TeliaSonera International Carrier – white paper

The natural evolution of the Internet ecosystem

ContentsExecutive summary 2The struggle for survival 3What users want 4Is content king? 4Finding additional revenue sources 5Micropayments to the rescue? 5Going global 6Focus on quality 6Getting content to users 7The plight of the access provider 7Who should pay for what and how? 8Revenue sharing 9The P2P issue 9Keeping it all together 10Quality differentiation 11Evolution drives specialization 11

Contact: Daniel Sjöberg, Head of Strategy and Business DevelopmentEmail: daniel.d.sjoberg@teliasonera.comPublished: September, 2009

or otherwise subsidized. The solution is to find payment models that users can accept and that compensate all parties fairly. Such models are bound to emerge, even though it may take time. The Internet is still only in its infancy. Specializa-tion rather than diversification will characterize its further development. As in other ecosystems, competition will bring about specialization because a highly specialized entity is more effective at competing with others.

Natural evolution will force the various Internet species to stop doing things that others do better and concentrate on their core skills. Content providers on developing quality content. Access providers on providing easy access for users. Transit providers on carrying traffic effectively with flawless quality.

This will benefit both Internet users and the entire Internet business.

The Internet ecosystem continues to grow dramatically in a fertile environment of user demand. Most of the growth stems from quality-sensitive applications, mainly all forms of video. As in all ecosystems, the species of the Internet ecosystem are engaged in intense competition. In the midst of growth and change, the competi-tion for resources is intensifying, especially for the scarcest resource of all – money.

The dominant Internet ecosystem species – content providers, access providers and transit providers – are feeling squeezed and increas-ingly suspect they are subsidizing the others. In an attempt to offset falling revenues, many venture into each other’s territories. Content providers, for example, by building distribution networks and access providers by developing content.

But diversification is not going to help. The heart of the problem is that users have become used to free content – advertising sponsored

ChapterExecutive summary

Executive summary

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ChapterThe struggle for survival

The struggle for survivalMany have likened the Internet to a biological ecosystem, and there is indeed a strong resem-blance. An ecosystem is “a system formed by the interaction of a community of organisms with their physical environment”. The biological ecosystem includes many species of animals, plants and microorganisms, and it interacts with the whole complex of physical factors forming the environment.

So, what does the Internet ecosystem look like? It is inhabited by thousands of hosts of different sizes, functions and business objec-tives. These systems constitute a number of species that interact in symbiotic relations to make up the global Internet. Their relations transfer not only traffic but also economic value with global, end-to-end reachability.

The dominant species of the Internet eco-system are (1) content providers that create and offer information, programs or services in digital form, (2) access providers – internet service providers that deliver content to end users, and (3) transit providers – IP carriers that transport large quantities of bits around the world. A host of other species complement, support, feed off, compete with or run parallel to these keystone species, including hardware

and software providers, advertising companies, payment services, consultants and other support providers.

These ecosystem inhabitants constantly interact with each other and with an environ-ment of Internet users – private persons as well as businesses and other organizations. This interaction shapes the Internet’s evolution. As in all ecosystems, there are fundamental conflicts about space and territory, and intense competi-tion for the resources available. Species of the same type compete, species of different types compete and, in many cases, both types of competition occur simultaneously. The intense competition brings about natural selection and evolutionary adaptation.

Despite competition, each part of the Internet ecosystem is dependent on the health of the others. In the interest of the whole ecosystem’s health, competitors sometimes set aside their narrow interests to work together, for example in policy development and standardization. Political, legal, economic, technological, and sociocultural environmental factors affect the development of the Internet ecosystem. But ultimately, users decide its future and fate. If enough people want something, they will get it. If they do not want it, they will kill it.

Environment

Private Users

Content providers

Transit providers

Ecosystem species

Access providers

Many organizational life forms maintain symbiotic relationships in the Internet ecosystem. The illustration shows just a few of them. Content providers, access providers and transit providers are dominant species.

Businesses

Organizations

Governments

Machines/devices

Software providers

Payment providers

Hardware providers

Private Users

Businesses

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ChapterWhat users want

Is content king?Content is clearly king in terms of Internet traf-fic. But it is definitely not king in terms of what people are willing to pay for. Most people today expect content to be mostly free. They have never become used to paying for music, movies, television shows and, in particular, news. All they could wish for has been easily available – either as a “free” public service from advertising-funded websites, or as downloads from (usually illegal) file sharing services.

