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Preliminary Draft
Pricing the Internet
by
Jeffrey K. MacKie-Mason
Hal R. Varian
University of Michigan
April 1993
Current version: June 14, 1993
Abstract. This is a preliminary version of a paper prepared
for the conference ``Public Access to the Internet,'' JFK
School of Government, May 26--27 , 1993. We describe
some of the technology and costs relevant to pricing access to
the Internet and suggest a possible smart-market mechanism
for pricing traffic on the Internet.
Keywords. Networks, Internet, NREN.
Address. Hal R. Varian, Jeffrey K. MacKie-Mason, Depart-
ment of Economics, University of Michigan, Ann Arbor, MI
48109-1220. E-mail: jmm@umich.edu, halv@umich.edu.
Pricing the Internet
Jeffrey K. MacKie-Mason
Hal R. Varian
On December 23, 1992 the National Science Foundation
announced that it will cease funding the ANS T3 Internet
backbone in the near future. This is a major step in the tran-
sition from a government-funded to a commercial Internet.
This movement has been welcomed by private providers of
telecommunication services and businesses seeking access
to the Internet.
We think that it is safe to say that no one is quite sure
about how this privatization effort will work. In particular,
it is far from clear how access to the privatized Internet will
be priced. Currently, the several Internet backbone networks
are public goods with exclusion: usage is essentially free to
all authorized users. Most users are connected to a backbone
through a ``pipe'' for which a fixed access fee is charged,
but the user's organization nearly always covers the access
fee as overhead without any direct charge to the user.1 In
any case, none of the backbones charge for actual usage in
the sense of the volume of data transmitted.
In this paper we describe some of the technological, cost,
and economic issues related to pricing the Internet. We
strongly suspect that efficiency will require usage pricing for
_________________________________________
We wish to thank Guy Almes, Eric Aupperle, Paul Green, Mark
Knopper, Ken Latta, Dave McQueeny, Jeff Ogden, Chris Parkin, Scott
Shenker and Paul Southworth for helpful discussions, advice and data.
1 Most users of the NSFNET backbone do not pay a pipeline fee to ANS,
the service provider, but instead pay for a connection to their ``regional'' or
mid-level network, which then is granted a connection to the NSFNET.
1
backbone services. In order to do this, it will be necessary
to develop new standards for TCP/IP packets in order to
facilitate accounting and priority-based routing. We offer
a proposal as to how access might be priced using a smart
market.
1. Internet Technology and Costs
The Internet is a network of networks. In this paper we focus
on network backbones, although most of our pricing ideas
apply equally well to mid-level and local area networks.
There are essentially three competing backbones for the
Internet: ANSnet, PSInet and Alternet. ANS is a non-
profit that was formed in 1990 to manage the publicly-
funded NSFNET for research and educational users. ANSnet
now provides the virtual backbone service for NSFNET,
as well as backbone service for commercial users (through
its subsidiary, ANS CO+RE, Inc.). PSInet and Alternet
are independent commercial providers of backbone Internet
services to both commercial and non-commercial users.
The Internet is defined as those connected networks
that use connectionless packet-switching communications
technology based on the TCP/IP protocols. Even though
much of the traffic moves across lines leased from telephone
common carriers, the technology is quite different from the
switched circuits used for voice telephony. A telephone
user dials a number and various switches then open a line
between the caller and the called number. This circuit stays
open and no other caller can share the line until the call
is terminated. A connectionless packet-switching network,
by contrast, uses statistical multiplexing to maximize use of
2
the communications lines.2 Each circuit is simultaneously
shared by numerous users, and no single open connection is
maintained for a particular communications session: some
of the data may go by one route while the rest may take a
different route. Because of the technology differences pricing
models appropriate for voice telephony will be inappropriate
for data networks.
Packet-switching technology has two major components:
packetization and dynamic routing. A data stream from a
computer is broken up into small chunks called ``packets.''
The IP (Internet protocol) specifies how to break up a
datastream into packets and reassemble it, and also provides
the necessary information for various computers on the
Internet (the routers) to move the packet to the next link on
the way to its final destination.
Packetization allows for the efficient use of expensive
communications lines. Consider a typical interactive terminal
session to a remote computer. Most of the time the user is
thinking. The network is needed only after a key is struck or
when a reply is returned. Holding an open connection would
waste most of the capacity of the network link. Instead, the
computer waits until after a key is struck, at which point
it puts the keystroke information in a packet which is sent
across the network. The rest of the time the network links
are free to be used for transporting packets from other users.
With dynamic routing a packet's path across the network
is determined anew for each packet transmitted. Because
multiple paths exist between most pairs of network nodes,
_________________________________________
2 ``Connection-oriented'' packet-switching networks also exist: X.25
and Frame Relay are examples of such.
3
it is quite possible that different packets will take different
paths through the network.3
The postal service is a good metaphor for the technology
of the Internet (Krol (1992), pp. 20--23). A sender puts
a message into an envelope (packet), and that envelope is
routed through a series of postal stations, each determining
where to send the envelope on its next hop. No dedicated
pipeline is opened end-to-end, and thus there is no guarantee
that envelopes will arrive in the sequence they were sent, or
follow exactly the same route to get there.
So that packets can be identified and reassembled in the
correct order, TCP packets consist of a header followed by
data. The header contains the source and destination ports,
the sequence number of the packet, an acknowledgment flag,
and so on. The header comprises 20 (or more) bytes of the
packet.
