The Western European Internet Market - continued

2        The Residential Sector:
Evolution of Dial-up Interconnect Structures

During the past two years, the economics of the Western European residential market have undergone fundamental restructuring. For some time, price competition throughout most of the Western European market has been intense, but towards the close of 1998 a number of organisations began to offer access services without the monthly subscription fee normally charged by ISPs in the dial-up segment. By the end of 1999 subscription-free services were available in Belgium, France, Germany, Italy, the Netherlands, Spain, Sweden, Switzerland and the UK. In addition, several of the subscription-free ISPs, including Freeserve, LibertySurf and X-Stream, had begun to extend their operations outside their domestic markets. In a further development, a number of ISPs in the UK, such as Net Call 0800 and NTL, began offering unmetered access services during the first half of 2000.

The launch of such services has been underpinned by the evolving interconnect regimes governing the exchange of traffic between the main categories of player involved in the transfer of dial-up traffic from the end user to the ISP’s first physical point of presence (POP)—the ISP, the incumbent local exchange carrier (ILEC) and the other local operator (OLO). This evolution is described in the following sections.

2.1              ISP/OLO Partnerships

Because the majority of ISPs possess no local loop infrastructure and have only limited local POP infrastructure, they have been forced to rely heavily upon the networks of the ILECs and OLOs for the delivery of their services. ISPs have therefore for several years remained customers of their network providers, purchasing facilities (local access, leased lines and virtual points of presence (VPOPs)) at volume-based discount rates, and relying on subscription revenue from their end users to cover their costs and generate a profit.

This situation is now changing throughout Western Europe, as ISPs that have accumulated large subscriber bases – which generate large amounts of Internet Protocol (IP) traffic—have been able to bargain with the OLOs for a share of the revenue that the OLOs receive from the interconnect payments system. Such revenue-sharing agreements can take a number of forms, depending upon the size of the access provider and whether or not the company owns a telecoms operator’s (TO) licence. Typically, however, an ISP with a large subscriber base uses a network operator other than its customers’ ILEC for termination of its call traffic, the end user pays the ILEC the local access call charge, the ILEC pays the ISP’s OLO for terminating the call, and the OLO shares some of that payment with the ISP (see Figure 1). The availability of this additional source of revenue has enabled ISPs to begin offering access services to their customers without a monthly subscription fee.

Figure 1 Evolution of ISP interconnection: ISP as partner
[Source: Analysys, 2000].

The subscription-free model allows ISPs to achieve rapid acceleration in growth of their subscriber bases, and to make substantial cost savings by removing the need to bill customers. ISPs also hope that their share of the interconnect payments will generate enough revenue in the short term to enable them to cover the cost of their operations.

Following the launch of services of companies such as Freeserve in the UK during late 1998, the practice of offering subscription-free services funded by interconnect revenue sharing spread throughout Western Europe during 1999 and 2000, facilitated by the liberalisation of the majority of telecoms markets in the European Union at the beginning of 1998. As access service price competition has intensified, ISPs have become eager to gain market share in order to fund their operations solely on the basis of advertising and ecommerce transactions; in the medium term they seek to generate most of their income (some forecasts suggest up to 70%) from such commissions and attain profitability. To accelerate subscriber growth further, a number have also begun to offer unmetered access services to their users (as shown in Figure 2). The first companies to introduce such services did so with the addition of a monthly subscription, but several have now announced services without a monthly charge to the end user. Typically, ISPs employing this model purchase their connectivity on a wholesale basis from the OLO, which in turn buys local access on a wholesale basis from the ILEC.

Figure 2: The unmetered access business model
[Source: Analysys, 2000].

For any interconnect deal at all, OLOs usually bear the burden of establishing the interconnect deal with the ILEC. Unlike the case with ISPs, interconnect rights and numbering resources for OLOs are set out within the licensing framework for Western European TOs. Many of them have used their licensed status, along with rapid growth in demand for Internet facilities on the part of ISPs, to establish healthy wholesale IP transmission businesses. The core of this business in the residential sector has been the deployment of extensive VPOP networks, through which OLOs are able to aggregate the traffic of smaller ISPs and benefit from the local call interconnect payments they receive from the ILECs. Companies such as Energis in the UK and Retevisión in Spain have realised that achieving economies of scale enables them both to cover the costs they incur from the provision of VPOP services and to offer ISPs a share of the interconnect payments they receive in order to generate loyalty and attract further business.

Some of these companies are ‘light carriers’, operators which, while possessing only limited telecoms facilities, are able to exploit voice regulation frameworks to generate significant revenue from interconnect payments. In particular, with the introduction of number translation services, OLOs are able to create substantial income by offering VPOP services to ISPs. Simply by operating their own single voice switches to collect the traffic generated by the customers of their ISP partners (as in Figure 3), these companies have been able to develop successful businesses. In the UK, for example, Telinco (acquired by World Online in January 2000) began offering its ‘Callshare’ and ‘Virtual ISP’ services towards the end of 1998, and by the end of 1999 had 78 ISPs on its customer list, which it claimed accounted for around 10% of the UK’s overall dial-up market.

Figure 3: Light carrier interconnection for ISP services (illustrative)
[Source: Analysys, 2000].

A number of operators with more developed telecoms and IP infrastructure have also begun offering a full set of wholesale services that makes it possible for companies to become virtual ISPs—in other words, to offer Internet access services while possessing no infrastructure of their own. This phenomenon is particularly advanced within the UK, for example, with providers including Cable & Wireless, Energis, NTL and UUNET now offering such services, but has spread throughout the rest of Western Europe as OLOs in the other countries have sought to capture additional sources of revenue that are less under the control of the ILECs than voice services.

1. Introduction <	3. The Business Sector
2. The Residential Sector	3b. Developing Competitive Advantage
> 2b. ISP and ILEC as Interconnect Partners	4. Market Outlook