But the notion that content is free is a fallacy. Digital content, as well as its distribution, has to be paid for in some way. Content creators and owners must be rewarded for their efforts. Each additional user who accesses a particular web-site imposes more bandwidth cost on the access provider. The real question is who should pay for what and in what way.

Content, in this paper, refers to any type or unit of information or entertainment that people may find useful or desirable. It can be text, images, graphics, movies, music, applications, etc. – especially material created by professionals for consumption via the Internet. A content provider (also content supplier or content owner) is a company that creates, structures and delivers such content. This also includes content aggregators – organizations that combine content such as news, sports scores, weather forecasts and reference materials from various sources to make it available to users.

The Internet is often seen primarily as a sys-tem for content delivery – as described with the phrase “content is king”. According to Andrew M. Odlyzko, a mathematician and well-known authority on the economics of the Internet, “Con-tent certainly has all the glamour. What content does not have is money.”

What users wantUsers want both quantity and quality, but they are not particularly eager to pay for it.

It is estimated that global IP traffic will grow at an annual rate of 40 percent the next few years (Cisco Visual Networking Index, June 2009). This is about the same rate as in the past several years.

Most of this growth will come from quality-sensitive applications, mainly all forms of video, which will account for more than 90 percent of all consumer Internet traffic in only a few years. Traditional, non-quality-sensitive applications, such as email, web browsing, file transfer and instant messaging, while still growing, will be a small portion of the total traffic.

Users will become more active as creators and distributors of content. The download-centric, asymmetric network model will become less relevant as users increasingly want to dissemi-nate their own content, as evidenced by the rise

of video chats, YouTube and many other applica-tions. Peer-to-peer (P2P) traffic (with lawful uses growing ten times as fast as illicit ones) will strain networks, especially the upload links. This will push networks toward symmetry.

Increasingly, users will want to access Internet content via mobile devices. Wireless broadband technology is driving Internet growth, particularly in developing countries. Mobile data traffic will double every year, with video accounting for more than 50 percent in just two or three years.

Business IP traffic will grow almost as fast as consumer traffic. Businesses will increasingly bring in advanced video communications, both for internal communications and for interacting with customers and suppliers. Machine-to-ma-chine (M2M) traffic is also expanding. Within the next few years, more machines and devices may be connected via the Internet than humans.

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ChapterFinding additional revenue sources

Micropayments to the rescue?Admittedly, the Internet is full of failed micro-payment providers. But things are changing. New micropayment systems, with reasonable costs, are encouraging people to buy content.

Much of the best and most innovative Internet content is developed by small, independent teams rather than by large, established content providers. Small developers often have trouble finding a viable outlet for their content within the traditional structure of the market. Few of them are able to develop direct billing relationships with end users. They may lose most of their potential revenue to third-party organizations, such as content delivery networks. Many will find themselves snapped up by larger content conglomerates. Some may never be able to get to market. What they need is better, less costly, more direct ways to reach end users – combined with a payment model that rewards them adequately and feels right for users.

Micropayments may solve the free rider problem for some content providers. A micropayment is a transaction involving a small sum of money in exchange for something made available online, such as content or applications. Such payments, which are too small to be feasible for processing by credit card companies, require a special type of systems. Third-party micropayment service providers accumulate small transactions until they can be collected as a single, larger pay-ment. Some large content providers are devel-oping their own micropayment systems.

Many people dislike micropayments, espe-cially in the U.S.: “Micropayments make you feel as if you’re being attacked by a horde of beggars, cups in hand” (Business Week, August 2009). But they are well accepted in many coun-tries. They have, for example, been essential for the success of NTT DoCoMo’s I-mode system. Micropayments are increasingly becoming a vital tool for revenue sharing between content owners, access providers – and, in some cases, transit providers.

Finding additional revenue sourceswill have to rely on charging subscription fees or using micropayments. But users’ willingness to pay for Internet content remains very limited. If accessing a website or downloading content becomes a financial issue, then free alternatives (legal or illegal) will soon spring up.