Once a packet is built TCP sends it to a router, a
computer that is in charge of sending packets on to their next
destination. At this point IP tacks on another header (20 or
more bytes) containing source and destination addresses and
other information needed for routing the packet. The router
then calculates the best next link for the packet to traverse
towards its destination, and sends it on. The best link
may change minute-by-minute, as the network configuration
changes.4 Routes can be recalculated immediately from the
_________________________________________
3 Dynamic routing contributes to the efficient use of the communications
lines, because routing can be adjusted to balance load across the network.
The other main justification for dynamic routing is network reliability, since
it gives each packet alternative routes to their destination should some links
fail. This was especially important to the military, which funded most of
the early TCP/IP research to improve the ARPANET.
4 Routing is based on a dynamic knowledge of which links are up and
4
routing table if a route fails. The routing table in a switch is
updated approximately continuously.
The data in a packet may be 1500 bytes or so. However,
recently the average packet on NSFNET carries about 200
bytes of data (packet size has been steadily increasing). On
top of these 200 bytes the TCP/IP headers add about 40; thus
about 17% of the traffic carried on the Internet is simply
header information.
Over the past 5 years, the speed of the NSFNET backbone
has grown from 56 Kbps to 45 Mbps (``T-3'' service).5 These
lines can move data at a speed of 1,400 pages of text per
second; a 20-volume encyclopedia can be sent across the net
in half a minute. Many of the regional networks still provide
T1 (1.5Mbps) service, but these too, are being upgraded.
The transmission speed of the Internet is remarkably
high. We recently tested the transmission delay at various
times of day and night for sending a packet to Norway. Each
packet traversed 16 links, and thus the IP header had to be
read and modified 16 times, and 16 different routers had to
calculate the best next link for the transmission. Despite
the many hops and substantial packetization and routing
overhead, the longest delay on one representative weekday
was only 0.333 seconds (at 1:10 PM); the shortest delay was
0.174 seconds (at 5:13 PM).
_________________________________________
a static ``cost'' assigned to each link. Currently routing does not take
congestion into account. Routes can change when hosts are added or deleted
from the network (including failures), which happens often with about 1
million hosts and over 11,000 subnetworks.
5 In fact, although the communications lines can transport 45 Mbps, the
current network routers can support only 22.5 Mbps service. ``Kbps'' is
thousand (kilo) bits per second; ``Mbps'' is million (mega) bits per second.
5
Current Backbone Network Costs
The postal service is a good metaphor for packet-switching
technology, but a bad metaphor for the cost structure of
Internet services. Most of the costs of providing the Internet
are more-or-less independent of the level of usage of the
network; i.e., most of the costs are fixed costs. If the network
is not saturated the incremental cost of sending additional
packets is essentially zero.
The NSF currently spends about $11.5 million per year
to operate the NSFNET and provides $7 million per year of
grants to help operate the regional networks.6 There is also
an NSF grant program to help colleges and universities to
connect to the NSFNET. Using the conservative estimate of
1 million hosts and 10 million users, this implies that the
NSF subsidy of the Internet is less than $20 per year per host,
and less than $2 per year per user.
Total salaries and wages for NSFNET have increased by
a little more than one-half (about 68% nominal) over 1988-
-1991, during a time when the number of packets delivered
has increased 128 times.7 It is hard to calculate total costs
because of large in-kind contributions by IBM and MCI
during the initial years of the NSFNET project, but it appears
that total costs for the 128-fold increase in packets have
increased by a factor of about 3.2.
Two components dominate the costs of providing a
backbone network: communications lines and routers. Lease
_________________________________________
6 The regional network providers generally set their charges to recover
the remainder of their costs, but there is also some subsidization from state
governments at the regional level.
7 Since packet size has been slowly increasing, the amount of data
transported has increased even more.
6
payments for lines and routers accounted for nearly 80% of
the 1992 NSFNET costs. The only other significant cost is
for the Network Operations Center (NOC), which accounts
for roughly 7% of total cost.8 In our discussion we focus
only on the costs of lines and routers.
We have estimated costs for the network backbone as of
1992--93.9 A T-3 (45 Mbps) trunk line running 300 miles
between two metropolitan central stations can be leased for
about $32,000 per month. The cost to purchase a router
capable of managing a T-3 line is approximately $100,000.
Assuming another $100,000 for service and operation costs,
and 50-month amortization at a nominal 10% rate yields a
rental cost of about $4900 per month for the router.
_________________________________________
8 A NOC monitors traffic flow at all nodes in the network and trou-
bleshoots problems.
9 We estimated costs for the network backbone only, defined to be links
between common carrier Points of Presence (POPs) and the routers that
manage those links. We did not estimate the costs for the feeder lines to
the mid-level or regional networks where the data packets usually enter and
leave the backbone, nor for the terminal costs of setting up the packets or
tearing them apart at the destination.
7
Table 1.
Communications and Router Costs
_(Nominal_$_per_million_bits)1_________________________________________________*
*_______
__Year________Communications_____________Routers______Design_Throughput________*
*_______
1960 1.00 2.4 kbps
1962 10.00
1963 0.42 40.8 kbps
1964 0.34 50.0 kbps
1967 0.33 50.0 kbps
1970 0.168
1971 0.102
1974 0.11 0.026 56.0 kbps
__1992____________________0.00094_______0.00007_______________45_mbps__________*
*_______
Notes: 1. Costs are based on sending one million bits of data approximately
1200 miles on a path that traverses five routers.
Sources: 1960--74 from Roberts (1974). 1992 calculated by the authors
using data provided by Merit Network, Inc.
