HANDBOOK OF TELECOMMUNICATIONS ECONOMICS

HANDBOOK OF TELECOMMUNICATIONS ECONOMICS VOLUME 2 TECHNOLOGY EVOLUTION AND THE INTERNET Edited by SUMIT K. MAJUMDAR University of Texas at Dallas, Richardson, USA INGO VOGELSANG Boston University, Boston, USA and MARTIN E. CAVE University of Warwick, Coventry, UK ELSEVIER Amsterdam Boston Heidelberg London New York Oxford Paris San Diego San Francisco Singapore Sydney Tokyo North-Holland is an imprint of Elsevier

CONTENTS OF VOLUME 2 OF THE HANDBOOK List of Contributors v Chapter 1 Technology Evolution and the Internet: Introduction SUMIT MAJUMDAR, INGO VOGELSANG and MARTIN CAVE 1. Introduction 2 2. Evolution of Major Alternatives to Traditional Telephone Networks 3 2.1. Emerging Network Technologies 3 2.2. Bandwagon Effects 5 2.3. Platform Competition in Telecommunications 6 2.4. Broadband 7 2.5. Cable Television 8 2.6. Wireless Communications 9 3. The Internet 12 3.1. The Economic Geography of the Internet Infrastructure 12 3.2. Economics of the Internet Backbone 15 3.3. Pricing Traffic on Interconnected Networks: Issues, Approaches, and Solutions 17 3.4. Toward an Economics of the Domain Name System 18 4. Institutional Considerations 20 4.1. Bottlenecks and Bandwagons: Access Policy in the New Telecommunications 21 4.2. Antitrust Remedies and the Institutional Design of Regulation 22 4.3. Telecommunications and Economic Development 24 4.4. Institutional Changes in Emerging Markets: Implications for the Telecommunications Sector 25 5. Conclusions 27 References 28 Chapter 2 Emerging Network Technologies DALE N. HATFIELD, BRIDGER M. MITCHELL and PADMANABHAN SRINAGESH 1. Introduction 31 2. Voice, Data, and Entertainment Video Signals 32 2.1. Signal Characteristics 32 2.2. Network Architectures 35

X Contents 3. Traditional Circuit-switched Wireline Architecture: Limitations in the Face of New Demands 4. Evolution of the Traditional Wireline Architecture 4.1. Interoffice Transport Facilities 4.2. Interoffice Signaling and the Intelligent Network 4.3. The Access Network 4.4. Architecture of the Internet 4.5. The Network of the Future 5. Evolution of Cable, Wireless, and Satellite Networks 5.1. Cable Television 5.2. Wireless 5.3. Satellite 6. Economic Issues in the Telecommunications Sector Raised by Converging Technologies 6.1. Increased Possibilities of Competition 6.2. Growth and Technology 7. Public Policy Puzzles 7.1. Regulatory Organization 7.2. Social Goals 7.3. Competition and Innovation Appendix A References Chapter 3 Bandwagon Effects in Telecommunications JEFFREY H. ROHLFS 1. Introduction 2. Theory of Bandwagon Demand 2.1. Equilibrium User Sets 2.2. Multiple Equlibria 2.3. Demand as a Function of Price 2.4. Metcalfe's Law 3. Pricing of Mature Bandwagon Services 3.1. Internalization of Externalities 3.2. Budget Constraint 3.3. Externalities 3.4. Externalities and Cross Elasticities 3.5. Nonuniform Pricing 4. Historical Pricing of Telephone Services 4.1. Promotion of Universal Service 4.2. Local Usage Charges

Contents of Volume 2 XI 5. Local-usage Charges for Calls to Internet Service Providers 101 5.1. Sensitivity of Demand to Price 101 5.2. Costs of Fixed Termination 102 5.3. Costs of Local Usage 103 5.4. Bandwagon Effects 103 5.5. Comparison with Actual Usage Charges for Calls to ISPs 104 6. Charges for Fixed-to-mobile Calls 105 6.1. Charges Under Calling-party-pays 107 6.2. Economically Efficient Mobile Termination Charges 109 6.3. Setting Mobile Termination Charges in Practice 111 6.4. A Possible Dual Regime 112 7. Conclusions 113 References 113 Chapter 4 Platform Competition in Telecommunications JEFFREY CHURCH and NEIL GANDAL 1. Introduction 119 2. Network Industries 120 2.1. Direct Networks 120 2.2. Virtual (Indirect) Networks 121 2.3. Network Effects 121 2.4. From Network Effects to Network Externalities 122 2.5. Implications for Consumer Demand 123 2.6. Expectations and Competition between Networks 124 3. Battles for Standards, Compatibility and Adoption 127 4. Standards Wars 128 4.1. Strategies in Standards Wars 128 4.2. Standard Wars and Efficiency 131 5. Battles for Compatibility 134 5.1. Denying Compatibility 135 5.2. Restricting Compatibility of Complementary Products 135 6. Cooperative Standard Setting 137 7. Mandated Standards 139 7.1. Advantages of Mandated Standards 140 7.2. Advantages of Market Standards 141 7.3. Mandated Standards in Telecommunications Networks 142 8. Case Studies 143 8.1. Competition in the Mobile Cellular Industry 143 8.2. Instant Messaging 145

