Ian & Stuart's Australian Mac: Not for Sale/Another.not.for.sale (Australia).iso/fade into you/being there/Internet Accounting/Economics of the Internet

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                   Economic FAQs About the Internet

                       Jeffrey K. MacKie-Mason
                              Hal Varian

                   University of Michigan and NBER
                        University of Michigan

                             May 13, 1994

This is a set of Frequently Asked Questions (and answers) about the
economic, institutional, and technological structure of the Internet.
We describe the current state of the Internet, discuss some of the
pressing economic and regulatory problems, and speculate about future
developments.


Department of Economics, University of Michigan, Ann Arbor, MI
48109-1220.  E-mail: [e-mail] and [e-mail].  The
most current version of this paper will be available for anonymous
ftp, gopher, or World Wide Web access at
gopher.econ.lsa.umich.edu.

The authors wish to acknowledge support from National Science
Foundation grant SBR-9230481.


What is a FAQ?

FAQ stands for Frequently Asked Questions.  There are dozens of FAQ
documents on diverse topics available on the Internet, ranging from
physics to scuba diving to how to contact the White House.  They are
produced and maintained by volunteers.  This FAQ answers questions
about the economics of the Internet (and towards the end offers some
opinions and forecasts).  The companion paper in this Symposium,
\cite{Goffe94}, describes Internet resources of interest to
economists, including how to find other FAQs.

Background

What is the Internet?

The Internet is a world-wide network of computer networks that use a
common communications protocol, TCP/IP (Transmission Control
Protocol/Internet Protocol).  TCP/IP provides a common language for
interoperation between networks that use a variety of local protocols
(Netware, AppleTalk, DECnet and others).

Where did it come from?

In the late sixties, the Advanced Research Projects Administration
(ARPA), a division of the U.S. Defense Department, developed the
ARPAnet to link together universities and high-tech defense
contractors.  The TCP/IP technology was developed to provide a
standard protocol for ARPAnet communications.  In the mid-eighties the
NSF created the NSFNET in order to provide connectivity to its
supercomputer centers, and to provide other general services. The
NSFNET adopted the TCP/IP protocol and provided a high-speed backbone
for the developing Internet.

How big is the Internet?

From 1985 to April 1994, the Internet has grown from about 200
networks to well over 30,000 and from 1,000 hosts (end-user computers)
to over two million.  About 640,000 of these hosts are at educational
sites, 520,000 are commercial sites, and about 220,000 are
government/military sites, while most of the other 700,000 hosts are
elsewhere in the world.  NSFNET traffic has grown from 85 million
packets in January 1988 to 56,190 million packets in March 1994.  (A
packet is about 200 bytes, and a byte corresponds to one ASCII
character.)  This is more than a six hundred-fold increase in only
six years.  The traffic on the network is currently increasing at a
rate of 6% a month.\footnote{Current NSFNET statistics are available by
anonymous ftp from nic.merit.edu.  All statistics we
report are current as of March 1994 unless otherwise indicated.}

What do people do on the Internet?

Probably the most frequent use is e-mail.  After that are file
transfer (moving data from one computer to another) and remote login
(logging into a computer that is running somewhere else on the
Internet).  In terms of traffic, about 37% of total traffic is file
transfer, 16% is e-mail and netnews, and 7% is from the information
retrieval programs gopher and World Wide Web.  People can
search databases (including the catalogs of the Library of Congress
and scores of university research libraries), download data and
software, and ask (or answer) questions in discussion groups on
numerous topics (including economics research).  See \cite{Goffe94}
for a catalog of network resources of interest to economists.

Organization

Who runs the Internet?

The short answer is ``no one.''  The Internet is a loose amalgamation
of computer networks run by many different organizations in over
seventy countries.  Most of the technological decisions are made by
small committees of volunteers who set standards for interoperability.

What is the structure of the Internet?

The Internet is usually described as a three-level hierarchy.  At the
bottom are local area networks (LANs); for example, campus networks.
Usually the local networks are connected to a regional, or mid-level
network.  The mid-levels connect to one or more backbones.  The U.S.
backbones connect to other backbone networks around the world.  There
are, however, numerous exceptions to this structure.


What is a regional net?

Regional networks provide connectivity between end users and the
NSFNET backbone.  Most universities and large organizations are
connected by leased line to a regional provider.  There are currently
about a dozen regional networks.

Some of the regional networks receive subsidies from the NSF; many
receive subsidies from state governments.  A large share of their
funds are collected through connection fees charged to organizations
that attach their local networks to the mid-levels.  For example, a
large university will typically pay $60,000--$100,000 per year to
connect to a regional.

Who runs the regionals?

The regionals are generally run by a state agency, or by a
coalition of universities in a given geographic region.  They are
operated as nonprofit organizations.


What are the backbone networks?

As of January 1994 there are four public fiber-optic backbones in the
U.S.: NSFNET, Alternet, PSInet, and SprintLink.  The NSFNET is funded
by the NSF, and is the oldest, having evolved directly out of ARPANET,
the original TCP/IP network.  The other backbones are private,
for-profit enterprises.

Why is there more than one backbone?

Due to its public funding, the NSFNET has operated under an Acceptable
Use Policy that limits use to traffic in support of research and
education.  When the Internet began to rapidly grow in the late 1980s,
there was an increasing demand for commercial use.  Since Internet
services are unregulated\footnote{Transport of TCP/IP packets is
considered to be a ``value-added service'' and as such is not
regulated by the FCC or state public utility commissions.} entry by
new providers is easy, and the market for backbone services is
becoming quite competitive.

Nowadays the commercial backbones and the NSFNET backbone interconnect
so that traffic can flow from one to the other.  Given the fact that
both research and commercial traffic is now flowing on the same fiber,
the NSF's Acceptable Use Policy has become pretty much of a dead
letter.  The charges for these interconnections are currently
relatively small lump-sum payments, but there has been considerable
debate about whether usage-based ``settlement charges'' will have to
be put in place in the future.


