From:
http://arstechnica.com/old/content/2008/09/peering-and-transit.ars/1
How the 'Net works: an introduction to peering and transit
| Published September 2, 2008 12:11 PM
Whose pipes?
In 2005, AT&T CEO Ed Whitacre famously told BusinessWeek, "What they [Google, Vonage, and others] would like to do is to use my pipes free. But I ain't going to let them do that…Why should they be allowed to use my pipes?"
The story of how the Internet is structured economically is not so much a story about net neutrality, but rather it's a story about how ISPs actually do use AT&T's pipes for free, and about why AT&T actually wants them to do so. These inter-ISP sharing arrangements are known as "peering" or "transit," and they are the two mechanisms that underlie the interconnection of networks that form the Internet. In this article, I'll to take a look at the economics of peering of transit in order to give you a better sense of how traffic flows from point A to point B on the Internet, and how it does so mostly without problems, despite the fact that the Internet is a patchwork quilt of networks run by companies, schools, and governments.
The basics
At the moment, the Internet consists of over 25,000 Autonomous Systems (AS). An Autonomous System can independently decide who to exchange traffic with on the 'Net, and it isn't dependent upon a third party for access.
Networks of Internet service providers, hosting providers, telecommunications monopolists, multinationals, schools, hospitals and even individuals can be Autonomous Systems; all you need is a single "AS number" and a block of provider independent IP-numbers. These can be had from a regional Internet registry (like RIPE, ARIN, APNIC, LACNIC and AFRINIC). Though one network may be larger or smaller, technically and economically they have equal possibilities.
(Most organizations and individuals do not interconnect autonomously to other networks, but connect via an ISP. One could say that an end-user is "buying transit" from his ISP.)
In order to get traffic from one end-user to another end-user, these networks need to have an interconnection mechanism. These interconnections can be either direct between two networks or indirect via one or more other networks that agree to transport the traffic.
A <--> B (direct)
A <-->C<-->D<-->…<-->B (indirect)
Most network connections are indirect, since it is nearly impossible to interconnect directly with all networks on the globe. (The likes of FLAG and AT&T might come close, but even they can't claim global network coverage.) In order to make it from one end of the world to another, the traffic will often be transferred through several indirect interconnections to reach the end-user. The economic arrangements that allow networks to interconnect directly and indirectly are called "peering" and "transit":
- Peering: when two or more autonomous networks interconnect directly with each other to exchange traffic. This is often done without charging for the interconnection or the traffic.
- Transit: when one autonomous network agrees to carry the traffic that flows between another autonomous network and all other networks. Since no network connects directly to all other networks, a network that provides transit will deliver some of the traffic indirectly via one or more other transit networks. A transit provider's routers will announce to other networks that they can carry traffic to the network that has bought transit. The transit provider receives a "transit fee" for the service.
The transit fee is based on a reservation made up-front for the number of Mbps. Traffic from (upstream) and to (downstream) the network is included in the transit fee; when you buy 10Mbps/month from a transit provider you get 10 up and 10 down. The traffic can either be limited to the amount reserved, or the price can be calculated afterward (often leaving the top five percent out of the calculation to correct for aberrations). Going over a reservation may lead to a penalty.
Figure 1: peering vs. transit
These mechanisms are pictured schematically in the diagrams above. Diagram I shows peering between two networks. Diagram II shows transit over two networks. Diagram III shows transit over three networks where there is a peering agreement between networks C and D, and A and B both pay for transit. Diagram IV shows how A pays to C, and B and C pay to D for transit.
Peering
When a network refuses to peer for another network, things can get ugly. I once heard the following anecdote at a RIPE meeting.
Allegedly, a big American software company was refused peering by one of the
incumbent telco networks in the north of
Given the rules of peering, we can examine how an ISP will behave when trying to build and grow its network, customer base, revenues, and profits. To serve its customers, an ISP needs its own network to which customers connect. The costs of the ISP's network (lines, switches, depreciation, people, etc.) can be seen as fixed; costs don't increase when an extra bit is sent over the network compared to when there is no traffic on the network.
Traffic that stays on the ISP's network is the cheapest traffic for that ISP. In fact, it's basically free.
