Journey to the Center of the Internet — continued

by Gordon Cook [May 24, 2004]

Farooq, in his discussion with me on April 4, detailed all the ways that providers of best effort service have found to drive prices through the floor. While home users and small businesses may have to make do with cheap best effort service, large business enterprises need something better than best effort service. This has been clearly understood since the mid 1990s. However, the technology to give it then wasn't ready, and the idea that it might be really needed for the further progress of the industry drowned among the waves of dot com speculation that ended the decade.

Plain and simple, in the best effort universe there was and still is no incentive to deliver any defined quality of service to someone on a competitor's network because with no settlements there were no means of getting paid for such a delivery. David Isenberg's famous stupid network paper of June 1997 argued that a digital end-to-end based IP network would be an orders of magnitude more cost effective for delivering telecommunication services. What never became clear, even after a trillion dollars were lost, is how to deal with the problem that without settlements there is no incentive for anyone to treat the customer of a competitor fairly.

Because inter provider settlements aren't practicable, every carrier in the game (well at least those in the American side of the game) is still caught up in the fantasy of trying to sell all the global connectivity any enterprise will ever need without ever having to traverse someone else's infrastructure.

The foundations are broken.

How much value can value-added services add?
For the last few years most industry discussion has focused on killer apps that would use lots of bandwidth and somehow bring in new revenue. However, if the fundamental economic structure on which the best effort network today works is broken, finding new applications to use new bandwidth will only be like adding new rooms to a termite infested and collapsing castle, sucking in more wealth to be inexorably chewed up without payback.

We see three groups on the best effort playing field:

• The Local Exchange Carriers in the US and National Carriers in Europe and Asia.
• Others who though various technology platforms and business models sell end user services.
• The long haul fiber players (Level 3, Global Crossing, Sprint, AT&T, MCI).

The local or national carriers have value only by virtue of the fact that they tend to have more customers directly attached to them. It can be argued that the long haul fiber players and sellers of end user services have set themselves up in the new optical backbone IP packet arena in such a way that they can be continuously by-passed. They are the interstate highways over which companies with business customers send packets. Companies with local customers will need to pay tolls to get traffic to other local customers.

But their fiber is a commodity. Carrier-neutral Internet business exchanges ensure give customers direct access to fiber, without forcing them to rely on any specific carrier. This creates the condition for commoditization and price competition down to cost pricing and even below cost pricing. For enterprise customers, the network acts as an enabler of topology bypass.

But such customers also have a second form of bypassing a direct business relationship with the owners of the core networks. This bypass operates at the protocol stack level and is driven by companies who buy bandwidth at layer two and deliver VPN services to the end user edges at layer 3. Topology bypass: if you don't get a low enough price at a carrier pop, just go to a neutral exchange and you can shop from carrier racks that will undercut each other with vigor to get your business. Protocol bypass: price still not low enough? Then buy VLAN service or VPN service from a party colocated at exchanges that operates as a carrier to deliver your traffic even more cheaply to whatever set of destinations you need.

Last one standing foots the bill
In the 1980s deregulated phone network, the carrier in the center was assumed to have the value proposition, and had to share fees for call origination and termination. Twenty years later, enabled by the IP protocol, the edges have effectively bypassed of the center. The center has been left without a value proposition while ironically it is still expected to pay termination fees to the edge.

A key future question may well be whether the center can ever deliver a value proposition to the edge. Best effort has no value beyond that of an ever deflating commodity. In this context, a critical future question may be wrapped up in the issue of whether QoS services can ever be constructed in such a way that they return a monetary value proposition to the center.

In our extended discussion, Dave Siegel, who runs Global Crossing's backbone, says: "At $25/meg, I'm already below what I believe my cost is to add additional bandwidth." Here is the COOK Report's translation of what Dave is saying: it would seem that income from long haul IP networks may be sinking below the cost of operations (let alone the cost of capital equipment and the amortization of same). Current best effort operations are devouring capital derived from sales of existing bonds or efforts to float new ones. Creative accounting may use income from other operations (depending on the business) to mask the flow of red ink. The ability to buy up assets for less than their cash value enables the deflationary spiral to continue.

Level 3—not yet bankrupt—has a business plan to be the last greenfield player standing. Yet a look at its 10-Q filing for the time period from January through March of 2004 shows a continued down hill slide in current assets from $1.946 billion a year ago to 1.747 billion now. In our opinion, even Level 3 will eventually run out of cash.

Given current circumstances as dominated by a best effort operational mindset, bandwidth will be paid for at some point in the future in one of two ways: either by devouring investors' remaining equity, or by public funds, through government purchase of services or taxpayer funded bailouts.

Nevertheless we have assembled a panel of the best minds in the industry to grapple with the problems and formulate some emergent models on which to build in order to emerge from the devastation.

A final installment will be published in mid June and will contain further discussion of MPLS, flow routing, QoS, and network economics. One emergent model could include launching a QoS provider built from assets that may be purchased at fire sale prices. For the summary of issue 13.04 of The Cook Report on Internet, its table of contents, and the list of expert participants in the dicussion, click here.

—End

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