New Market Models for Traffic Exchange. Dennis Weller Chief Economist, Verizon WIK International Workshop Konigswinter 4 April 2006

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1 New Market Models for Traffic Exchange Dennis Weller Chief Economist, Verizon WIK International Workshop Konigswinter 4 April 2006

2 Markets and Policies for the Exchange of Value Among Networks Do we need a default rule? If so, what rule? For traditional networks? For next-generation networks? 2

3 Universal Connectivity for Old Networks Regulatory framework for the circuit-switched world Theodore Vail and the Kingsbury commitment, 1913 Obligation to interconnect Regulation as a necessary result Ensured that anyone who had a phone could call anyone else with a phone, because networks were interconnected What Vail meant by universal service 3

4 Universal Connectivity in the New World Development of the Internet Huge value to consumers, the economy, society Income, jobs, productivity Worldwide connectivity on the Internet Achieved without any obligation to interconnect, or any regulation How has this been possible? 4

5 Why has the market for exchange of traffic worked on the Internet? 1)Different culture 2)Different structure 3)IP really is different 4)No regulation 5

6 Why has the market for exchange of traffic worked on the Internet? 1) Different culture History of cooperation Rewards for cooperation: The Internet marketplace has rewarded players who got more connections, customers, and traffic. 6

7 Why has the market for exchange of traffic worked on the Internet? 2) Different market structure Over 20,000 entities No provider is in a position to dominate Doesn t matter who has end-user connection, or whether that market is competitive Room for small players as well as large ones 7

8 Why has the market for exchange of traffic worked on the Internet? 3) IP really is different More routing options in IP world It s OK if two networks don t connect directly Packets will find available connections through other networks Limited ability for holdup 8

9 Why has the market for exchange of traffic worked on the Internet? Exchange of IP traffic has not been regulated Regulation protects against market power, but in this case also creates it Obligation to interconnect creates terminating monopoly Takes away the ability to say no If parties don t agree, need regulatory backstop Regulatory answer crowds out negotiated agreements Example AT&T petition led to regulation of CLEC access 9

10 When Worlds Collide..Interconnection Traditional Telephone Obligation to Interconnect Heavily regulated Declining market Arbitrage, bad incentives Internet No obligation to Interconnect No regulation Growing market Market incentives to invest, create value 10

11 Do We Need a Default Rule for Exchange of IP Traffic? No, intervention in this market would be harmful Obligation to interconnect Supervision of terms Where to draw a line? At the circuit-switched interface to the old network 11

12 Whose Ox? Carriers who rely heavily on intercarrier charges today PTTs with high settlement charges Small incumbent telcos in the US Mobile carriers with high termination charges Regulators who are used to regulating 12

13 What to do with traffic exchange on old network? One option: Do nothing In time, new IP model will replace the old one Make patient comfortable Wait for it to die Second option: Can we replace current default rule with a better one? 13

14 What Can Economics tell US? Very little religion on offer See for example Katz and Hermalin Ramsey solution Choice of network Choice to communicate Demand elasticities of calling and called parties Marginal costs of the networks CPP, Bill &Keep are corner solutions if one assumes extreme parameter values. 14

15 What Can We Learn From the IP Market Solution? Low and declining prices But peering is not the same as bill and keep Peering is an agreement to barter, not a price of zero The diamond-emerald paradox Concern about a default rule at zero 15

16 What Can We Learn From the IP Market Solution? Focus on exchange of value among networks Value as perceived by the market participants Incentives to invest to add value Important for investment in NGN Multiple dimensions of value Not just the balance of voice traffic Reach, capabilities, content, customers Multiple dimensions of service 16

17 US Compensation in Geologic Time 1980s: Rebalancing 1990s: Price caps 2000: CALLS plan Today: Various efforts to negotiate a son of CALLS 17

18 Conclusion: Where to go from here? For exchange of IP traffic: Allow the market to work No obligation to interconnect No supervision of terms Correct framework for NGN investment and competition For exchange of circuit-switched traffic: Address outliers and distortions in rates Draw white line at interface with circuit-switched network 18