Peering costs a bit more, since the ISP will have to pay for a port and the line to connect to the other network, but over an established peering connection there is no additional cost for the traffic.
Transit traffic is the most expensive. The ISP will have to estimate how much traffic it needs, and any extra traffic will cost extra. If the ISP is faced with extra traffic (think large-scale P2P use), its first priority will be to keep the traffic on its own network. If it can't, it will then use peering, and as a last resort it will pay for transit.
Figure 2
Every ISP will need to buy some amount of transit to be able to interconnect with the entire world, and to achieve resilience, an ISP will choose more than one transit provider. Transit costs money, and as the ISP grows, its transit bill will grow, too. In order to reduce its transit bill, the ISP will look for suitable networks to peer with. When two networks determine that the costs of interconnecting directly (peering) are lower than the costs of buying transit from each other, they'll have an economic incentive to peer.
Peering's costs lie in the switches and the lines necessary to connect the networks; after a peering has been established, the marginal costs of sending one bit are zero. It then becomes economically feasible to send as much traffic between the two network peers as is technically possible, so when two networks interconnect at 1Gbps, they will use the full 1Gbps. But with transit, even though it is technically possible to interconnect at 1Gbps, if the transit-buying network has only bought 100Mbps, it will be limited to that amount. Transit will remain as a backup for when the peering connection gets disrupted. The money an ISP saves by peering will go into expanding the business.
Another important limitation of peering is that it is open only to traffic coming from a peer's end-users or from networks that have bought transit. A transit provider will not announce a route toward a network it peers with to other networks it peers with or buys transit from. If it did announce the route, it would be providing free transit over its network for its peers or, even worse, buying transit from another network and giving it away freely to a peer. This situation is illustrated below (blue is peering, red is transit).
Figure 3
- Network G can see all the networks because networks E, D and H buy transit from it.
- Network A can see network F and its customers directly, but not network B through network F.
- Network C can see Network B through its peer D, but not via its transit customer F.
- Traffic from C to H will go trough E, but not through D.
The higher up in the network you are, the more networks you can see without needing to pay someone else for transit. In the example above, a network like G is sometimes said to be a Tier 1 network, because it buys transit from no one, yet still has access to the whole network.
It's a common misconception that the benefit an ISP derives from peering depends upon the direction of the flow of traffic. According to this way of thinking, if YouTube peers with an ISP, this benefits YouTube more than it does the ISP (since YouTube sends so much data but receives comparatively little). But in practice, the flow of traffic is not an issue for an interconnect. Whether it goes to or from the network, companies still need the same Cisco equipment.
In practice, it is actually quite likely that the ISP side of an ISP-YouTube relationship would see the greatest savings both in absolute costs and as a percentage of total traffic costs. Most ISPs have less traffic (and buy less transit) than YouTube and its parent Google have. Their buying power therefore is less than that of YouTube/Google, so their price per Mbps/month for transit is likely to be higher. Given that the amount of traffic saved from transit is by definition equal for both YouTube and the ISP, it follows that the ISP is saving more money.
Hot potato, cold potato
Another source of contention and confusion is arguments between "hot potato" and "cold potato" routing. Hot potato routing is the practice of handing over traffic at the earliest convenience (hot, hot! Here, you take it!), while cold potato routing is where you hold onto traffic as long as you can before handing it over to another network.
There are long debates in the networking world about which of these is the
best solution. Hot potato routing may overload a link to an interconnection
point with many peers, or it might force a global network provider to carry
traffic all the way from Europe to
Cold potato routing may give the originating network greater control over quality, except that it is making a guess on the status of the network beyond its own routers. In a cold potato scenario, it's difficult to factor in changes that happen over time, as guesses are made based on the past. Hot potato routing, on the other hand, assumes that the other guy knows best how to route traffic on his network, and it also assumes that if the other network gets overloaded at a location, it will have the biggest incentive to upgrade or to restructure its interconnects.
Pay to peer?
Would it be advisable to pay for peering? There has been significant debate on whether it is beneficial to pay for peering, but I think that peering should typically be free. When two networks peer, they both save the same amount of traffic from transit.
