Internet Business Models and the
Competitive Dynamics of the Backbone
Market
Michael Kende
9 April 2001
Introduction

Analysys is Europe’s 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”
Backbone 1
ISP A
A
B
Web site C
C
Traffic from ISP A can
only reach Web site C.
ISP D
Web site B
D
E
Backbone 2
F
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
Backbone 1
ISP A
A
Web site C
B
C
Peering
connection
Backbone 3
Backbone 2
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
Backbone 1
ISP A
A
Web site C
B
C
Backbone 3
Web site D
Traffic from ISP A to
Web site B will pass
between points A and
B in both directions
Y
Z
Entry into the backbone market
Connectivity
Transit is a comprehensive alternative to
peering

In a transit relationship, one backbone
agrees to route another backbone’s 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
Backbone 1
ISP A
A
Web site C
B
C
Peering
Connection
Transit
Connection
Backbone 3
Backbone 2
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
Content
providers
Backbone
provider
ISPs
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
provider’s network

Local telcos can use market power over last mile
as leverage against national backbone providers
International transport

International traffic can bypass national backbone
provider’s 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
Cache
Content from Web site C
is pulled by ISP A to a
cache closer to its users
Backbone 1
ISP A
A
B
Web site C
C
Mirror
Web site B
D
E
Backbone 2
Content from Web site B
is pushed to a mirror
site closer to ISP D
F
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 multihomed connections to end-users
Competitive constraints
Technical substitutability
Diagram of multi-homing
Backbone 1
A
B
Web site C
C
By multi-homing to both
backbones, ISP A is
directly connected to
Web site C and ISP D,
without any peering
ISP A
D
ISP D
E
Backbone 2
F
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