XII 8.3. The 56K Modem Standards War 8.4. Satellite Vs. Cable Television (CATV) 8.5. DVD Vs. DIVX Standards War Appendix: Modeling Issues References Chapter 5 Broadband Communications ROBERT W. CRANDALL 1. The Technology 1.1. Digital Subscriber Line 1.2. Cable Modems 1.3. Fiber to the Home 1.4. Wireless Access 2. Broadband Diffusion 2.1. Cross Country Comparisons 2.2. Comparing Broadband Diffusion with Other 'Breakthrough' Technologies 3. The Economics of Broadband Supply 3.1. Cable Modems, DSL, and Fixed Wireless 3.2. Fiber to the Home 3.3. The Weak Dominance of Cable 4. The Demand for Broadband 5. Network and Bandwagon Effects 5.1. Internalizing Network Externalities 5.2. Network Effects and First-mover Advantages 5.3. The Broadband 'Bandwagon' 5.4. Consumer Value after the Bandwagon 6. Regulation and Competition 6.1. Platform Competition 6.2. Interconnection and Network Unbundling 6.3. Cable Open Access 7. Subsidies, Universal Service, and the 'Digital Divide' 8. Conclusions References Chapter 6 Cable Television THOMAS W. HAZLETT 1. Spectrum in a Tube 1.1. Emergence of Cable Television

Contents of Volume 2 XIII 1.2. Cable Television's Rise to Dominance 198 1.3. Basic Structure of the Cable Television Industry 202 1.4. Basic Structure of a Cable Television System 205 2. Market Power in Local Cable Television Service 206 2.1. Defining Cable's Market Power 208 2.2. Pricing Power 210 2.3. Cable Asset Valuation 213 2.4. Entry Barriers 214 2.5. Intermodal Competition 218 3. Regulation of Rates 221 3.1. Deregulation in the 1984 Cable Act 221 3.2. Reregulation in the 1992 Cable Act 222 3.3. Deregulation Pursuant to the 1996 Telecommunications Act 225 4. Cable Television Programming 226 4.1. Monopsony Power 227 4.2. Vertical Integration 229 4.3. Program Access Rules 231 4.4. Carriage of Broadcast TV Signals 232 4.5. Common Carrier Video 233 5. The Evolution of Cable 235 References 235 Chapter 7 Wireless Communications JOSHUA S. GANS, STEPHEN P. KING and JULIAN WRIGHT 1. Introduction 243 2. Background 244 2.1. Spectrum Allocation 244 2.2. The Range of Wireless Services 245 2.3. The Rise of Mobile Telephony 246 3. Economic Issues in Wireless Communications 248 3.1. Spectrum as a Scarce Resource 248 3.2. Complementarities in Spectrum Use 251 3.3. Standards 253 4. Diffusion and Demand for Mobile Telephony 256 4.1. Diffusion 256 4.2. The Relationship between Fixed and Mobile Telephony 257 4.3. Costs 259