The costs of both communications and switching have
been dropping rapidly for over three decades. In the 1960s,
digital computer switching was more expensive (on a per
packet basis) than communications (Roberts (1974)), but
switching has become substantially cheaper since then. We
have estimated the 1992 costs for transporting 1 million bits
of data through the NSFNET backbone and compare these
to estimates for earlier years in Table 1. As can be seen, in
1992 the line cost is about eight times as large as the cost of
routers.
The topology of the NSFNET backbone directly reflects
the cost structure: lots of cheap routers are used to manage
a limited number of expensive lines. We illustrate a portion
of the network in Figure 1. Each of the numbered squares
is an RS6000 router; the numbers listed beside a router are
8
links to regional networks. Notice that in general any packet
coming on to the backbone has to move through two separate
routers at the entry and exit node. For example, a message
we send from the University of Michigan to a scientist at
Bell Laboratories will traverse link 131 to Cleveland, where
it passes through two routers (41 and 40). The packet goes to
New York, where it again moves through two routers (32 and
33) before leaving the backbone on link 137 to the JVNCnet
regional network that Bell Labs is attached to. Two T-3
communications links are navigated using four routers.
/afs/umich.edu/user/h/a/halv/Shared/Figures/NetFrag.eps
Figure 1. Network Topology Fragment
Technological and Cost Trends
The decline in both communications link and switching costs
has been exponential at about 30% per year (see the semi-log
9
plot in Figure 2). But more interesting than the rapid decline
in costs is the change from expensive routers to expensive
transmission links. Indeed, it was the crossover around 1970
(Figure 2) that created a role for packet-switching networks.
When lines were cheap relative to switches it made sense
to have many lines feed into relatively few switches, and
to open an end-to-end circuit for each connection. In that
way, each connection wastes transmission capacity (lines are
held open whether data is flowing or not) but economizes on
switching (one set-up per connection).
/afs/umich.edu/user/h/a/halv/Shared/Figures/CommCost.eps
Figure 2. Trends in costs for communications links and
routers.
When switches became cheaper than lines the network is
more efficient if data streams are broken into small packets
and sent out piecemeal, allowing the packets of many users
to share a single line. Each packet must be examined at each
switch along the way to determine its type and destination,
but this uses the relatively cheap switch capacity. The gain
10
is that when one source is quiet, packets from other sources
use the same (relatively expensive) lines.
Although the same reversal in switch and line costs oc-
curred for voice networks, circuit-switching is still the norm
for voice. Voice is not well-suited for packetization because
of variation in delivery delays, packet loss, and packet or-
dering.10 Voice customers will not tolerate these delays in
transmission (although some packetized voice applications
are beginning to emerge as transmission speed and reliability
increases, see (Anonymous (1986)) ).11
2. Congestion problems
Another aspect of cost of the Internet is congestion cost.
Although congestion costs are not paid for by the providers
of network services, they are paid for by the users of the
service. Time spent by users waiting for a file transfer
is a social cost, and should be recognized as such in any
economic accounting.
The Internet experienced severe congestion problems
in 1987. Even now congestion problems are relatively
common in parts of the Internet (although not currently on
the T-3 backbone). According to Kahin (1992): ``However,
problems arise when prolonged or simultaneous high-end
_________________________________________
10 Our tests found packet delays ranging between 156 msec and 425 msec
on a trans-Atlantic route (N=2487 traces, standard deviation = 24.6 msec).
Delays were far more variable to a Nova Scotia site: the standard deviation
was 340.5 msec when the mean delay was only 226.2 msec (N=2467); the
maximum delay was 4878 msec.
11 The reversal in link and switch costs has had a profound effect on voice
networks. Indeed, Peter Huber has argued that this reversal made inevitable
the breakup of ATT (Huber (1987)). He describes the transformation of the
network from one with long lines all going into a few central offices into
a web of many switches with short lines interconnecting them so that each
call could follow the best path to its destination.
11
uses start degrading service for thousands of ordinary users.
In fact, the growth of high-end use strains the inherent
adaptability of the network as a common channel.'' (page
11.) It is apparent that contemplated uses, such as real-
time video and audio transmission, would lead to substantial
increases in the demand for bandwidth and that congestion
problems will only get worse in the future unless there is
substantial increase in bandwidth:
If a single remote visualization process were
to produce 100 Mbps bursts, it would take only a
handful of users on the national network to gener-
ate over 1Gbps load. As the remote visualization
services move from three dimensions to [animation]
the single-user bursts will increase to several hun-
dred Mbps : : :Only for periods of tens of minutes
to several hours over a 24-hour period are the high-
end requirements seen on the network. With these
applications, however, network load can jump from
average to peak instantaneously.'' Smarr and Catlett
(1992), page 167.
There are cases where this has happened. For example dur-
ing the weeks of November 9 and 16, 1992, some packet
audio/visual broadcasts caused severe delay problems, espe-
cially at heavily-used gateways to the NSFNET backbone,
and in several mid-level networks.
To investigate the nature of congestion on the Internet
we timed the delay in delivering packets to seven different
sites around the world. We ran our test hourly for 37
days during February and March, 1993. Deliveries can
be delayed for a number of reasons other than congestion-
induced bottlenecks. For example, if a router fails then
packets must be resent by a different route. However, in
a multiply-connected network, the speed of rerouting and
12
delivery of failed packets measures one aspect of congestion,
or the scarcity of the network's delivery bandwidth.
Our results are summarized in Figure 3 and Figure 4; we
present the results only from four of the 24 hourly probes.