As stated previously, the monetary benefits of not having to use transit depend upon the transit price that each network pays. The network that saves the least is the network that has the best transit deals. If, for both networks, a peering agreement is cheaper than buying transit, then the choice of who should pay for the peering agreement becomes completely arbitrary.
One could say that the network that saves more money should share the savings with the network that saves less, but on what basis? The peering in itself is already there. Paying money for it or sharing the benefits doesn't make it better. The only reason the smaller party pays more is because it is in a less fortunate position when it comes to buying transit. If, through renegotiation of transit contracts, it is all of a sudden better off, it would still be hard to convince the other network to reverse payments. Worse still, it would in fact be sponsoring the other network to attain even lower overall traffic costs. If the two networks at the same time compete for the same customers, it would now be sponsoring its competitor.
There might be situations where a peering might be beneficial to network A, but the savings are too little for network B. In such a case it might look good to A to pay B for a peering agreement to increase B's savings to such a level that both parties will profit. Though this might sound good at first, it could have unintended consequences for network A. If the traffic between the two networks grows to such a level that both parties benefit equally from the peering, B will still want to try to keep the payment for the peering; it's essentially free money.
Another problem with pay to peer is that networks would have an incentive to understate their transit costs in order to become a receiving party. This makes it less likely that both parties would reach a peering agreement, because one party is lying about its benefits and the other is not willing to pay. This is hard to check for either party. The best thing a network can do is hope that when it's economical for this network to peer for free, it is the same case for the other network. If not, the transaction costs of other arrangements are probably too high.
Peering Locations
Peering will happen at a location that is most convenient for both networks.
When two networks decide to peer in one location, that location immediately
becomes a valuable place at which to peer for other networks, too. This
increase in value causes more and more networks to cluster together at certain
locations. In the history of the internet, we can see that at first, these
locations were at the sites where academic networks interconnected, and later
on at large co-location facilities. In order to facilitate peering, Internet
exchange points (IXPs) were established at those
locations. In Europe these IXPs are typically
not-for-profit associations, while in the
Putting a single switch in between all the parties who want to interconnect makes it possible to reach all parties with one connection (public interconnect), instead of having to dedicate a line and a port on a switch for each interconnection. This does require IXP's to be neutral and uninvolved in the business of their customers; the process of peering and transit is up to the networks, and the IXP is just responsible for the technical functioning of the switch.
This doesn't mean, however, that peerings will take place only through the IXP. There will still be direct interconnects that bypass the exchange (known as private interconnects), where the exchange can act as a backup for that interconnect (and a transit connection often acts as a backup for that backup).
When more and more networks roll out in the location of the Internet exchange point, this location becomes valuable not only for peering, but also for buying and selling transit. This will attract transit providers to the location in order to peer with other networks that sell transit and also to try and sell transit to networks needing it. The increase in transit providers will cause more competition and, therefore, a lowering of transit costs, which will, in turn, increase the attractiveness of the location for other networks through the combination of more peers and lower transit costs.
As networks grow, some of them will exchange more and more traffic with
networks that are not yet present at the local Internet exchange. If the costs
of buying a direct connection to another location where networks are present is lower than the costs of transit, then the network will
expand toward the low-cost location. This is quite clear in Europe, where
medium and large networks will almost always be present at the IXPs of Amsterdam,
The irony is that in some of these towns, transit prices have dropped to such lows that it's no longer economical for some smaller networks to interconnect at an IXP, since the transit fee saved is lower than the monthly fee for the IXP.
In a nutshell, the economics of interconnection are:
- Peer as much as you can, to avoid transit fees.
- Use the savings from peering to expand your business and network.
- Use the expansion of your business and network to become more attractive for others to peer with and to reach those that are attractive to peer with.
- Establish IXPs in order to further lower the costs of peering, to bring together as many networks as possible, and to create locations where there is competition between providers of transit.
- Repeat.
Transit economics
Providing transit has its own rationales and economic mechanisms. Transit providers charge transit fees in order to recoup their investment in the lines and switches that make up their networks. The price of transit will be a combination of the costs of running the network, plus the amount of transit the transit provider has bought, minus (maybe) the traffic that is destined directly for peers and customers of the transit provider.