Who runs the NSFNET?

Currently the NSF pays Merit Network, Inc. (Michigan Educational
Research Information Triad) to run the NSFNET.  Merit in turn
subcontracts the day-to-day operation of the network to Advanced
Network Services (ANS), which is is a nonprofit firm founded in 1990
to provide network backbone services.  The initial funding for ANS was
provided by IBM and MCI.

How much does NSFNET cost?

It is difficult to say how much the Internet as a whole costs, since
it consists of thousands of different networks, many of which are
privately owned.  However, it is possible to estimate how much the
NSFNET backbone costs, since it is publicly supported.  As of 1993,
NSF pays Merit about $11.5 million per year to run the backbone.
Approximately 80% of this is spent on lease payments for the fiber
optic lines and routers (computer-based switches).  About 7% of the
budget is spent on the Network Operations Center, which monitors
traffic flows and troubleshoots problems.

To give some sense of the scale of this subsidy, add to it the
approximately $7 million per year that NSF pays to subsidize various
regional networks, for a total of about $20 million.  With current
estimates that there are approximately 20 million Internet users (most
of whom are connected to the NSFNET in one way or another) the NSF
subsidy amounts to about $1 per user per year.  Of course, this is
significantly less than the total cost of the Internet; indeed, it
does not even include all of the public funds, which come from state
governments, state-supported universities, and other national
governments as well.  No one really knows how much all this adds up
to, although there are some research projects underway to try to
estimate the total U.S. expenditures on the Internet.  It has been
estimated---read ``guessed''--- that the NSF subsidy of $20 million
per year is less than 10% of the total U.S. expenditure on the
Internet.

What is the future for a federally-funded backbone?

The NSFNET backbone will likely be gone by the time this article is
published, or soon thereafter. With the proliferation of commercial
backbones and regional network interconnections, a general-purpose
federally subsidized backbone is no longer needed.  In the new NSF
awards just announced, the NSF will only fund a set of Network Access
Points (NAPs), which will be hubs to connect the many private
backbones and regional networks.  The NSF will also fund a service
that will provide fair and efficient routing among the various
backbones and regionals.  Finally, the NSF will fund a very-high speed
backbone network service (vBNS) connecting the six supercomputer
sites, with restrictions on the users and traffic that it can carry.
Its emphasis will be on developing capabilities for high-definition
remote visualization and video transmission.  The new U.S. network
structure will be less hierarchical and more interconnected. The
separation between the backbone and regional network layers of the
current structure will become blurred, as more regionals are connected
directly to each other through NAPs, and traffic passes through a
chain of regionals without any backbone transport.

What are independent providers?

Most users access the Internet through their employer's
organizational network, which is connected to a regional.  However,
in the past few years a number of for-profit independent providers of
Internet access have emerged.  These typically provide connections
between small organizations or individuals and a regional, using
either leased lines or dial-up access.  Starting in 1993 some of the
private computer networks (e.g., Delphi and World) have begun
to offer full Internet access to their customers (Compuserve and the
other private networks have offered e-mail exchange to the Internet
for several years).


Who provides access outside of the U.S.?

There are now a large number of backbone and mid-level networks in
other countries.  For example, most western European countries have
national networks that are attached to EBone, the European backbone.
The infrastructure is still immature, and quite inefficient in some
places.  For example, the connections between other countries often
are slow or of low quality, so it is common to see traffic between two
countries that is routed through the NSFNET in the U.S.
(\cite{BraunClaffy93}).

Technology

Is the Internet different from telephone networks?

Yes and no.  Most backbone and regional network traffic moves over
leased phone lines, so at a low level the technology is the same.
However, there is a fundamental distinction in how the lines are used
by the Internet and the phone companies.  The Internet provides
connectionless packet-switched service whereas telephone service is
circuit-switched. (We define these terms below.)  The difference may
sound arcane, but it has vastly important implications for pricing and
the efficient use of network resources.

What is circuit-switching?

Phone networks use circuit switching: an end-to-end circuit must be
set up before the call can begin.  A fixed share of network resources
is reserved for the call, and no other call can use those resources
until the original connection is closed.  This means that a long
silence between two teenagers uses the same resources as an active
negotiation between two fast-talking lawyers.  One advantage of
circuit-switching is that it enables performance guarantees such as
guaranteed maximum delay, which is essential for real-time
applications like voice conversations.  It is also much easier to do
detailed accounting for circuit-switched network usage.


How is packet-switching technology different from circuit-switching?

The Internet uses ``packet-switching'' technology.  The term
``packets'' refers to the fact that the data stream from your computer
is broken up into packets of about 200 bytes (on average), which are
then sent out onto the network.\footnote{Recall that a byte is equivalent
to one ASCII character.} Each packet contains a ``header'' with
information necessary for routing the packet from origination to
destination.  Thus each packet in a data stream is independent.

The main advantage of packet-switching is that it permits
``statistical multiplexing'' on the communications lines. That is, the
packets from many different sources can share a line, allowing for
very efficient use of the fixed capacity.  With current technology,
packets are generally accepted onto the network on a first-come,
first-served basis.  If the network becomes overloaded, packets are
delayed or discard (``dropped'').

How are packets routed to their destination?

The Internet technology is connectionless.  This means that there is
no end-to-end setup for a session; each packet is independently routed
to its destination.  When a packet is ready, the host computer sends
it on to another computer, known as a router. The router examines the
destination address in the header and passes the packet along to
another router, chosen by a route-finding algorithm.  A packet may go
through 30 or more routers in its travels from one host computer to
another.  Because routes are dynamically updated, it is possible for
different packets from a single session to take different routes to
the destination.