Figure 3 shows the average and maximum delivery delays by
time of day. Average delays are not always proportional to
distance: the delay from Michigan to New York University
was generally longer than to Berkeley, and delays from
Michigan to Nova Scotia, Canada, were often longer than to
Oslo, Norway.
/afs/umich.edu/user/h/a/halv/Shared/Figures/DelayAvgMax.eps
Figure 3. Maximum and Average Transmission Delays on
the Internet
13
/afs/umich.edu/user/h/a/halv/Shared/Figures/DelayStdDev.eps
Figure 4. Variability in Internet Transmission Delays
There is substantial variability in Internet delays. For
example, the maximum and average delays in Figure 3 are
quite different by time of day. There appears to be a large
4PM peak problem on the east coast for packets to New York
and Nova Scotia, but much less for ATT Bell Labs (in New
Jersey).12 The time-of-day variation is also evident in Figure
5, borrowed from Claffy, Polyzos, and Braun (1992).13
Figure 4 shows the standard deviation of delays by time
of day for each destination. The delays to Canada are
extraordinarily variable, yet the delays to Oslo have no more
variability than does transmission to New Jersey (ATT).
_________________________________________
12 The high maximum delay for the University of Washington at 4PM is
correct, but appears to be aberrant. The maximum delay was 627 msec; the
next two highest delays (in a sample of over 2400) were about 250 msecs
each. After dropping this extreme outlier, the University of Washington
looks just like UC Berkeley.
13 Note that the Claffy et al. data were for the old, congested T-1 network.
We reproduce their figure to illustrate the time-of-day variation in usage;
the actual levels of link utilization are generally much lower in the current
T-3 backbone. Braun and Claffy (1993) show time-of-day variations in T-3
traffic between the US and three other countries in their Figure 5.
14
/afs/umich.edu/user/h/a/halv/Shared/Figures/UsageTOD.eps
Figure 5. Utilization of Most Heavily Used Link in Each
Fifteen Minute Interval (Claffy et al. (1992))
Variability in delay fluctuates widely across times of day, as
we would expect in a system with bursty traffic, but follows
no obvious pattern.
According to Kleinrock (1992), ``One of the least un-
derstood aspects of today's networking technology is that of
network control, which entails congestion control, routing
control, and bandwidth access and allocation.'' We expect
that if access to Internet bandwidth continues to be provided
at a zero cost there will inevitably be congestion. Essen-
tially, this is the classic problem of the commons: unless
the congestion externality is priced, there will inevitably be
inefficient use of the common resource. As long as users face
a zero price for access, they will continue to ``overgraze.''
Hence, it makes sense to consider how networks such as the
Internet should be priced.
There is a large literature on network congestion control;
15
see Gerla and Kleinrock (1988) for an overview. However,
there is very little work in using pricing for congestion con-
trol. Cocchi, Estrin, Shenker, and Zhang (1992) and Shenker
(1993) make the important point that if different applications
use different types of network services (responsiveness, re-
liability, throughput, etc.), then it will be necessary to have
some sort of pricing to sort out users' demands for these
characteristics. These papers lay out the problem in general
and describe how it might be solved.
Faulhaber (1992) has considered some of the economic
issues related to pricing access to the Internet. He suggests
that ``transactions among institutions are most efficiently
based on capacity per unit time. We would expect the ANS
to charge mid-level networks or institutions a monthly or
annual fee that varied with the size of the electronic pipe
provided to them. If the cost of providing the pipe to an
institution were higher than to a mid-level network : : :the
fee would be higher.''
Faulhaber's suggestion makes sense for a dedicated line--
-e.g., a line connecting an institution to the Internet backbone.
But we don't think that it is necessarily appropriate for
charging for backbone traffic itself. The reason is that the
bandwidth on the backbone is inherently a shared resource-
--many packets ``compete'' for the same bandwidth. There
is an overall constraint on capacity, but there are is no such
thing as individual capacity level on the backbone.14
_________________________________________
14 Although it may be true that an institution's use of the backbo*
*ne
bandwidth is more-or-less proportional to the bandwidth of its connection
to the backbone. That is, the size of an institution's dedicated line to
the backbone may be a good signal of its intended usage of the common
backbone.
16
Although we agree that it is appropriate to charge a
flat fee for connection to the network, we also think that
it is important to charge on a per packet basis, at least
when the network is congested. After all, during times of
congestion the scarce resource is bandwidth for additional
packets.15 The problem with this proposal is the overhead,
or, in economics terms, the transactions cost. If one literally
charged for each individual packet, it would be extremely
costly to maintain adequate records. However, given the
astronomical units involved there should be no difficulty in
basing charges on a statistical sample of the packets sent.
Furthermore, accounting can be done in parallel to routing
using much less expensive computers.
Conversely when the network is not congested there
is very small marginal cost of sending additional packets
through the routers. It would therefore be appropriate to
charge users a very small price for packets when the system
is not congested.
There has been substantial recent work on designing
mechanisms for usage accounting on the Internet. The In-
ternet Accounting Working Group has published a draft
architecture for Internet usage reporting (Internet Account-
ing: Usage Reporting Architecture, July 9, 1992 draft). ANS
has developed a usage sampling and reporting system it
calls COMBits. COMBits was developed to address the
need to allocate costs between government-sponsored re-
search and educational use, and commercial usage, which is
_________________________________________
15 As we have already pointed out the major bottleneck in backbone
capacity is not the bandwidth of the medium itself, but the switch technology.
We use the term bandwidth to refer to the overall capacity of the network.
