPP system in the world today. • Flat rates: Calls included in monthly fees (bandwidth) • Banded flat rates (buckets of minutes): Non-linear prices

18. Traditional Telephony Interconnection ModelsWholesale arrangements • Calling Party's Network Pays (CPNP) wholesale arrangements

19. IP Interconnection ModelsVoluntary Interconnection • Peering • Definition: a bilateral agreement between ISPs to carry traffic for each other and for their respective customers. Peering does not include the obligation to carry traffic to third parties. • Symmetric • Often “bill and keep” • Transit • Definition: The transit provider (the ISP) carries traffic for the transit customer, but the transit customer is not under any obligation to carry traffic for the transit provider. The transit customer pays the provider, not the other way around. • Asymmetric • Transit customer pays • Typically connects to entire Internet

20. IP Interconnection ModelsVoluntary Interconnection • Two peers and their respective transit customers

21. Economic implications:How things work today: Wholesale and retail • In an unregulated CPNP system, carriers will tend to establish very high termination charge levels (the termination monopoly). • Smaller operators will be motivated to set termination fees even higher than large operators. • The problem is addressed in the EU by regulating all rates. • Several factors contribute to the termination monopoly. • Since the charges are ultimately borne by another operator’s customers, normal market forces do not adequately constrain them. • Customers have little visibility into termination fees. • Termination charges at the wholesale level have some interaction with retail pricing arrangements. • The termination fee generally sets a floor on the retail price. • Where termination fees are high, they generally limit the applicability of flat rate or “buckets of minutes” plans.

22. US ARPU France ARPU GermanARPU Economic implications:How things work today Note: ML does not count on-net mobile in CPNP countriesthus under-counting about 20%.

23. Economic implications:How things work today • CPNP with high mobile termination rates tends to lead to: • Subsidies for mobile adoption, and thus rapid penetration. • High retail prices. • Exclusion of calls with high termination from flat rate plans. • Low usage. • Rapid penetration is beneficial (but needs no stimulus in the EU today); the other aspects are harmful. • There is only limited interaction between wholesale and retail arrangements. • CPNP with high termination rates practically mandates CPP retail arrangements. • The termination fee represents a floor on retail price. • Low or zero termination rates, however, place no constraints on retail arrangements.

24. Economic implications:How things work today: Termination rates • Optimal rates could depend in complicated ways on • Costs • Network externalities • Call externalities • Calling habits (induced calling) • Institutional factors (CPP, RPP traditions; reciprocity) • Customer heterogeneity: Targeting of customers (e.g., ISPs) • Very hard to determine and will depend on circumstances • Very likely range: 0  p* << LRAIC • Prof. Littlechild describes determination of an optimal termination rate as a Sisyphean task. • Even if one cannot say that a particular rate is right, perhaps it is possible to identify rates that are wrong?

25. Economic implications:How things work today: Termination rates • Mobile termination rates vary from one Member State to another, but the average of € 0.0967 per minute (13th Implementation Report) is likely well in excess of real average incremental cost. • Large differences between on-net and off-net pricing suggest that operators view their costs as being less than the termination fee. • Service-based revenue per minute of use (which is a good proxy for average price) in Europe is consistently 50% - 400% higher than in the U.S, Singapore and Canada. The differences are largely attributable to termination rates. • Service-based revenue per MoU in the U.S. was about € 0.03 per minute (4Q2006). Cost is presumably less than price. • Cyprus prices termination at some € 0.02 per minute. • A WIK study found average incremental cost in Australia to be between € 0.03 and € 0.04 per minute, depending on share.

26. Traditional Telephony Interconnection Models Regulated vs. negotiated prices • What are the conditions for efficient (“Coasean”) bargaining for voice? • reciprocity • capped rates to fixed incumbents

27. Economic implications:How things work today: Penetration • Many authors (not all) contend that CPNP leads to higher mobile penetration than Bill and Keep. • There is reason to believe that it leads to faster mobile penetration. • Operators are motivated to subsidize consumers in order to terminate calls to them at prices well in excess of cost. • Handset subsidies. • No monthly fees. • Pre-paid cards with low administrative burden. • A case of “giving away the razor in order to sell blades”. • Is it appropriate to stimulate penetration in the EU today? • High penetration is generally viewed positively. • Nominal penetration in the EU is already in excess of 100%. • Current arrangements may promote inefficiencies, including overly rapid handset replacement, and multiple subscriptions.

28. Economic implications:How things work today: Penetration • One must be cautious in interpreting penetration data. • Mobile penetration in 17 Member States is nominally in excess of 100%; for the EU as a whole, it is 111.8% (per the 13th Implementation Report), measured against total population. • Only six Member States had penetration less than 100%. • Nonetheless, per Eurobarometer survey data (Jan 2006), 20% of households in Europe do not have access to a mobile phone. • CPNP systems encourage multiple subscriptions more than Bill and Keep, because of on-net/off-net price differences. • Bill and Keep countries can achieve quite respectable levels of penetration. • Singapore: 98% • U.S.: 80% as of the end of 2006 (source: FCC), and gaining 5 or 6 points per year.

