Prepared For: GSM Association 71 High Holborn London WC1V E6A United Kingdom Economic study on IP interworking Prepared By: Bridger Mitchell, Paul Paterson, Moya Dodd, Paul Reynolds, Astrid Jung of CRA International Peter Waters, Rob Nicholls, Elise Ball of Gilbert + Tobin Date: 2 March 2007 TABLE OF CONTENTS EXECUTIVE SUMMARY .................................................................................................. 1 1. INTRODUCTION........................................................................................................ 8 1.1. AIM AND SCOPE..............................................................................................................8 1.2. STRUCTURE OF THE REPORT...........................................................................................9 2. IP INTERCONNECTION IN THE CURRENT PUBLIC INTERNET ......................... 10 2.1. INTRODUCTION.............................................................................................................10 2.1.1. Implications of packet switching and circuit switching ................................................ 10 2.2. INTERCONNECTING IP NETWORKS .................................................................................11 2.2.1. Direct interconnection................................................................................................. 11 2.2.2. Indirect interconnection .............................................................................................. 12 2.3. ANY-TO-ANY CONNECTIVITY ..........................................................................................13 3. INTERCONNECTION PRICING MODELS IN CURRENT INTERNET.................... 15 3.1. OPERATOR HIERARCHY WITHIN THE INTERNET ...............................................................15 3.2. BASIS OF CHARGING .....................................................................................................17 3.3. INTERNET PRICING MODELS FOR DIRECT INTERCONNECTION ...........................................17 3.3.1. Interconnection between Tier 1 IAPs.......................................................................... 18 3.3.2. Interconnection between Tier 1 IAPs and Tier 2 ISPs................................................ 20 3.3.3. Interconnection between Tier 2 and Tier 3 ISPs......................................................... 21 3.3.4. Initiating Party Network Pays (IPNP).......................................................................... 21 3.4. WHO PAYS FOR TRANSIT?.............................................................................................22 3.4.1. Multiple charging models applied in a single internet session .................................... 23 3.5. WHAT IS PAID FOR?......................................................................................................26 3.6. CURRENT TECHNOLOGY SHAPES INTERCONNECTION CHARGING MODELS ........................26 4. THE CHANGING WORLD OF IP............................................................................. 29 4.1. INTRODUCTION.............................................................................................................29 4.2. NEXT GENERATION NETWORKS ....................................................................................29 4.2.1. Introduction ................................................................................................................ 29 4.2.2. NGN architecture........................................................................................................ 30 4.3. QUALITY OF SERVICE....................................................................................................31 4.4. NGN INTERCONNECTION ..............................................................................................32 4.5. IPX .............................................................................................................................33 Page ii 5. DETERMINANTS OF EFFICIENT IP INTERCONNECTION FEES ........................ 37 5.1. INTRODUCTION.............................................................................................................37 5.2. THE MEANING OF ECONOMIC EFFICIENCY .......................................................................37 5.2.1. Components of efficiency ........................................................................................... 38 5.2.2. Relationship to consumer welfare and competition .................................................... 39 5.2.3. Market outcomes of economic efficiency.................................................................... 39 5.3. WHO SHOULD PAY FOR INTERCONNECTION?...................................................................42 5.3.1. The economic role of interconnection charges........................................................... 43 5.3.2. Determining the efficient retail model ......................................................................... 44 5.3.3. Efficient direct interconnection ................................................................................... 48 5.3.4. Efficient transit interconnection .................................................................................. 52 5.3.5. The combination of efficient direct and transit interconnection................................... 54 5.3.6. Efficient interconnection charges when traffic is balanced ......................................... 55 5.3.7. Quality of service in efficient interconnection ............................................................. 55 5.3.8. Welfare consequences of inefficient interconnect charges......................................... 57 5.4. THE EFFICIENCY OF MULTIPLE IP INTERCONNECTION MODELS.........................................61 5.5. CONCLUSION ...............................................................................................................62 5.5.1. The role of interconnection fees in determining market outcomes ............................. 62 5.5.2. Circumstances determining the efficient interconnection fee ..................................... 63 6. ECONOMIC ASSESSMENT OF ALTERNATIVE CHARGING MODELS................ 69 6.1. INTRODUCTION.............................................................................................................69 6.2. EFFICIENCY OF “BILL-AND-KEEP”...................................................................................70 6.2.1. Direct interconnection................................................................................................. 71 6.2.2. Transit ........................................................................................................................74 6.2.3. BAK in the presence of QoS differentiation ................................................................ 75 6.2.4. BAK imposed by regulation ........................................................................................ 77 6.2.5. Conclusion .................................................................................................................78 6.3. EFFICIENCY OF IPNP....................................................................................................80 6.3.1. IPNP when interconnection price is held constant...................................................... 81 6.3.2. Enhanced performance of IPNP when interconnection fees can vary........................ 84 6.3.3. IPNP imposed by regulation....................................................................................... 85 6.3.4. Conclusion .................................................................................................................85 6.4. EFFICIENCY OF RPNP ..................................................................................................86 6.4.1. RPNP when interconnection fees are held constant .................................................. 87 6.4.2. Enhanced performance of RPNP when interconnection fees can vary ...................... 88 6.4.3. RPNP and regulation.................................................................................................. 88 6.4.4. Conclusion .................................................................................................................89 6.5. EFFICIENCY OF SETTLEMENT-BASED INTERCONNECTION (SBI) ........................................89 6.6. CONCLUSION ...............................................................................................................90 Page iii 6.6.1. Direct interconnection................................................................................................. 90 6.6.2. Transit ........................................................................................................................92 7. POLICY IMPLICATIONS.......................................................................................... 93 7.1. INTRODUCTION.............................................................................................................93 7.2. EFFICIENCY OF IP INTERCONNECTION IN THE INTERNET AND IN NGN ..............................95 7.2.1. Current IP Interconnection models............................................................................. 95 7.2.2. Future IP Interconnection models............................................................................... 97 7.3. ROLE FOR REGULATORY INTERVENTION.........................................................................98 7.3.1. Risks in Intervention..................................................................................................