17
rapidly growing. COMBits collects an aggregate measure of
packets and bytes usage, using a statistical sampling tech-
nique.16 However, COMBits only collects data down to the
network-to-network level of source and destination. Thus,
the resulting data can only be used to charge at the level of the
subnetwork; the local network administrator is responsible
for splitting up the bill (Ruth and Mills (1992)).17
Braun and Claffy (1993) describe current traffic patterns
of the Internet by type of application and by international
data flows, and discuss some of the accounting issues that
need to be solved.
Existing support for prioritizing packets
IP packets contain fields known Precedence and Type of
Service (TOS). Currently, most commercial routers do not
use these fields.18 However, it is widely anticipated that
this must change due to increased congestion on the Internet:
``An obvious application would be to allow router and host
configuration to limit traffic entering the internet to be above
some specific precedence. Such a mechanism could be used
to reduce traffic on an internet as often as needed under crisis
conditions'' (Cerf (1993)).
The current interpretations of these fields described in
Postel (1981) will probably be changed to the more flexible
_________________________________________
16 See K. Claffy and Polyzos (1993) for a detailed study of sampling
techniques for measuring network usage.
17 COMBits has been plagued by problems and resistance and currently
is used by almost none of the mid-level networks.
18 In 1986 the NSFNET experienced severe congestion and the there was
some experimentation with routing based on the IP precedence field and
the type of application. When the NSFNET was upgraded to T1 capacity,
priority queuing was abandoned for end-user traffic.
18
form described in Almquist (1992). Almquist discusses
only the TOS fields, and proposes that the user be able to
request that the network should minimize delay, maximize
throughput, maximize reliability, or minimize monetary cost
when delivering the packet. Prototype algorithms to provide
such service are described in Prue and Postel (1988). In this
proposed protocol a router looks up the destination address
and examines the possible routes. Each route has a TOS
number. If the TOS number of the route matches the TOS
number of the datagram, then that route is chosen. Note that
the TOS numbers must match; inequality relationships are
not allowed.
To an economist's eye, this specification seems some-
what inflexible. In particular, the TOS value ``minimize
monetary cost'' seems somewhat strange. Of course senders
would want to minimize monetary cost for a given quality
of service: minimizing monetary cost is an objective, not a
constraint. Also, the fact that TOS numbers do not allow for
inequality relations is strange. Normally, one would think of
specifying the amount that one would be willing to pay for
delivery, with the implicit assumption that any less expensive
service (other things being equal) would be better.
As Almquist (1992) explains, ``There was considerable
debate over what exactly this value [minimize monetary cost]
should mean.'' However, he goes on to say:
``It seems likely that in the future users may need
some mechanism to express the maximum amount
they are willing to pay to have a packet delivered.
However, an IP option would be a more appropriate
mechanism, since there are precedents for having
IP options that all routers are required to honor,
and an IP option could include parameters such as
19
the maximum amount the user was willing to pay.
Thus, the TOS value defined in this memo merely
requests that the network ``minimize monetary cost.''
Almquist (1992)
Currently there is much discussion in the network com-
munity about what forms of pricing should become part of
the Internet protocol. As Estrin (1989) puts it: ``The Internet
community developed its original protocol suite with only
minimal provision for resource control : : :This time it would
be inexcusable to ignore resource control requirements and
not to pay careful attention to their specification.''
3. General observations on pricing
The Internet uses scarce resources. Telecommunications
lines, computer equipment, and labor are not free; if not
employed by the Internet, they could be put to productive use
in other activities. Bandwidth is also scarce: when the back-
bone is congested, one user's packet crowds out another's,
resulting in dropped or delayed transmissions. Economics
is concerned with ways to allocate scarce resources among
competing uses, and it is our belief that economics will be
useful in allocating Internet resources as well.
We are not concerned with pricing the Internet to generate
profits from selling backbone services. Indeed, a network
need not be private to be priced; governments are perfectly
capable of charging prices.19 Rather, our goal is to find
pricing mechanisms that lead to the most efficient use of
existing resources, and that guide investment decisions in an
appropriate manner.
_________________________________________
19 In fact, many of the mid-level regional networks are government
agencies, and they charge prices to connect organizations to their networks.
20
One common resource allocation mechanism is random-
ization: each packet has an equal chance of getting through
(or being dropped). Another allocation scheme is first-come,
first-served: all packets are queued as they arrive and if the
network is congested, every packet suffers a delay based
on its arrival time in the queue. It is easy to see why these
schemes are not good ways to achieve efficiency.20 However
one measures the social value of expeditious delivery for a
packet, it will surely be true that some packets are worth
more than others. For example, a real-time video transmis-
sion of a heart operation to a remote expert may be more
valuable than a file transfer of a recreational game or picture.
Economic efficiency will be enhanced if the mechanism al-
locating scarce bandwidth gives higher priority to uses that
are more socially valuable.
We do not want the service provider---government or
otherwise---to decide which packets are more socially valu-
able and allocate scarce bandwidth accordingly. We know
from the Soviet experience that allowing bureaucrats to de-
cide whether work shoes or designer jeans are more valuable
is a deeply flawed mechanism. A price mechanism works
quite differently. The provider knows the costs of providing
services and can announce these to the users; users then
can decide for themselves whether their packets are more or
less valuable than the cost of providing the packet transport
service. When the backbone is congested the cost of service
will be high due to the the cost of crowding out or delaying
the packets of other users; if prices reflect costs only those
_________________________________________
20 Current backbones use a mix of queuing and random dropping as their
mechanisms for allocating congested capacity.