Along the way packets may be broken up into smaller packets, or
reassembled into bigger ones.  When the packets reach their final
destination, they are reassembled at the host computer.  The
instructions for doing this reassembly are part of the TCP/IP
protocol.

Some packet-switching networks are ``connection-oriented'' (notably,
X.25 networks, such as Tymnet and frame-relay networks). In such a
network a connection is set up before transmission begins, just as in
a circuit-switched network.  A fixed route is defined, and information
necessary to match packets to their session and defined route is
stored in memory tables in the routers.  Thus, connectionless networks
economize on router memory and connection set-up time, while
connection-oriented networks economize on routing calculations (which
have to be redone for every packet in a connectionless network).

What is the physical technology of the Internet?

Most of the network hardware in the Internet consists of
communications lines and switches or routers.  In the regional and
backbone networks, the lines are mostly leased telephone trunk lines,
which are increasingly fiber optic.  Routers are computers; indeed,
the routers used on the NSFNET are modified commercial IBM RS6000
workstations, although custom-designed routers by other companies such
as Cisco, Wellfleet, 3-Com and DEC probably have the majority share of
the market.


What does ``speed'' mean?

``Faster'' networks do not move electrons or photons at faster than
the speed of light; a single bit travels at essentially the same speed
in all networks.  Rather, ``faster'' refers to sending more bits of
information simultaneously in a single data stream (usually over a
single communications line), thus delivering n bits faster.  Phone
modem users are familiar with recent speed increases from 300 bps
(bits per second) to 2400, 9600 and now 19,200 bps.  Leased-line
network speeds have advanced from 56 Kbps (kilo, or 10^3 bps) to 1.5
Mbps (mega, or 10^6 bps, known as T-1 lines) in the late 80s, and
then to 45 Mbps (T-3) in the early 90s.  Lines of 155 Mbps are now
available, though not yet widely used.  The U.S.~Congress has called
for a 1 Gbps (giga, or 10^9 bps) backbone by 1995.

The current T-3 45 Mbps lines can move data at a speed of 1,400 pages
of text per second; a 20-volume encyclopedia can be sent coast to
coast on the NSFNET backbone in half a minute.  However, it is
important to remember that this is the speed on the superhighway---the
access roads via the regional networks usually use the much slower T-1
connections.

Why do data networks use packet-switching?

Economics can explain most of the preference for packet-switching over
circuit-switching in the Internet and other public networks.  Circuit
networks use lots of lines in order to economize on switching and
routing.  That is, once a call is set up, a line is dedicated to its
use regardless of its rate of data flow, and no further routing
calculations are needed.    This network design makes sense when lines
are cheap relative to switches.

The costs of both communications lines and computers have been
declining exponentially for decades.  However, since about 1970,
switches (computers) have become relatively cheaper than lines.  At
that point packet switching became economic: lines are shared by
multiple connections at the cost of many more routing calculations by
the switches.  This preference for using many relatively cheap routers
to manage few expensive lines is evident in the topology of the
backbone networks.  For example, in the NSFNET any packet coming on to
the backbone has to pass through two routers at its entry point and
again at its exit point.  A packet entering at Cleveland and exiting
at New York traverses four NSFNET routers but only one leased T-3
communications line.

What changes are likely in network technology?

At present there are many overlapping information networks (e.g.,
telephone, telegraph, data, cable TV), and new networks are emerging
rapidly (paging, personal communications services, etc.). Each of the
current information networks is engineered to provide a particular
type of service and the added value provided by each of the different
types was sufficient to overcome the fixed costs of building
overlapping physical networks.

However, given the high fixed costs of providing a network, the
economic incentive to develop an ``integrated services'' network is
strong.  Furthermore, now that all information can be easily digitized
separate networks for separate types of traffic are no longer
necessary.  Convergence toward a unified, integrated services
network is a basic feature in most visions of the much publicized
``information superhighway.''  The migration to integrated services
networks will have important implications for market structure and
competition.

The international telephone community has committed to a future
network design that combines elements of both circuit and packet
switching to enable the provision of integrated services.  The ITU
(formerly CCITT, an international standards body for
telecommunications) has adopted a ``cell-switching'' technology called
ATM (asynchronous transfer mode) for future high-speed networks.  Cell
switching closely resembles packet switching in that it breaks a data
stream into packets which are then placed on lines that are shared by
several streams.  One major difference is that cells have a fixed size
while packets can have different sizes.  This makes it possible in
principle to offer bounded delay guarantees (since a cell will not get
stuck for a surprisingly long time behind an unusually large packet).

An ATM network also resembles a circuit-switched network in that it
provides connection-oriented service.  Each connection has set-up
phase, during which a ``virtual circuit'' is created.  The fact that
the circuit is virtual, not physical, provides two major advantages.
First, it is not necessary to reserve network resources for a given
connection; the economic efficiencies of statistical multiplexing can
be realized.  Second, once a virtual circuit path is established
switching time is minimized, which allows much higher network
throughput.  Initial ATM networks are already being operated at 155
Mbps, while the non-ATM Internet backbones operate at no more than 45
Mbps.  The path to 1000 Mbps (gigabit) networks seems much clearer for
ATM than for traditional packet switching.

When will the ``information superhighway'' arrive?

The federal High Performance Computing Act of 1991 aimed for a gigabit
per second (Gbps) national backbone by 1995.  Six federally-funded
testbed networks are currently demonstrating various gigabit
approaches.  To get a feel for how fast a gigabit per second is, note
that most small colleges or universities today have 56 Kbps Internet
connections.  At 56 Kbps it takes about five hours to transmit one
gigabit!