XIV Contents of Volume 2 5. Regulation and Competition 259 5.1. Limitations of Wireless Competition 259 5.2. Access Pricing and Caller vs. Receiver Pays 272 6. Conclusions 280 References 281 Chapter 8 The Economic Geography of Internet Infrastructure in the United States SHANE M. GREEN STEIN 1. Introduction 289 2. Dispersion and Concentration of Internet Infrastructure 290 2.1. What is Internet Infrastructure? 291 2.2. The Origins of Internet Infrastructure 292 2.3. Scale and Urban Location 295 2.4. Scale and Standardization 299 2.5. Summary 303 3. The Spread of Commercial Internet Access 303 3.1. The Activity of Commercial Suppliers 304 3.2. Government Policy Encouraged a Diverse Geographic Supply 306 3.3. The Founding of Commercial Organizations 308 3.4. Coverage by Dial-up Providers 310 3.5. Organizational Strategy and Coverage 313 3.6. Variety and Quality Over Geography 315 3.7. Summary 318 4. The Location of Network Backbone 318 4.1. The Geographic Features of the Backbone 319 4.2. The Industrial Organization of the Commercial Backbone 320 4.3. Interpreting Networking Practices 324 4.4. Interpreting the Geographic Dispersion of Capacity 326 4.5. The Economic Interpretation of Redundancy 331 4.6. Boom Leads to Bust in the Backbone 334 4.7. Interpreting a Decade of Building 335 4.8. Summary 336 5. The Growth of Broadband 337 5.1. Why Broadband Favors Urban Areas 337 5.2. The Empirical Evidence 339 5.3. The Regulation of Broadband Suppliers 341 5.4. Summary 345 6. The Location of Business Internet Infrastructure Services 345 6.1. The Geography of Private Investment in IT-overview 346 6.2. Empirical Evidence on Domain Names 348 6.3. Evidence on Urban and Rural Business Use of Internet Technology 351 6.4. Local Internet and Information Services 355

Contents of Volume 2 XV 6.5. Summary 356 7. Summaries of Answers to Motivating Questions 357 7.1. Why did Near-geographic Ubiquity Arise after Commercialization? 358 7.2. Why did Market Forces Encourage Extensive Growth? 358 7.3. Has the Internet Diffused Disproportionately to Urban Areas? 359 7.4. Is the Internet a Substitute or a Complement for Urban Agglomeration? 360 7.5. Which Policies Mattered? Were these Effects the Intended or Unintended Consequences? 361 7.6. Are there Lessons for Other Countries? 363 References 364 Chapter 9 The Economics of the Internet Backbone NICHOLAS ECONOMIDES 1. Competition among Internet Backbone Service Providers 375 1.1. Internet Backbone Services 375 1.2. Interconnection 375 1.3. The Transit and Peering Payment Methods for Connectivity 379 1.4. Conduct of Internet Backbone Service Providers 382 2. Structural Conditions for Internet Backbone Services; Negligible Barrier to Entry and Expansion 385 2.1. The Markets for Raw Transport Capacity and Other Inputs to Internet Transport Services 385 2.2. Ease of Expansion and Entry 386 2.3. Public Standards and Protocols on the Internet 386 3. Potential for Anticompetitive Behavior on the Internet Backbone 388 4. Network Externalities and the Internet 388 4.1. Procompetitive Consequences of Network Externalities 390 4.2. Conditions Under Which Network Externalities may Inhibit Competition 391 5. Network Externalities and Competition on the Internet 392 5.1. Conditions Necessary for the Creation of Bottlenecks Fail on the Internet 392 5.2. Bottlenecks Such as the Ones of the Local Exchange Telecommunications Network do Not Exist on the Internet 393 6. Strategies that a Large IBP Might Pursue 394 6.1. Raising the Price of Transport 394

XVI Contents of Volume 2 6.2. Discriminatory Price Increases Directed Simultaneously against All Backbone Rivals 397 6.3. Raising Rivals' Costs and Degrading Connectivity 398 7. Conclusions 407 Appendix 407 References 410 Chapter 10 Pricing Traffic on Interconnected Networks: Issues, Approaches, and Solutions ALOK GUPTA, DALE O. STAHL and ANDREW B. WHINSTON 1. Introduction 414 2. Congestion, Overuse, and Economic Implications 416 2.1. Approaches to Deal with Congestion in Computing Systems 416 2.2. Economic Implications: Tragedy of the Commons Problem 418 3. Pricing Approaches for the Internet Traffic 420 4. A Generic Model of Priority Pricing for Data Networks 422 4.1. Model Description 423 4.2. Simulation and Results 425 5. Future Issues and Challenges 431 5.1. Overlay Networks 431 5.2. Multihoming and Smart Routing 433 5.3. Channelling 434 6. Conclusions 435 References 436 Chapter 11 Toward an Economics of the Domain Name System MILTON MUELLER 1. Introduction 443 2. Technical Description of DNS 447 2.1. The Name Space and Name Assignment 447 2.2. Resolution, Name Servers, and BIND Software 448 2.3. The Root Servers 449 3. The Demand for Domain Names 450 3.1. Demand for Technical Functions 450 3.2. Demand for Semantic Functions 455 4. Domain Name Supply 461 4.1. Root Servers 461 4.2. Registries and Registrars 465 4.3. The Secondary Market 469