21
packets with high value will be sent until congestion dimin-
ishes. The users themselves decide how valuable each packet
is, and sort out for themselves which packets are serviced (or
in a multiple service quality network, receive which quality
of service; see Shenker (1993)).
Furthermore, if network congestion is properly priced,
the revenues collected from the congestion surcharges can
be used to fund further capacity expansion. Under certain
conditions, the fees collected from the congestion charges
turn out to be just the ``right'' amount to spend on expanding
capacity. We return to this point below.
One commonly expressed concern about pricing the In-
ternet is that ``poor'' users will be deprived of access. This
is not a problem with pricing, but with the distribution of
wealth. A pricing mechanism determines how the scarce
bandwidth will be allocated given the preferences and re-
sources of the users. If we wish to ensure that certain users
have sufficient resources to purchase a base level of services
then we can redistribute initial resources, say by providing
vouchers or lump sum grants.21
Universal access and a base endowment of usage for all
citizens---if desired---can be provided through vouchers or
other redistribution schemes. But for a given distribution
of resources, how should backbone services be allocated?
They are currently allocated (among paid-up subscribers) on
_________________________________________
21 Food stamps are an example of such a scheme. The federal government
more or less ensures that everyone has sufficient resources to purchase a
certain amount of food. But food is priced, so that given one's wealth plus
food stamps, the consumer still must decide how to allocate scarce resources
relative to the costliness of providing those resources. The government does
not guarantee unlimited access to foodstuffs, nor to all varieties of caloric
substances (alcoholic beverages are not eligible).
22
the basis of randomization and first-come, first-served. In
other words, users are already paying the costs of congestion
through delays and lost packets. A pricing mechanism will
convert delay and queuing costs into dollar costs. If prices
are designed to reflect the costs of providing the services,
they will force the user to compare the value of her packets
to the costs she is imposing on the system. Allocation will
then be on the basis of the value of the packets, and the total
value of service provided by the backbones will be greater
than under a non-price allocation scheme.
In the rest of the paper we discuss how one might
implement pricing that reflects the cost (including congestion
costs) of providing backbone services. We begin with a
review of some current pricing schemes and their relationship
to costs.
4. Current Pricing Mechanisms
NSFNET, the primary backbone network of the Internet,
has been paid for by the NSF, IBM, MCI and the State of
Michigan until the present.22 However, most organizations
do not connect directly to the NSFNET. A typical university
will connect to its regional mid-level network; the mid-
level maintains a connection to the NSFNET. The mid-level
networks (and a few alternative backbone networks) charge
their customers for access.
There are dozens of companies that offer connections
to the Internet. Most large organizations obtain direct con-
nections, which use a leased line that permits unlimited
_________________________________________
22 NSF restricts the use of the backbone to traffic with a research or
educational purpose, as defined in the Acceptable Use Policies.
23
usage subject to the bandwidth of the line. Some customers
purchase ``dial-up'' service which provides an intermittent
connection, usually at much lower speeds. We will discuss
only direct connections below.
Table 3 summarizes the prices offered to large universi-
ties by ten of the major providers for T-1 access (1.5 mbps).23
There are three major components: an annual access fee, an
initial connection fee and in some cases a separate charge
for the customer premises equipment (a router to serve as
a gateway between the customer network and the Internet
provider's network).24 The current annualized total cost per
T-1 connection is about $30--35,000.
_________________________________________
23 The fees for some providers are dramatically lower due to public
subsidies.
24 Customers will generally also have to pay a monthly ``local loop''
charge to a telephone company for the line between the customer's site and
the Internet provider's ``point of presence'' (POP), but this charge depends
on mileage and will generally be set by the telephone company, not the
Internet provider.
24
All of the providers use the same type of pricing: annual
fee for unlimited access, based on the bandwidth of the
connection. This is the type of pricing recommended by
Faulhaber (1992). However, these pricing schemes provide
no incentives to flatten peak demands, nor any mechanism for
allocating network bandwidth during periods of congestion.
It would be relatively simple for a provider to monitor a
customer's usage and bill by the packet or byte. Monitoring
requires only that the outgoing packets be counted at a single
point: the customer's gateway router.
However, pricing by the packet would not necessarily
increase the efficiency of network service provision, because
the marginal cost of a packet is nearly zero. As we have
shown, the important scarce resource is bandwidth, and thus
25
efficient prices need to reflect the current state of the network.
Neither a flat price per packet nor even time-of-day prices
would come very close to efficient pricing.
5. Matching prices to costs
In general we want the prices that users face to reflect the
resource costs that they generate so that they can make
intelligent decisions about resource utilization. In the case of
the Internet, there are several costs that might be considered:
o The fixed costs of providing the network infrastruc-
ture. As we have seen this is basically the rent for the
line, the cost of the routers, and the salary for the support
staff.
o The incremental costs of sending extra packets. If
the network is not congested, this is essentially zero.
o The social costs of delaying other users' packets when
the network is congested. This is not directly a resource
cost, but should certainly be considered part of the social
cost of a packet.
o The cost of expanding capacity of the network. This
will normally consist of adding new routers, new lines,
and new staff.
We first consider how ideal prices would incorporate
this cost information, then consider how market-based prices
might work.
26
The incremental costs of sending extra packets.
The price of sending a packet in a non-congested network
should be close to zero; any higher price is socially inefficient
since it does not reflect the true incremental costs. If
the incremental cost is high enough to justify the cost of
monitoring and billing, it should be charged as a per-packet
cost.25
The social costs of delaying other users' packets when the
network is congested.