Efforts to develop integrated services networks also have exploded.
Several cable companies have already started offering Internet
connections to their customers.\footnote{Because most cable networks are
one-way, these connections usually use an ``asymmetric'' network
connector that brings the input in through the TV cable at 10 Mbps,
but sends the output out through a regular phone line at about 14.4
Kbps.  This scheme may be popular since most users tend to download
more information than they upload.} ATT, MCI and all of the ``Baby
Bell'' operating companies are involved in mergers and joint ventures
with cable TV and other specialized network providers to deliver new
integrated services such as video-on-demand.  ATM-based networks,
although initially developed for phone systems, ironically have been
first implemented for data networks within corporations and by some
regional and backbone providers.


How is Internet access priced?

What types of pricing schemes are used?

Until recently, nearly all users faced the same pricing structure for
Internet usage.  A fixed-bandwidth connection was charged an annual
fee, which allowed for unlimited usage up to the physical maximum flow
rate (bandwidth).  We call this ``connection pricing''.  Most
connection fees were paid by organizations (universities, government
agencies, etc.) and the users paid nothing themselves.

Simple connection pricing still dominates the market, but a number of
variants have emerged.  The most notable is ``committed information
rate'' pricing.  In this scheme, an organization is charged a two-part
fee.  One fee is based on the bandwidth of the connection, which is
the maximum feasible flow rate; the second fee is based on the
maximum guaranteed flow to the customer.  The network provider
installs sufficient capacity to simultaneously transport the committed
rate for all of its customers, and installs flow regulators on each
connection.  When some customers operate below that rate, the excess
network capacity is available on a first-come, first-served basis for
the other customers.  This type of pricing is more common in private
networks than in the Internet because a TCP/IP flow rate can be
guaranteed only network by network, greatly limiting its value unless
a large number of the 20,000 Internet networks coordinate on offering
this type of guarantee.

Networks that offer committed information pricing generally have
enough capacity to meet the entire guaranteed bandwidth.  This is a
bit like a bank holding 100% reserves, but is necessary with existing
technology since there is no commonly used way to prioritize packets.

For most usage, the marginal packet placed on the Internet is priced
at zero.  At the outer fringes there are a few exceptions.  For
example, several private networks (such as Compuserve) provide email
connections to the Internet.  Several of these charge per message
above a low threshold.  The public networks in Chile and New Zealand
charge their customers by the packet for all international traffic.
We discuss some implications of this kind of pricing below.

What economic problems does the Internet face?

If you have read this far in the article, you should have a good basic
understanding of the current state of the Internet---we hope that most
of the questions you have had about the how the Internet works have
been answered.  Starting here we will move from FAQs and ``facts''
towards conjectures, FEOs (firmly expressed opinions), and PBIs
(partially baked ideas).

How can the Internet deal with increasing congestion?

Nearly all usage of the Internet backbones is unpriced at the margin.
Organizations pay a fixed fee in exchange for unlimited access up to
the maximum throughput of their particular connection.  This is a
classic problem of the commons. The externality exists because a
packet-switched network is a shared-media technology: each extra
packet that Sue User sends imposes a cost on all other users because the
resources Sue is using are not available to them.  This cost can come
in form of delay or lost (dropped) packets.

Without an incentive to economize on usage, congestion can become
quite serious.  Indeed, the problem is more serious for data networks
than for many other congestible resources because of the tremendously
wide range of usage rates.  On a highway, for example, at a given
moment a single user is more or less limited to putting either one or
zero cars on the road.  In a data network, however, single user at a
modern workstation can send a few bytes of e-mail or put a load of
hundreds of Mbps on the network.  Within a year any undergraduate with
a new Macintosh will be able to plug in a video camera and transmit
live videos home to mom, demanding as much as 1 Mbps.  Since the
maximum throughput on current backbones is only 45 Mbps, it is clear
that even a few users with relatively inexpensive equipment could
bring the network to its knees.

Congestion problems are not just hypothetical.  For example,
congestion was quite severe in 1987 when the NSFNET backbone was
running at much slower transmission speeds (56 Kbps).
%See ``Mitigating...'' page 2.
Users running interactive remote terminal sessions were experiencing
unacceptable delays.  As a temporary fix, the NSFNET programmed the
routers to give terminal sessions (using the telnet program)
higher priority than file transfers (using the ftp program).
(See \cite{Goffe94} paper for a description of telnet and ftp.)

More recently, many services on the Internet have experienced severe
congestion problems.  Large ftp archives, Web servers
at the National Center for Supercomputer Applications, the original
Archie site at McGill University and many services have had
serious problems with overuse.  See \cite{Markoff-Jams} for more
detailed descriptions.

If everyone just stuck to ASCII email congestion would not likely
become a problem for many years, if ever.  However, the demand for
multi-media services is growing dramatically.  New services such as
Mosaic and Internet Talk Radio are consuming ever-increasing amounts
of bandwidth.  The supply of bandwidth is increasing dramatically, but
so is the demand.  If usage remains unpriced is is likely that there
will be periods when the demand for bandwidth exceeds the supply in
the foreseeable future.

What non-price mechanisms can be used for congestion control?

Administratively assigning different priorities to different types of
traffic is appealing, but impractical as a long-run solution to
congestion costs due to the usual inefficiencies of rationing.
However, there is an even more severe technological problem: it is
impossible to enforce.  From the network's perspective, bits are bits
and there is no certain way to distinguish between different types of
uses.  By convention, most standard programs use a unique identifier
that is included in the TCP header (called the ``port'' number); this
is what NSFNET used for its priority scheme in 1987.  However, it is a
trivial matter to put a different port number into the packet headers;
for example to assign the telnet number to ftp packets to
defeat the 1987 priority scheme.  To avoid this problem, NSFNET kept
its prioritization mechanism secret, but that is hardly a long-run
solution.