29. Economic implications:How things work today (reprise) • CPNP with high mobile termination rates tends to lead to: • Subsidies for mobile adoption, and thus rapid penetration. • High retail prices. • Exclusion of calls with high termination from flat rate plans. • Low usage. • Rapid penetration is beneficial (but needs no stimulus in the EU today); the other aspects are harmful. • There is only limited interaction between wholesale and retail arrangements. • CPNP with high termination rates practically mandates CPP retail arrangements. • The termination fee represents a floor on retail price. • Low or zero termination rates, however, place no constraints on retail arrangements.

30. Economic implications:How things might work tomorrow (reprise) • Network costs are driven by capacity requirements. In future integrated IP-based networks, where voice represents only a small fraction of the traffic, total costs will have little to do with minutes of voice use. • Traditional interconnection arrangements historically represented an attempt to use wholesale payments (between network operators) to correct for imbalanced retail payments (between service providers). • To the extent that the network and service providers are different firms, and to the extent that voice is only a small fraction of the cost of the network, this system makes even less sense going forward than it did in the past.

31. The Future of IP Interconnection: The Evolution from PSTN to NGN • Network evolution: NGN, VoIP, IPTV • Economic implications of the migration to NGN for interconnection • Conclusions and recommendations

32. Conclusions and recommendations (mobile) • Independent of the migration to NGN, we think that societal welfare would be substantially enhanced if mobile termination rates were much lower than they are today, and possibly no higher than the rates that prevail today for fixed termination rates. This could be implemented by (1) accelerating the speed with which the maximum call termination rate declines from year to year under existing CPNP arrangements, so as to reasonably quickly achieve levels much lower than those that pertain today; or (2) by requiring all fixed and mobile operators to eliminate call termination fees altogether; or (3) by permitting negotiated termination fees subject to an obligation that the fees be reciprocal (the same in both directions) between each pair of interconnected (fixed or mobile) networks.

33. Conclusions and recommendations (mobile) • In an ideal world, the second option would appear to offer many advantages in comparison to the other two. The outright elimination of call termination fees is simple, it minimises economic distortions, and it involves the fewest impediments to the evolution over time of interconnection arrangements as networks evolve to an IP basis. • We nonetheless stop short of recommending the second option, because (1) it is not clear how it would be justified under the current regulatory framework, and (2) a glide path would be necessary in any case in order to enable operators to adjust their retail payment plans over time to match the changing wholesale arrangements.

34. Conclusions and recommendations (mobile) • What we concretely recommend instead is that the Commission mandate that fixed and mobile call termination rates “fast glide” to pre-specified target levels over a predefined number of years (somewhere between three and five). This corresponds to option 1. This fast glide path gives the operators time to adjust their business plans, and allows for mid-course corrections if necessary.

35. Conclusions and recommendations (mobile) • We are not indicating exactly what the target levels for fixed and mobile voice termination should be, since this is far beyond the scope of this study. We note that zero is in many respects an ideal number, for reasons noted above. We also observe that, were mobile termination fees to be in the same range as current fixed termination fees, one could reasonably expect that flat rate retail plans would emerge that included off-net calls to mobile phones. • Reduction in mobile termination rates would tend to lead to a substantial decrease in usage-based retail prices for mobile service, at the expense of a significantly smaller increase in the fixed portion of the retail price of mobile service (the “waterbed effect”); to increased availability and consumer take-up of flat rate and “buckets of minutes” retail plans; and to substantially increased use (expressed in minutes of use per month) of mobile telephones.

36. Conclusions and recommendations • There is a strong argument that this lowering of mobile termination rates should be implement before the migration to IP-based NGNs; otherwise, attempts by operators to preserve high rates would tend to distort the migration. • Any necessary remedies should operate at the wholesale level, absent a compelling need for retail remedies. In particular, the choice of retail payment model (for example, CPP versus flat rate) should be a matter for the service provider to determine (reflecting the preferences of its customers), not something for the regulator to mandate.

37. Conclusions and recommendations • The study also contains a range of recommendations relating to • IP data interconnection • QoS and network neutrality • The QoS for voice interconnection • Transitional arrangements during migration to NGN

38. Comparison to the recommendations of Profs. Cambini and Littlechild • The study recommendations are not at all incompatible with those put forward today by Cambini and Littlechild. • If the target termination rate were zero, then our recommendations represent a call for an orderly transition to Bill and Keep. • A glide path is appropriate. Operators will want to adjust retail business plans to shift retail payments away from per-minute fees, and in favor of higher per-month and initial fees. • Consumer preferences need some time to adjust. • We took an agnostic position as to whether termination fees should be zero versus just being very low. • Zero minimises distortions with migration to IP; but • We do not rule out that there might be some benefit in a low but non-zero rate (cf. India, where experience has been good).

39. J. Scott Marcus, Dieter Elixmann, Kenneth R. Carter, and senior experts Scott Bradner, Klaus Hackbarth, Bruno Jullien, Gabriele Kulenkampff, Karl-Heinz Neumann, Antonio Portilla, Patrick Rey, and Ingo Vogelsang, The Future of IP Interconnection: Technical, Economic, and Public Policy Aspects, a study prepared for the European Commission, available at: http://ec.europa.eu/information_society/policy/ecomm/doc/library/ext_studies/future_ip_intercon/ip_intercon_study_final.pdf.

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