Even tiny charges based on utilization tend to reduce usage substantially. Websites have been known to lose 80 percent of their visitors almost overnight with the introduction of subscription charges. A classic example is what happened when the New York Times began charging for access to its website in 2005. The number of visitors fell, which reduced the amount of available advertising revenue. Charges for access had to be abandoned in 2007. In spite of this, the New York Times is again contemplating the introduction of charges for content.

Advertising funding works well for some content providers, especially large and well-established ones. But advertising cannot support the entire content industry, especially since the growth of online advertising is declining. As of September 2009, global online advertising revenues are estimated to be down 4 percent from a year ago.High bandwidth costs in relation to available advertising revenue is making life difficult for many advertising funded content providers, facing them with the choice of either closing down or finding additional sources of income. Even Rupert Murdoch’s giant News Corporation (NWS), with properties in film, television, maga-zines and newspapers, is preparing to charge users for content at all its websites.

Most content providers have slim chances of surviving solely on advertising. Eventually, they

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ChapterGoing global

Focus on quality

Quality of Experience (QoE) is a subjective measure of a user’s experiences with content delivery, either with the delivery of a piece of content or with all content delivered by a content provider. Unless a content provider delivers optimal QoE, users will defect to the competition. QoE is a function of two factors: quality of content (QoC) and quality of service (QoS).

Quality of Content (QoC) is a user’s subjective, often unconscious, appraisal of the attractiveness or importance of a piece of content or of a content provider’s entire offering. Is it entertaining, exciting, educational or helpful? Is it well produced, designed and written? Is it easy to find and access?

Quality of Service (QoS) is an objective measure of the accuracy of content transport from the content provider, over the Internet, to the user’s receiving device. It can be quantified in terms of available bandwidth, latency, packet losses, etc., and used to guarantee a certain

level of a specified resource to selected traffic on a network. If users experience freezing in video playback, color blurring, significant delays for startup or other transmission errors, then they may abandon the service, temporarily or permanently. Quality of content is of little value unless delivered intact to the user. Quality of experience is what counts.

QoCQoS

Quality of content is of little value unless delivered to users with the right quality of service.

Going globalThis means content providers cannot control users’ quality of experience. Shabby presentation will undermine even the highest quality content. Without guarantees of end-to-end delivery quality, it is impossible to charge users a fair price for content. So content providers must obtain such guarantees one way or another.

To maximize their business potential, content providers need to make their products available to the largest possible audience. This often involves global distribution.

The architecture of the Internet makes it difficult for content providers to secure direct connections to their customers – connections whose quality can be monitored and assured. Content must typically traverse several different networks on its journey from source to destina-tion, and quality of service can be compromised by congestion or other problems at any stage.

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ChapterGetting content to users

The plight of the access provider Delaying network upgrades to improve return on capital is not an option. Users constantly expect more for less, and competitors are always prepared to give them just that.

Increasingly, access providers are complaining that other companies are making money from content put across their networks without paying for the costs: “We can’t give these companies a free ride any more.” In the short term, it may be desirable that access providers refrain from levying a fee on content providers because this subsidizes creativity and innovation in new content creation. But in the long term, a business model based on subsidies will not be sustainable.

Neither will charging flat monthly fees to users, depending only on the size of access links, not on usage. The many users who account for smaller portions of the traffic are subsidizing the few users who account for larger portions. And heavy users tend to slow down connections for others. Furthermore, flat rate pricing is incom-patible with quality-differentiated services.

Most access providers sell only one commod-ity – Internet access. Customers buy bandwidth, not services or content. Intense competition puts a limit to the price that can be charged to customers. At the same time, as video is becom-ing increasingly popular among users, access providers need to upgrade bandwidth with little ability to charge more for it. Peer-to-peer (P2P) traffic may consume as much as 60 percent of network resources without creating additional revenue. As a result, average revenue per user (ARPU) remains static at best, and usually declines gradually.

Most access providers find it difficult to add value to the bandwidth they sell. Few have been successful in developing services, applications and content that users are willing to pay for. In the past ten years, access providers have spent billions (in any currency) trying to find new services that could increase revenues – but to little or no avail. Customers have clearly demonstrated that they are not attracted to “walled-garden” offerings from their access providers; new services tend to be introduced free of charge or deeply discounted.