What other mechanisms can be used to control congestion?  The most
obvious approach for economists is to charge some sort of usage price.
However, to date, there has been almost no serious consideration of
usage pricing for backbone services, and even tentative proposals for
usage pricing have been met with strong opposition.  We will discuss
pricing below but first we examine some non-price mechanisms that have
been proposed.

Many proposals rely on voluntary efforts to control congestion.
Numerous participants in congestion discussions suggest that peer
pressure and user ethics will be sufficient to control congestion
costs.  For example, recently a single user started broadcasting a
350--450Kbps audio-video test pattern to hosts around the world,
blocking the network's ability to handle a scheduled audio broadcast
from a Finnish university.  A leading network engineers sent a
strongly-worded e-mail message to the user's site administrator, and
the offending workstation was disconnected from the network.  However,
this example also illustrates the problem with relying on peer
pressure: the inefficient use was not terminated until after it had
caused serious disruption.  Further, it apparently was caused by a
novice user who did not understand the impact of what he had done; as
network access becomes ubiquitous there will be an ever-increasing
number of unsophisticated users who have access to applications that
can cause severe congestion if not properly used.  And of course, peer
pressure may be quite ineffective against malicious users who want to
intentionally cause network congestion.

One recent proposal for voluntary control is closely related to the
1987 method used by the NSFNET (\cite{Bohn93}).  This proposal would
require users to indicate the priority they want each of their
sessions to receive, and for routers to be programmed to maintain
multiple queues for each priority class.  Obviously, the success of
this scheme would depend on users' willingness to assign lower
priorities to some of their traffic.  In any case, as long as it is
possible for just one or a few abusive users to create crippling
congestion, voluntary priority schemes that are not robust to
forgetfulness, ignorance, or malice may be largely ineffective.

In fact, a number of voluntary mechanisms are in place today.  They
are somewhat helpful in part because most users are unaware of them,
or because they require some programming expertise to defeat.  For
example, most implementations of the TCP protocols use a ``slow
start'' algorithm which controls the rate of transmission based on the
current state of delay in the network.  Nothing prevents users from
modifying their TCP implementation to send full throttle if they do
not want to behave ``nicely.''

A completely different approach to reducing congestion is purely
technological: overprovisioning.  Overprovisioning means maintaining
sufficient network capacity to support the peak demands without
noticeable service degradation.\footnote{The effects of network
congestion are usually negligible until usage is very close to
capacity.} This has been the most important mechanism used to date in
the Internet.  However, overprovisioning is costly, and with both
very-high-bandwidth applications and near-universal access fast
approaching, it may become too costly.  In simple terms, will the cost
of capacity decline faster than the growth in capacity demand?

Given the explosive growth in demand and the long lead time needed to
introduce new network protocols, the Internet may face serious
problems very soon if productivity increases do not keep up.
Therefore, we believe it is time to seriously examine
incentive-compatible allocation mechanisms, such as various forms of
usage pricing.

How can users be induced to choose the right level of service?

The current Internet offers a single service quality: ``best efforts
packet service.''  Packets are transported first-come, first-served
with no guarantee of success.  Some packets may experience severe
delays, while others may be dropped and never arrive.

However, different kinds of data place different demands on network
services.  E-mail and file transfers requires 100% accuracy, but can
easily tolerate delay.  Real-time voice broadcasts require much higher
bandwidth than file transfers, and can only tolerate minor delays, but
they can tolerate significant distortion.  Real time video
broadcasts have very low tolerance for delay and distortion.

Because of these different requirements, network routing algorithms
will want to treat different types of traffic differently---giving
higher priority to, say, real-time video than to e-mail or file
transfer.  But in order to do this, the user must truthfully indicate
what type of traffic he or she is sending.  If real-time video bit
streams get the highest quality service, why not claim that all of
your bit streams are real-time video?

\cite{Estrin92a} point out that it is useful to look at network
pricing as mechanism design problem.  The user can indicate the
``type'' of his transmission, and the workstation in turn reports this
type to the network.  In order to ensure truthful revelation of
preferences, the reporting and billing mechanism must be incentive
compatible.  The field of mechanism design has been criticized for
ignoring bounded rationality of human subjects.  However, in this
context, the workstation is doing most of the computation, so that
quite complex mechanisms may be feasible.

What are the problems associated with Internet accounting?

One of the first necessary steps for implementing usage-based pricing
(either for congestion control or multiple service class allocation)
is to measure and account for usage.  Accounting poses some serious
problems.  For one thing, packet service is inherently ill-suited to
detailed usage accounting, because every packet is independent.  As an
example, a one-minute phone call in a circuit-switched network
requires one accounting entry in the usage database.  But in a packet
network that one-minute phone call would require around 2500
average-sized packets; complete accounting for every packet would then
require about 2500 entries in the database.  On the NSFNET alone
nearly 60 billion packets are being delivered each month.
Maintaining detailed accounting by the packet similar to phone company
accounting may be too expensive.

Another accounting problem concerns the granularity of the records.
Presumably accounting detail is most useful when it traces traffic to
the user.  Certainly if the purpose of accounting is to charge prices
as incentives, those incentives will be most effective if they affect
the person actually making the usage decisions.  But the network is at
best capable of reliably identifying the originating host computer
(just as phone networks only identify the phone number that placed a
call, not the caller).  Another layer of expensive and complex
authorization and accounting software will be required on the host
computer in order to track which user accounts are responsible for
which packets.\footnote{Statistical sampling could lower costs
substantially, but its acceptability depends on the level at which
usage is measured---e.g., user or organization---and on the
statistical distribution of demand.  For example, strong serial
correlation can cause problems.} Imagine, for instance, trying to
account for student e-mail usage at a large public computer cluster.

Accounting is more practical and less costly the higher the level of
aggregation.  For example, the NSFNET already collects some
information on usage by each of the subnetworks that connect to its
backbone (although these data are based on a sample, not an exhaustive
accounting for every packet).  Whether accounting at lower levels of
aggregation is worthwhile is a different question that depends
importantly on cost-saving innovations in internetwork accounting
methods.