The price for sending a packet when the network is in a
congested state should be positive: if my packet precludes
(or delays) another user's packet, then I should face the cost
that I impose on the other user. If my packet is more valuable
than hers, then it should be sent; if hers is more valuable than
mine, then hers should be sent.
We can depict the logic of this argument graphically
using demand and supply curves. Suppose the packet price
were very high; then only a few users would want to send
packets. As the packet price decreases, more users would
be willing to send more packets. We depict this relationship
between price and the demand for network access in Figure
6. If the network capacity is some fixed amount K, then the
optimal price for access is where the demand curve crosses
the capacity supply. If demand is small relative to capacity,
the efficient price is zero---all users are admitted. If demand
_________________________________________
25 Note that much of the necessary monitoring and billing cost may
already be incurred to implement our other pricing proposals.
27
/afs/umich.edu/user/h/a/halv/Shared/Figures/Demand.eps
Figure 6. Demand for network access with fixed capacity.
When demand is low, the packet price is low. When demand
is high, the packet price is high.
is high, users that are willing to pay more than the price of
admission to the network are admitted; the others are not.
This analysis applies for the extreme case where there is
a fixed capacity. If increase in use by some agents imposes
delay on other agents, but not outright exclusion, the analysis
is slightly different. Suppose that we know the amount of
delay as a function of number of packets, and that we have
some idea of the costs imposed on users by a given amount of
delay. Then we can calculate a relationship between number
of packets sent and delay costs. The relevant magnitude for
determining the optimal number of users is the marginal cost
of delay, as depicted in Figure 7.
The efficient price is where the marginal willingness to
pay for an additional packet just covers the marginal increase
in delay costs generated by that packet. If a potential user
faces this price he will be able to compare his own benefit
from sending a packet to the marginal delay costs that this
imposes on other users.
28
/afs/umich.edu/user/h/a/halv/Shared/Figures/DemandSupply.eps
Figure 7. Demand for network access with a marginal cost
of delay. When demand is low, the packet price is low. When
demand is high, and congestion is high, the packet price is
high.
The cost of expanding capacity of the network.
If the network usage never reaches capacity, even at a zero
price of packets, then clearly there is no need for expanding
capacity. It is only appropriate to expand capacity when the
network is sometimes congested. Consider first the model
with fixed capacity. If the packet prices are set correctly, we
have seen that they measure the marginal value of the last
admitted packet. If the cost of expanding capacity enough
to accommodate one more packet is less than the marginal
value of that packet, then it makes economic sense to expand
capacity. If this condition is not satisfied, then capacity
expansion is not economically worthwhile.
Hence the optimal congestion prices play a two roles---
they serve to efficiently ration access to the network in times
of congestion and they send the correct signals with respect
to capacity expansion. In this framework, all the revenues
29
generated by congestion prices should be plowed back into
capacity expansion.
Note that only the users who want to use the network
when it is at capacity pay for capacity expansion. Users
who are willing to wait until after the demand peak do
not pay anything towards expanding network capacity. We
think that this point is important from a political perspective.
The largest constituency of the Internet apparently is e-mail
users.26 A proposal to charge high prices for e-mail is likely
to be politically infeasible. However, e-mail can usually
tolerate moderate delays. Under congestion pricing of the
sort we are describing, e-mail users could put a low or zero
bid price on their traffic, and would continue to face a very
low cost.
The situation is only slightly different in the case of delay
costs. Here the price measures the marginal benefit of an
additional packet (which is equal to the marginal cost of
delay); if additional investment can reduce the marginal cost
of delay by more than the willingness-to-pay for reduced
delay then it should be undertaken, otherwise it should not.
We examine the analytics of pricing a congested network in
the Appendix 1. It turns out that essentially the same result
holds: if the packet price is chosen to be optimal with respect
to delay and congestion costs it will be the appropriate price
to use for determining whether capacity should be expanded.
_________________________________________
26 More traffic is generated by file transfers, but this reflects fewer users
sending bigger data streams (files vs. e-mail messages).
30
The fixed costs of providing the network infrastructure.
Think of the initial investment in network infrastructure
as a discrete decision: if you pay a certain amount of
money you can create a usable network of minimal size.
Further expansion can be guided by the congestion prices,
as indicated above. But what criterion can be used to decide
whether the initial investment is warranted?
The simple answer is that the investment should be
undertaken if total benefits exceed costs. But since the
existence of the network is a public good that provides
benefits for all users, we have to add up all potential users'
willingnesses-to-pay for the network infrastructure, and see
if this total willingness-to-pay exceeds the cost of provision.
In the case of a computer network like the Internet, it is
natural to think of paying for the network infrastructure via
a flat access fee. Each party who connects to the network
pays a flat price for network access distinct from the usage
based fee described earlier. In general, these connect fees
will be different for different people, since different people
and institutions will value connection to the net differently.
Note that in general efficiency will require some sort of price
discrimination in connect fees; but it will also require that
users pay the same prices for congestion fees.
In summary: there are four types of costs associated
with providing a broad-based computer network: 1) the fixed
costs of providing initial infrastructure; 2) the marginal costs
of sending packets when the network is not congested; 3)
the congestion costs of sending packets when the network is
congested; 4) the costs of expanding capacity. An efficient
pricing mechanism will have a structure that is parallel to
31
this cost structure: 1) a fixed connection charge that differs
from institution to institution; 2) a packet charge close to
zero when the network is not congested; 3) a positive packet
charge when the network is congested; 4) the packet charge
revenues can then be used to guide capacity expansion
decisions.
6. Implementing prices
We have argued that prices should reflect costs. But we
have not yet considered how these efficient prices should be
implemented. We turn now to that task.
