My friend Tim Lee has an article at Vox that argues that interconnection is the new frontier on which the battle for the future of the Internet is being waged. I think the article doesn’t really consider how interconnection has worked in the last few years, and consequently, it makes a big deal out of something that is pretty harmless.
How the Internet used to work
The Internet is a network of networks. Your ISP is a network. It connects to the other ISPs and exchanges traffic with them. Since connections between ISPs are about equally valuable to each other, this often happens through “settlement-free peering,” in which networks exchange traffic on an unpriced basis. The arrangement is equally valuable to both partners.
Not every ISP connects directly to every other ISP. For example, a local ISP in California probably doesn’t connect directly to a local ISP in New York. If you’re an ISP that wants to be sure your customer can reach every other network on the Internet, you have to purchase “transit” services from a bigger or more specialized ISP. This would allow ISPs to transmit data along what used to be called “the backbone” of the Internet. Transit providers that exchange roughly equally valued traffic with other networks themselves have settlement-free peering arrangements with those networks.
How the Internet works now
A few things have changed in the last several years. One major change is that most major ISPs have very large, geographically-dispersed networks. For example, Comcast serves customers in 40 states, and other networks can peer with them in 18 different locations across the US. These 18 locations are connected to each other through very fast cables that Comcast owns. In other words, Comcast is not just a residential ISP anymore. They are part of what used to be called “the backbone,” although it no longer makes sense to call it that since there are so many big pipes that cross the country and so much traffic is transmitted directly through ISP interconnection.
Another thing that has changed is that content providers are increasingly delivering a lot of a) traffic-intensive and b) time-sensitive content across the Internet. This has created the incentive to use what are known as content-delivery networks (CDNs). CDNs are specialized ISPs that locate servers right on the edge of all terminating ISPs’ networks. There are a lot of CDNs—here is one list.
By locating on the edge of each consumer ISP, CDNs are able to deliver content to end users with very low latency and at very fast speeds. For this service, they charge money to their customers. However, they also have to pay consumer ISPs for access to their networks, because the traffic flow is all going in one direction and otherwise CDNs would be making money by using up resources on the consumer ISP’s network.
CDNs’ payments to consumer ISPs are also a matter of equity between the ISP’s customers. Let’s suppose that Vox hires Amazon CloudFront to serve traffic to Comcast customers (they do). If the 50 percent of Comcast customers who wanted to read Vox suddenly started using up so many network resources that Comcast and CloudFront needed to upgrade their connection, who should pay for the upgrade? The naïve answer is to say that Comcast should, because that is what customers are paying them for. But the efficient answer is that the 50 percent who want to access Vox should pay for it, and the 50 percent who don’t want to access it shouldn’t. By Comcast charging CloudFront to access the Comcast network, and CloudFront passing along those costs to Vox, and Vox passing along those costs to customers in the form of advertising, the resource costs of using the network are being paid by those who are using them and not by those who aren’t.
What happened with the Netflix/Comcast dust-up?
Netflix used multiple CDNs to serve its content to subscribers. For example, it used a CDN provided by Cogent to serve content to Comcast customers. Cogent ran out of capacity and refused to upgrade its link to Comcast. As a result, some of Comcast’s customers experienced a decline in quality of Netflix streaming. However, Comcast customers who accessed Netflix with an Apple TV, which is served by CDNs from Level 3 and Limelight, never had any problems. Cogent has had peering disputes in the past with many other networks.
To solve the congestion problem, Netflix and Comcast negotiated a direct interconnection. Instead of Netflix paying Cogent and Cogent paying Comcast, Netflix is now paying Comcast directly. They signed a multi-year deal that is reported to reduce Netflix’s costs relative to what they would have paid through Cogent. Essentially, Netflix is vertically integrating into the CDN business. This makes sense. High-quality CDN service is essential to Netflix’s business; they can’t afford to experience the kind of incident that Cogent caused with Comcast. When a service is strategically important to your business, it’s often a good idea to vertically integrate.
It should be noted that what Comcast and Netflix negotiated was not a “fast lane”—Comcast is prohibited from offering prioritized traffic as a condition of its merger with NBC/Universal.
What about Comcast’s market power?
I think that one of Tim’s hangups is that Comcast has a lot of local market power. There are lots of barriers to creating a competing local ISP in Comcast’s territories. Doesn’t this mean that Comcast will abuse its market power and try to gouge CDNs?
Let’s suppose that Comcast is a pure monopolist in a two-sided market. It’s already extracting the maximum amount of rent that it can on the consumer side. Now it turns to the upstream market and tries to extract rent. The problem with this is that it can only extract rents from upstream content producers insofar as it lowers the value of the rent it can collect from consumers. If customers have to pay higher Netflix bills, then they will be less willing to pay Comcast. The fact that the market is two-sided does not significantly increase the amount of monopoly rent that Comcast can collect.
Interconnection fees that are being paid to Comcast (and virtually all other major ISPs) have virtually nothing to do with Comcast’s market power and everything to do with the fact that the Internet has changed, both in structure and content. This is simply how the Internet works. I use CloudFront, the same CDN that Vox uses, to serve even a small site like my Bitcoin Volatility Index. CloudFront negotiates payments to Comcast and other ISPs on my and Vox’s behalf. There is nothing unseemly about Netflix making similar payments to Comcast, whether indirectly through Cogent or directly, nor is there anything about this arrangement that harms “the little guy” (like me!).
For more reading material on the Netflix/Comcast arrangement, I recommend Dan Rayburn’s posts here, here, and here. Interconnection is a very technical subject, and someone with very specialized expertise like Dan is invaluable in understanding this issue.
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