Does network usage need to be priced?

Network resources are scarce, and thus some allocation scheme is
required.  We explained above why voluntary and technological
allocation mechanisms are unlikely to remain satisfactory.  Various
forms of usage pricing have desirable features for congestion control,
and are likely to be equally desirable for allocating multiple service
classes in an integrated services network.

In any case, voluntary schemes will require substantial
overprovisioning to handle the burstiness of demand, and the wide
range of bandwidths required by different applications.  Excess
capacity has been subsidized heavily---directly or
indirectly---through public funding.  While providing network
services as a zero marginal price public good probably made sense
during the research, development and deployment phases of the
Internet, it is harder to rationalize as the network matures and
becomes widely used by commercial interests.  Why should data network
usage be free even to universities, when telephone and postal usage
are not?\footnote{Many university employees routinely use email
rather than the phone to communicate with friends and family at other
Internet-connected sites.  Likewise, a service is now being offered
to transmit faxes between cities over the Internet for free, then
paying only the local phone call charges to deliver them to the
intended fax machine.}

Indeed, the Congress required that the federally-developed gigabit
network technology must accommodate usage accounting and pricing.
Further, the NSF will no longer provide backbone services, leaving the
general purpose public network to commercial and state agency
providers.  As the net increasingly becomes privatized, competitive
forces may necessitate the use of more efficient allocation
mechanisms.  Thus, it appears that there are both public and private
pressures for serious consideration of pricing.  The trick is to
design a pricing system that minimizes transactions costs.

What should be priced?

Standard economic theory suggests that prices should be matched to
costs.  There are three main elements of network costs: the cost of
connecting to the net, the cost of providing additional network
capacity, and the social cost of congestion.  Once capacity is in
place, direct usage cost is negligible, and by itself is almost surely
is not worth charging for given the accounting and billing
costs.\footnote{See \cite{JmmAndHrv93a}.}

Charging for connections is conceptually straightforward: a connection
requires a line, a router, and some labor effort.  The line and the
router are reversible investments and thus are reasonably charged for
on annual lease basis (though many organizations buy their own
routers).  Indeed, this is essentially the current scheme for Internet
connection fees.

Charging for incremental capacity requires usage information.
Ideally, we need a measure of the organization's demand during the
expected peak period of usage over some period, to determine its share
of the incremental capacity requirement.  In practice, it might seem
that a reasonable approximation would be to charge a premium price for
usage during pre-determined peak periods (a positive price if the base
usage price is zero), as is routinely done for electricity.  However,
casual evidence suggests that peak demand periods are much less
predictable than for other utility services.  One reason is that it is
very easy to use the computer to schedule some activities for off-peak
hours, leading to a shifting peaks problem.\footnote{The single largest
current use of network capacity is file transfer, much of which is
distribution of files from central archives to distributed local
archives.  The timing for a large fraction of file transfer is likely
to be flexible.  Just as most fax machines allow faxes to be
transmitted at off-peak times, large data files could easily be
transferred at off-peak times---if users had appropriate incentives to
adopt such practices.} In addition, so much traffic traverses long
distances around the globe that time zone differences are important.
Network statistics reveal very irregular time-of-day usage patterns
(\cite{JmmAndHrv93b}).

How might congestion be priced?

We have elsewhere described a scheme for efficient pricing of the
congestion costs (1994a,b).  The basic problem is that when the
network is near capacity, a user's incremental packet imposes costs on
other users in the form of delay or dropped packets.  Our scheme for
internalizing this cost is to impose a congestion price on usage that
is determined by a real-time Vickrey auction.  Following the
terminology of Vernon Smith and Charles Plott, we call this a ``smart
market.''

The basic idea is simple.  Much of the time the network is
uncongested, and the price for usage should be zero.  When the network
is congested, packets are queued and delayed.  The current queuing
scheme is FIFO.  We propose instead that packets should be prioritized
based on the value that the user puts on getting the packet through
quickly.  To do this, each user assigns her packets a bid measuring
her willingness-to-pay for immediate servicing.  At congested routers,
packets are prioritized based on bids.  In order to make the scheme
incentive-compatible, users are not charged the price they bid, but
rather are charged the bid of the lowest priority packet that
is admitted to the network.  It is well-known that this mechanism
provides the right incentives for truthful revelation.

This scheme has a number of nice features.  In particular, not only
do those with the highest cost of delay get served first, but the
prices also send the right signals for capacity expansion in a
competitive market for network services.  If all of the congestion
revenues are reinvested in new capacity, then capacity will be
expanded to the point where its marginal value is equal to its
marginal cost.

What are some problems with a smart market?

Prices in a real-world smart market cannot be updated continuously.
The efficient price is determined by comparing a list of user bids to
the available capacity and determining the cutoff price.  In fact,
packets arrive not all at once but over time, and thus it would be
necessary to clear the market periodically based on a time-slice of
bids.  The efficiency of this scheme, then, depends on how costly it
is to frequently clear the market and on how persistent the periods of
congestion are.  If congestion is exceedingly transient then by the
time the market price is updated the state of congestion may have
changed.

A number of network specialists have suggested that many
customers---particularly not-for-profit agencies and schools---will
object because they do not know in advance how much network
utilization will cost them.  We believe that this argument is
partially a red herring, since the user's bid always controls the {\it
maximum network usage costs.  Indeed, since we expect that for most
traffic the congestion price will be zero, it should be possible for
most users to avoid ever paying a usage charge by simply setting all
packet bids to zero.\footnote{Since most users are willing to tolerate
some delay for email, file transfer and so forth, most traffic should
be able to go through with acceptable delays at a zero congestion
price, but time-critical traffic will typically pay a positive price.}
When the network is congested enough to have a positive congestion
price, these users will pay the cost in units of delay rather than
cash, as they do today.

