Network economics and the Internet backbone

Why the fact that carriers are not making money operating Internet backbones is a problem for everyone

It's official: The carriers are not making money operating Internet backbones.

Why should you care? Because defying the laws of economics is a bit like defying the law of gravity -- it appears to work for a while, but you're in for an unpleasant surprise at the end.

Here's the issue: The carriers that are currently running Internet backbones are subsidizing that service from other offerings. Competitive pressures and new technologies, however, are driving the price of these offerings down -- at the same time that IPTV, Internet-based video on demand, and multimedia interactive games are driving Internet bandwidth requirements dramatically up. As a result, carriers will need to beef up their networks to handle the capacity.

And where's the financing for that investment coming from?

There are a couple of possible scenarios. Carriers could fund Internet-backbone investments from the pockets of their customers, but there are signs that gravy train is slowing to a stall. Enterprise users quite rightly object to paying top dollar for network services -- particularly in an environment where Internet services (for the present at least) are far cheaper and almost equally reliable. And consumers are already screaming about the "high" cost of broadband services.

Another option is for carriers to put in place a peering exchange -- similar to stock market trading exchanges -- that lets them pass traffic from one backbone to another at fair market rates. Currently, peering arrangements are one-off deals between individual carriers, and they typically don't differentiate between types of traffic. That's as if, instead of the New York Stock Exchange, you had two guys in a smoky back room making deals without distinguishing between blue chips and penny stocks.

The advantage of a peering exchange would be the ability to trade "like for like," at the lowest possible rates -- and thus would make operating Internet backbones profitable. Of course, that would require carriers to be able to charge differentially for different traffic types -- something the 'Net neutrality folks adamantly oppose. So what are the other options?

Carriers could bite the bullet and get out of the Internet backbone business altogether. (Frankly, I'm half-expecting this to happen). The logical next step? Government takeover. There's a long history of private innovations becoming so valuable to society that the government steps in to ensure service continuity. One good example: The New York City subways started out as private services and were taken over by the government.

Personally, I think this is a really bad idea -- and not just because I tend toward libertarian. Government-operated services tend to slow innovation dramatically, and there are the political implications of having governments (United States or others) with a direct window onto the world's communications networks.

What are the other options? Some say that if the current crop of carriers can't operate Internet backbones cost effectively, a new bunch will arise that can. I don't buy it -- the laws of network economics will apply to the new guys, too.

So what happens? Hmm. Brace yourselves for a sharp impact with reality.

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Johna Till Johnson

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