Contents of Volume 2 XVII 5. Economic Policy Issues 473 5.1. New TLDs: Expanding Supply 474 5.2. Domain Name Trademark Conflicts 477 5.3. Competition Policy 479 5.4. WHOIS and Privacy Policy 481 6. Conclusions 483 References 483 Chapter 12 Bottlenecks and Bandwagons: Access Policy in the New Telecommunications GERALD R. FAULHABER 1. Introduction 488 2. Essential Facilities (Bottleneck Access) 490 3. Network Effects and Interconnection (Bandwagon Access) 495 3.1. Network Effects and Corporate Strategy 499 3.2. Is Tipping Irrevocable? The 'Serial Monopoly' Hypothesis 506 3.3. The FCC's Instant Messaging Condition in the AOL-Time Warner Merger 511 4. Lessons of the AOL-Time Warner Case 513 4.1. Proactive vs. Reactive 513 4.2. Serial Monopoly and the New Economy 514 5. Conclusions 515 References 515 Chapter 13 European and American Approaches to Antitrust Remedies and the Institutional Design of Regulation in Telecommunications DAMIEN GERADIN and J. GREGORY SIDAK 1. Introduction 518 2. The U.S. Model 520 2.1. Ex Ante, Ex Post, and Hybrid Remedies 520 2.2. Antitrust as a New Form of Ex Ante Regulation 527 2.3. The Shifting Balance of Influence between Antitrust and Sector-specific Regulation: Telecommunications Law's Potential to Shape Antitrustremedies in Network Industries 528 2.4. The U.S. Trade Representative as Regulator 532 3. The EC Model 534 3.1. Ex Ante, Ex Post, and Hybrid Remedies 535

XVIII Contents of Volume 2 3.2. Antitrust as a New Form of Regulation 540 3.3. The Shifting Balance of Influence between Antitrust and Sector-specific Regulation: Competition Law Concepts Penetrating Sector-specific Regulation 541 3.4. DG Trade as a Regulator? 547 4. Conclusions 548 References 550 Chapter 14 Telecommunications and Economic Development BJÖRN WELLENIUS and DAVID N. TOWNSEND 1. Introduction 557 2. Development Significance of Telecommunications 559 3. Evolution of Policies and Markets 561 3.1. Directions of Change 562 3.2. Entry and Competition 564 3.3. Private Sector Participation 566 3.4. Policy and Regulation 570 4. Results 571 4.1. Investment 572 4.2. Growth, Productivity, and Prices 575 4.3. New Services Mobile and the Internet 577 5. Lessons From Reform 579 5.1. Competition as Driver of Change 579 5.2. Narrowing the Development Gap 582 5.3. Designing Attractive Business Opportunities 585 5.4. Developing Regulatory Capability 589 5.5. Managing the Reform Process 593 6. The Internet 594 6.1. Evolution of the Internet in the Developing World 595 6.2. Internet Policy Issues for Developing Countries 599 6.3. Information Technology and International Trade 603 7. Economic Opportunity and the Future 606 7.1. E-commerce 606 7.2. E-learning 608 7.3. E-government 609 7.4. Knowledge Societies and E-readiness 610 8. The Path Ahead 612 8.1. The Unfinished Reform Agenda 614 8.2. Universal Access 615 References 616

Contents of Volume 2 XIX Chapter 15 Institutional Changes in Emerging Markets: Implications for the Telecommunications Sector PABLO T. SPILLER 1. Introduction 622 2. The Utilities' Problem 622 2.1. The Political Profitability of Expropriation 625 2.2. The Implications of Government Opportunism 625 3. Sources of Regulatory Commitment 627 3.1. Institutional Endowment 627 3.2. A Tale of Two Countries 630 4. Regulatory Governance: Administrative Process with Judicial Review 635 4.1. Why Judicial Review? 638 4.2. Why Delegate to Independent Agencies 642 5. Commitment in Unified Government Systems 644 5.1. Contract-based Regulation 645 5.2. Adapting Contract-based Regulation to Unexpected Shocks: Renegotiation 650 6. Final Comments 652 References 652 Subject Index 657