We also expect that in a competitive market for network services,
fluctuating congestion prices would usually be a ``wholesale''
phenomenon, and that intermediaries would repackage the services and
offer them at a guaranteed price to end-users.  Essentially this would
create a futures market for network services.

There are also auction-theoretic problems that have to be solved.  Our
proposal specifies a single network entry point with auctioned access.
In practice, networks have multiple gateways, each subject to
differing states of congestion.  Should a smart market be located in a
single, central hub, with current prices continuously transmitted to
the many gateways?  Or should a set of simultaneous auctions operate
at each gateway?  How much coordination should there be between the
separate auctions?  All of these questions need not only theoretical
models, but also empirical work to determine the optimal rate of
market-clearing and inter-auction information sharing, given the costs
and delays of real-time communication.

Another serious problem for almost any usage pricing scheme is how to
correctly determine whether sender or receiver should be billed.  With
telephone calls it is clear that in most cases the originator of a
call should pay.  However, in a packet network, both ``sides''
originate their own packets, and in a connectionless network there is
no mechanism for identifying party B's packets that were solicited as
responses to a session initiated by party A.  Consider a simple
example: A major use of the Internet is for file retrieval from public
archives.  If the originator of each packet were charged for that
packet's congestion cost, then the providers of free public goods (the
file archives) would pay nearly all of the congestion charges induced
by a user's file request.\footnote{Public file servers in Chile and New
Zealand already face this problem: any packets they send in response
to requests from foreign hosts are charged by the network.  Network
administrators in New Zealand are concerned that this blind charging
scheme is stifling the production of information public goods.  For
now, those public archives that do exist have a sign-on notice
pleading with international users to be considerate of the costs they
are imposing on the archive providers.} Either the public archive
provider would need a billing mechanism to charge requesters for the
(ex post) congestion charges, or the network would need to be
engineered so that it could bill the correct party.  In principle this
problem can be solved by schemes like ``800'', ``900'' and collect
phone calls, but the added complexity in a packetized network may make
these schemes too costly.

How large would congestion prices be?

Consider the average cost of the current NSFNET backbone: about
$10^6 per month, for about 60,000x10^6 packets per month.
This implies a cost per packet (around 200 bytes) of about 1/600
cents.  If there are 20 million users of the NSFNET backbone (10 per
host computer), then full cost recovery of the NSFNET subsidy would
imply an average monthly bill of about $0.08 per person.  If we
accept the estimate that the total cost of the U.S. portion of the
Internet is about 10 times the NSFNET subsidy, we come up with 50
cents per person per month for full cost recovery.  The
revenue from congestion fees would presumably be significantly less
than this amount.\footnote{If revenue from congestion fees exceeded the
cost of the network, it would be profitable to expand the size of the
network.}

The average cost of the Internet is so small today because the
technology is so efficient: the packet-switching technology allows for
very cost-effective use of existing lines and switches.  If everyone
only sent ASCII email, there would probably never be congestion
problems on the Internet.  However, new applications are creating huge
demands for additional bandwidth.  A video e-mail message
could easily use 10^4 more bits than a plain text ASCII e-mail with
the ``same'' information content and providing this amount of
incremental bandwidth could be quite expensive.  Well-designed
congestion prices would not charge everyone the average cost of this
incremental bandwidth, but instead charge those users whose demands
create the congestion and need for additional capacity.

How should information services be priced?

Our focus thus far has been on the technology, costs and pricing of
network transport.  However, most of the value of the network is not
in the transport, but in the value of the information being
transported.  For the full potential of the Internet to be realized
it will be necessary to develop methods to charge for the value of
information services available on the network.

There are vast troves of high-quality information (and probably
equally large troves of dreck) currently available on the Internet,
all available as free goods.  Historically, there has been a strong
base of volunteerism to collect and maintain data, software and other
information archives.  However, as usage explodes, volunteer providers
are learning that they need revenues to cover their costs.  And of
course, careful researchers may be skeptical about the quality of any
information provided for free.

Charging for information resources is quite a difficult problem.  A
service like Compuserve charges customers by establishing a billing
account.  This requires that users obtain a password, and that the
information provider implement a sophisticated accounting and billing
infrastructure. However, one of the advantages of the Internet is that
it is so decentralized: information sources are located on thousands
of different computers.  It would simply be too costly for every
information provider to set up an independent billing system and give
out separate passwords to each of its registered users.  Users could
end up with dozens of different authentication mechanisms for
different services.

A deeper problem for pricing information services is that our
traditional pricing schemes are not appropriate.  Most pricing is
based on the measurement of replications: we pay for each copy of a
book, each piece of furniture, and so forth.  This usually works
because the high cost of replication generally prevents us from
avoiding payment.  If you buy a table we like, we generally have to go
to the manufacturer to buy one for ourselves; we can't just simply
copy yours.  With information goods the pricing-by-replication scheme
breaks down. This has been a major problem for the software industry:
once the sunk costs of software development are invested, replication
costs essentially zero.  The same is especially true for any form of
information that can be transmitted over the network.  Imagine, for
example, that copy shops begin to make course packs available
electronically.  What is to stop a young entrepreneur from buying one
copy and selling it at a lower price to everyone else in the class?
This is a much greater problem even than that which publishers face
from unauthorized photocopying, since the cost of replication is
essentially zero.

There is a small literature on the economics of copying that examines
some of these issues.  However, the same network connections that
exacerbate the problems of pricing ``information goods'' may also help
to solve some of these problems.  For example, \cite{Cox92} describes
the idea of ``superdistribution'' of ``information objects'' in which
accessing a piece of information automatically sends a payment to the
provider via the network.  However, there are several problems
remaining to be solved before such schemes can become widely used.