Getting content to usersthe content is replicated in servers that connect directly to the access provider’s network. The access provider then carries it across its own interconnects, core and access networks to its customers. Because content is served from a local server, customers can count on good quality. The server caches are updated from central servers using ordinary best-effort trans-mission through the global Internet.

Truly global reach requires many thousands of servers distributed around the world. Only a few CDNs have come close to this, the rest running out of money before the task was complete. CDNs are expensive to set up and run – which makes them expensive for content providers to use. For small content providers, especially companies involved in video, paying for a content delivery network can eat up a significant chunk of revenue.

A few large content providers, such as Amazon, AOL, Google and Microsoft, are building their own global networks, down to the physical fiber, to be in complete control of all network resources. These networks bypass the global Internet, connecting to local access providers’ networks, which are used as far as possible only for the final hops. Google is particularly ambitious in pushing its server caches wide and deep into access providers’ networks, largely motivated by the popularity of its YouTube video sharing service.

Private content delivery networks, of course, make economic sense for only a handful of the most globalized content providers. Most content providers will have to rely on other means of distribution.

The usual solution is to use a dedicated con-tent delivery network (CDN) to get the content to the edge of an access provider’s network. There,

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ChapterWho should pay for what and how?

Who should pay for what and how?

The Internet keeps growing at an annual rate of 40 percent, with global IP traffic quintupling over the next five years. But Internet actors are not happy. Content providers are squeezed by high distribution costs. Access providers are plagued by falling ARPU. Transit providers are struggling with commoditization. All of them feel they are subsidizing the others.

Customers have become used to free content and are unwilling to pay. In the end, of course,

they will pay one way or the other, whether as flat Internet access fees, or bills by the byte, or micropayments, or higher prices on goods or services as a result of companies passing on advertising costs to customers—or combina-tions of these and other methods.

New payment models that compensate all parties fairly while being acceptable to custom-ers would benefit the entire Internet ecosystem. It may take some time until they are in place.

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ChapterRevenue sharing

The P2P issueto provide acceptable service. A special problem is that the upstream traffic may be much larger than the downstream traffic. This congests the upstream link, putting pressure on access provid-ers to reconfigure their asymmetric networks to be more symmetric. Because people were seen largely as consumers of professional content, not as creators or distributors, most networks were originally download-centric. This is now changing fast.

There are two divergent schools of thought among access providers on how to handle P2P traffic. Some would like to block P2P or demote it to the lowest possible priority. Others see it as an opportunity to charge for additional value-added services. With legitimate P2P applications increasing in importance and concerted efforts being made to curb illegal use, the latter school of thought will probably prevail.

New developments are moving P2P into the mainstream and legitimizing it for large-scale commercial content delivery. Next-generation P2P technology, based on new peer-assignment algorithms, can overcome many of the earlier problems. Transmission time for the requesting peer can be reduced, keeping peer chains short, and minimizing bandwidth use. In the end, P2P may turn out to be not a ravenous monster but a tool to boost ARPU.

Peer-to-peer (P2P) traffic consumes network resources, usually without creating additional revenue. It is estimated that 70 percent or more of broadband bandwidth is consumed by down-loads of video, games, music and other content. Consumption will increase as P2P downloads multiply because of increases in file sizes and subscriber adoption. This traffic growth causes network congestion, performance deterioration, customer dissatisfaction and ultimately customer churn.

Critics have claimed that P2P will consume all available bandwidth; that it will render even the most ambitious network upgrades futile. The question is whether actual growth rates bear out that assertion.

P2P is growing fast, but declining as a per-centage of overall IP traffic. Furthermore, its growth rate has been slowing for some time. According to Cisco Visual Networking index, June 2009, P2P will grow at an annual rate of 18 percent over the next few years, while total IP traffic will grow at a rate of 40 percent. As a percentage of consumer Internet traffic, P2P will drop to 20 percent by 2013. Perhaps more surprising than the slowing growth rate is the fact that lawful P2P uses seem to be growing ten times faster than illicit uses.

P2P traffic will continue to strain networks, forcing access providers to upgrade networks

Revenue sharing therefore are pushing for a law that would require broadband providers to pay money to content developers.

Access providers’ trump card in their struggle to improve ARPU is their billing relationship with users. This, the strongest link in the Internet value chain, can be capitalized to enhance revenue. Only the very largest content providers (Amazon, Google, etc.) can interfere with access providers’ customer ownership. The vast majority cannot access customers directly.