Being a pure transit provider with only Autonomous Systems as customers puts a network in a weird spot. Such a network's business case is built on being the intermediary in the flow of traffic, so it tries to charge all of the other autonomous systems for their traffic. The problem for a pure transit provider is that its customers are always looking at ways to lower their transit fees, and lower transit fees can be had by switching to a competitor or by not using the transit provider at all. So disintermediating the transit provider is standard behavior for the transit provider's customers.
How can the transit provider prevent its customers from going to competitors
or from cutting it out of the loop? The first way is to keep prices down. If a
transit provider is the only provider of a link between
The other trick is to actively work to keep competitors from entering the market. How do you persuade people not to enter the market? By keeping margins low, even as growth rises. Fiber is a fixed-cost investment, because traffic can be supported for little or no extra cost. Though it's tempting to let profits rise with the growth of traffic, the network will actually have to lower its traffic price every month in order for margins to remain the same, thereby keeping intact the barrier to entry for a competing network.
A couple of cooperating ISPs can also be dangerous to the business plan of a pure transit player. These networks could cooperate in creating a backbone between their networks in order to carry traffic to and from eachother's systems. For instance, Dutch, Belgian, French, and Swiss ISPs could work together and bypass a Trans-European transit provider. So a pure transit play is under constant threat even from existing customers who resell traffic.
An interesting tactic that I once heard about was from a content-heavy hosting provider who was trying to buy transit from residential ISPs. ISPs have a high inflow of traffic; hosting providers have high outbound traffic. Because incoming and outgoing traffic are bundled into the same price, the hosting provider rightly had determined that there would be ISPs willing to resell upstream capacity they didn't use. For the pure transit player this might be seen as a loss of income.
In the end, pure transit is debatable as a real business model. An average end-user is bound to its ISP by numerous switching costs (change of e-mail address, lack of knowledge, time, hassle, etc.), but this customer lock-in just does not apply to transit. The Border Gateway Protocol propagates a change in transit provider within seconds, globally. Autonomous Systems can switch within seconds and there is little a transit provider can do to differentiate itself from rivals. Add to this the effect of competitors and mutually assured destruction, and one can understand that there is not much money to be had in this business.
Tough at the top: word about Tier 1 networks
Tier 1 networks are those networks that don't pay any other network for transit yet still can reach all networks connected to the internet. There are about seven such networks in the world. Being a Tier 1 is considered very "cool," but it is an unenviable position. A Tier 1 is constantly faced with customers trying to bypass it, and this is a threat to its business. On top of the threat from customers, a Tier 1 also faces the danger of being de-peered by other Tier 1s. This de-peering happens when one Tier 1 network thinks that the other Tier 1 is not sufficiently important to be considered an equal. The bigger Tier 1 will then try to get a transit deal or paid peering deal with the smaller Tier 1, and if the smaller one accepts, then it is acknowledging that it is not really a Tier 1. But if the smaller Tier 1 calls the bigger Tier 1's bluff and actually does get de-peered, some of the customers of either network can't reach each other.
If a network has end-users (consumers or businesses), it's probably in a better business position than a Tier 1 or a pure-play transit provider, since having end-users provides stability to a business. Autonomous Systems can switch within seconds, but end-users are stickier customers. Churn is less of a problem and revenues are therefore more stable and easier to base decisions on, since prices don't have to drop on a monthly basis. So an end-user business, combined with a bit of transit is, therefore, ideal for a network provider.
Can peering and transit lead to a steady state?
Economists often ask if peering and transit can lead to a steady state, i.e., a situation that can sustain itself by generating enough money for investments while also providing a dynamic and competitive environment.
I personally think the answer is yes. Experiences in recent years have shown a big boom and bust in long haul networks. However, I do believe these are the result of over-investment and not problems with the model of peering and transit. Five overprovisioned networks on the same route are too much for any business case. So yes, if investment is done prudently, and if the owners of transit networks understand that they will have to lower prices continuously or face mutually assured destruction, then it is possible to have a stable state.