What is required for electronic commerce over th
Internet?}

Some companies have already begun to advertise and sell products and
services over the Internet.  Home shopping is expected to be a major
application for future integrated services networks that transport
sound and video.  Electronic commerce could substantially increase
productivity by reducing the time and other transactions costs
inherent in commerce, much as mail-order shopping has already begun to
do.  One important requirement for a complete electronic commerce
economy is an acceptable form of electronic payment.\footnote{In our work
on pricing for network transport (1994a, 1994b), we have found that
some form of secure electronic currency is almost surely necessary if
the transactions costs of accounting and billing are to be low enough
to justify usage pricing.}

Bank debit cards and automatic teller cards work because they have
reliable authentication procedures based on both a physical device and
knowledge of a private code. Digital currency over the network is more
difficult because it is not possible to install physical devices and
protect them from tampering on every workstation.\footnote{Traditional
credit cards are unlikely to receive wide use over a data network,
though there is some use currently.  It is very easy to set up an
untraceable computer account to fraudulently collect credit card
numbers; fraudulent telephone mail order operations are more difficult
to arrange.}  Therefore, authentication and authorization most likely
will be based solely on the use of private codes.  Another objective
is anonymity so individual buying histories cannot be collected and
sold to marketing agencies (or Senate confirmation committees).

A number of recent computer science papers have proposed protocols for
digital cash, checks and credit, each of which has some desirable
features, yet none of which has been widely implemented thus far.  The
seminal paper is \cite{Chaum85} which proposed an anonymous form of
digital cash, but one which required a single central bank to
electronically verify the authenticity of each ``coin'' when it was
used.  \cite{MedvinskyNeuman93} propose a form of digital check that
is not completely anonymous, but is much more workable for widespread
commerce with multiple banks.  \cite{Low94a} suggest a protocol for
anonymous credit cards.


What does the Internet mean for telecommunications regulation?

The growth of data networks like the Internet are an
increasingly important motivation for regulatory reform of
telecommunications.  A primary principle of the current regulatory
structure, for example, is that local phone service is a natural
monopoly, and thus must be regulated.  However, local phone companies
face ever-increasing competition from data network services.  For
example, the fastest growing component of telephone demand has been
for fax transmission, but fax technology is better suited to
packet-switching networks than to voice networks, and faxes are
increasingly transmitted over the Internet.  As integrated services
networks emerge, they will provide an alternative for voice calls and
video conferencing, as well.  This ``bypass'' is already occurring in the
advanced private networks that many corporations, such as General
Electric, are building.

As a result, the trend seems to be toward removing of barriers against
cross-ownership of local phone and cable TV companies. The regional
Bell operating companies have filed a motion to remove the remaining
restrictions of the Modified Final Judgement that created them (with
the 1984 breakup of ATT). The White House, Congress, and the FCC are
all developing new models of regulation, with a strong bias towards
deregulation (for example, see the New York Times, 12 January
1994, p. 1).

Internet transport itself is currently unregulated. This is consistent
with the principal that common carriers are natural monopolies, and
must be regulated, but the services provided over those common
carriers are not.  However, this principal has never been consistently
applied to phone companies: the services provided over the phone lines
are also regulated.  Many public interest groups are now arguing for
similar regulatory requirements for the Internet.

One issue is ``universal access,'' the assurance of basic service for
all citizens at a very low price.  But what is ``basic service''?  Is it
merely a data line, or a multimedia integrated services connection?
And in an increasingly competitive market for communications services,
where should the money to subsidize universal access be raised?
High-value uses which traditionally could be charged premium prices by
monopoly providers are increasingly subject to competition and bypass.

A related question is whether the government should provide some data
network services as public goods.  Some initiatives are already
underway.  For instance, the Clinton administration has required that
all published government documents be available in electronic form.
Another current debate concerns the appropriate access subsidy for
primary and secondary teachers and students.

What will be the market structure of the information highway?

If different components of local phone and cable TV networks are
deregulated, what degree of competition is likely?  Similar questions
arise for data networks.  For example, a number of observers believe
that by ceding backbone transport to commercial providers, the federal
government has endorsed above-cost pricing by a small oligopoly of
providers.  Looking ahead, equilibrium market structures may be quite
different for the emerging integrated services networks than they are
for the current specialized networks.

One interesting question is the interaction between pricing schemes
and market structure. If competing backbones continue to offer only
connection pricing, would an entrepreneur be able to skim off
high-value users by charging usage prices, but offering more efficient
congestion control?  Alternatively, would a flat-rate connection price
provider be able to undercut usage-price providers, by capturing a
large share of low-value ``baseload'' customers who prefer to pay for
congestion with delay rather than cash?  The interaction between
pricing and market structure may have important policy implications,
because certain types of pricing may rely on compatibilities between
competing networks that will enable efficient accounting and billing.
Thus, compatibility regulation may be needed, similar to the
interconnect rules imposed on regional Bell operating companies.

Further Reading

We have written two papers that provide further details on Internet
technology, costs, and pricing problems (1994a, 1994b).  In addition,
a longer and more up-to-date version of this paper is available as a
World Wide Web (WWW) document, with hypertext links to many related
papers and data sources.  These files can be found at
http://gopher.econ.lsa.umich.edu.

Scott Shenker and his colleagues have written two papers dealing with
pricing problems and the use of mechanism design to deal with them
(\cite{Estrin92a}, \cite{Shenker93}, \cite{Shenker91}).
\cite{HubermanBook88} is a book that discusses computer networks as
market economies.

\cite{Partridge93} has written an excellent book for a general
audience interested in network technology now and in the near future.
For a detailed discussion of computer networking theory and
technologies, see \cite{Tanenbaum89}.  The best detailed treatment of
the emerging ATM technology is \cite{DePrycker93}.



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