Instead of trying to develop their own exclusive content and services, access providers may be far better off just distributing content providers’ materials within their territories. They can help developers sell their content by packaging and marketing it. But they must concentrate on ensur-ing quality of experience over their local networks and billing customers for the content they buy, sharing revenues with content providers.

Usage billing may be inevitable in the future whether we like it or not. (A U.S. Congress-man wants to make it illegal for Internet service providers to charge subscribers based on the amount of data they download.) An obstacle is that many billing systems accommodate only fixed flat tariff-based billing, but some Internet access providers already bill by the byte, or plan to start doing so soon.

Sharing revenue with content providers may also be inevitable in the long term. Creating win-win situations will require clear policies and solid agreements. New business models and billing systems will have to be introduced, probably based on micropayments.

Incidentally, not everyone agrees that access providers are subsidizing content providers. In Canada, content providers think they are subsidizing access providers and

Keeping it all togethersalers, at least in part. But very few networks are pure wholesalers.

The reach of the backbone and the network’s status in relation to other networks is of prime importance to its ability to provide effective connectivity. So called Tier 1 networks reach any portion of the Internet without paying settle-ments to any other network. Therefore, to be a Tier 1 network, a network must peer with every other Tier 1 network. There are only ten or twelve such networks in the world. TeliaSonera Interna-tional Carrier, a dedicated wholesaler, is one of these.

Some species play a particularly important role in ecosystem function, with other species depending on them for their survival. Transit providers are a keystone species in the Internet ecosystem.

Transit provider refers to an organization that provides connectivity to networks around the world. These organizations sell wholesale bandwidth to both access providers and content providers. Their services are typically priced per megabit per second per month and combined with service level agreements (SLAs). To some extent, all large networks in the world are whole-

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ChapterKeeping it all together

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Quality differentiationFor content providers, especially smaller ones and entrepreneurial start-ups, a Tier 1 Internet carrier can be a better and less costly proposition than a content delivery network. The carrier can directly provide the universal connectivity that CDNs have pursued with limited success. Tier 1 Internet carriers already have huge pipes into local access providers, and are especially good at providing strength and depth of coverage in continent-sized regions. In the US, for example, the top three Tier-1 carriers have between them access to 95 percent of the domestic ISPs. In Europe, just one Tier-1 carrier, TeliaSonera International Carrier, is directly connected to 85 percent of the continent’s broadband ISPs.

A transit provider that offers global reach, economies of scale and quality focus is increas-ingly crucial for ensuring the end-to-end quality of experience that today’s Internet users crave.

For years, wholesale IP services were sold mainly on price. Companies that could afford to lose money for a long time kept prices below costs in the hope of driving competitors out of business – and afterwards capture market share and make money through economies of scale and raising prices. This phase is now ending.Beacuse quality-sensitive applications, mainly all forms of video, are now dominating Internet traffic, quality matters as much as price. Research has shown that transit providers’ networks have significantly different levels of quality with respect to, among other things, outages and stability. An outage, misconfigura-tion or other problem could be very expensive for the content provider. Therefore, reliability over time, responsiveness, ease of provisioning and other factors are increasingly influencing buying decisions.

Evolution drives specializationrise to specialization. A highly specialized organ-ism is more effective at competing with other organisms. In the Internet ecosystem, specializa-tion will lead to greater competence, increased productivity and lower costs.

Natural evolution will force the various types of organizations that make up the Internet to con-centrate on their core skills and stop doing things that others do better. Content providers should concentrate on developing quality content. Access providers on providing easy access for users. Transit providers on carrying traffic effectively with flawless quality.

The return to basics will be good for all involved in the Internet business.

The continued, relentless growth of the Internet, combined with shifts in users’ preferences and behavior, will present opportunities as well as problems for all species in the Internet eco-system. As the environment of users changes, the content providers, access providers and transit providers that inhabit the ecosystem will have to change, too. This will require a new model for sharing the management, the provi-sion of content, the transmission of data and, especially, the costs.

The new model will arise from natural evolu-tion and not because of planned, coordinated action or artificially engineered development. As in a biological ecosystem, competition will give

ChapterQuality differentiation