The connect charges are the easiest to deal with, since
that is very much like the current methods of charging for
provision. Each customer pays a flat fee for connection; often
this fee will depend on the characteristics of the customer
(educational, commercial) and on the size of the bandwidth of
the connection. Presumably the bandwidth of the connection
purchased by a user is correlated to some degree with the
user's willingness to pay, so this should serve as a reasonable
characteristic upon which to base connect charges.27
A zero cost of packet charges when the network is not
congested is not hard to arrange either---that's what we have
now. The novel part of the pricing mechanism we propose
is the per packet congestion charge. We have discussed
how one might implement such a fee in MacKie-Mason and
Varian (1993). We briefly review that proposal here. In
Appendix 2 we describe some of the details that would be
necessary to implement a smart market.
_________________________________________
27 We intend to investigate how a profit-maximizing or welfare-maximizing
provider of network access might price discriminate in connect fees in future
work.
32
If congestion has a regular pattern with respect to time of
day, or day of week, then prices could vary in a predictable
way over time. However, this is a relatively inflexible form
for pricing. We think that it would be better to use a ``smart
market'': a price for packet access to the net that varies
minute-by-minute to reflect the current state of the network
congestion.
This would not be terribly difficult to implement, at
least in a minimal form. Each packet would have a ``bid''
field in the header that would indicate the willingness-to-pay
for that packet. Users would typically set default bids for
various applications, then override these defaults in special
circumstances. For example, a user might assign a low bid
to e-mail packets, for which immediate access to the net is
usually not required. Real-time audio or visual data might be
assigned a high bid price. The network would then admit all
packets whose bid exceeded some cutoff amount. The cutoff
amount is determined by the condition that the marginal
willingness-to-pay for an additional packet has to equal the
marginal congestion costs imposed by that packet.
A novel feature of this kind of smart market is that
users do not pay the price that they actually bid; rather they
pay for their packets at the market-clearing price, which
by construction will be lower than the bids of all admitted
packets. Note how this is different from priority-pricing
by say, the post office. In the post-office model you pay
for first-class mail even if there is enough excess capacity
that second-class mail could move at the same speed. In
the smart market described here, a user pays at most their
willingness-to-pay for an additional packet.
33
The smart market has many desirable features. By con-
struction the outcome is the classic supply-equals-demand
level of service of which economists are so fond.28 The
equilibrium price, at any point in time, is the bid of the
marginal user. Each infra-marginal user is charged this price,
so each infra-marginal user gets positive consumer surplus
from his or her purchase.
The major differences from the textbook demand and
supply story is that no iteration is needed to determine
the market-clearing price---the market is cleared as soon
as the users have submitted their bids for access.29 This
mechanism can be viewed as a Vickrey auction where the n
highest bidders gain access at the n + 1st highest price bid.30
We have assumed that the bid-price set by the users
accurately reflects the true willingness-to-pay. One might
well ask whether users have the correct incentives to reveal
this value: is there anything to be gained by trying to ``fool''
the smart market? It turns out that the answer is ``no.'' It
can be shown that it is a dominant strategy in the Vickrey
auction to bid your true value, so users have no incentive to
misprepresent their bids for network access. By the nature of
_________________________________________
28 For good reason, we might add.
29 Of course, in real time operation, one would presumably cumulate
demand over some time interval. It is an interesting research issue to
consider how often the market price should be adjusted. The bursty nature
of Internet activity suggests a fairly short time interval. However, if users
were charged for the congestion cost of their usage, it is possible that the
bursts would be dampened.
30 Waldspurger, Hogg, Huberman, Kephart, and Stornetta (1992) de-
scribes some (generally positive) experiences in using this kind of ``second-
bid'' auction to allocate network resources. However, they do not examine
network access itself, as we are proposing here.
34
the auction, you are assured that you will never be charged
more than this amount and normally you will be charged
much less.
7. Remarks about the smart market solution
Who sets the bids?
We expect that choice of bids would be done by three parties:
the local administrator who controls access to the net, the
user of the computer, and the computer software itself.
An organization with limited resources, for example, might
choose low bid prices for all sorts of access. This would
mean that they may not have access during peak times, but
still would have access during off-peak periods.31
Within any limits imposed by institution policies, the
users could then set priority values for their own usage.
Normally, users would set default values in their software
for different services. For example, file transfers might
have lower priority than e-mail, e-mail would be lower than
telnet (terminal sessions), telnet would be lower than audio,
and so on. The user could override these default values to
express his own preferences---if he was willing to pay for
the increased congestion during peak periods.
Note that this access control mechanism only guarantees
relative priority, not absolute priority. A packet with a
_________________________________________
31 With bursty traffic, low-priority packets at ``peak time'' might experi-
ence only moderate delays before getting through. This is likely to be quite
different from the telephone analogue of making customers wait until after
10PM to obtain low-priority, low-rate service. The average length of delays
for low-priority traffic will depend on the average level of excess capacity
in the system. One advantage of our scheme is that it correctly signals the
efficient level of capacity to maintain.
35
high bid is guaranteed access sooner than a low bid, but no
absolute guarantees of delivery time can be made.32 Rejected
packets could be bounced back to the users, or be routed to
a slower network, possibly after being stored for a period in
a buffer in case the permitted priority level falls sufficiently
a short time later.
Offline accounting
If the smart market system is used with the sampling system
suggested earlier the accounting overhead doesn't have to
slow things down much since it can be done in parallel. All
the router has to do is to compare the bid of a packet with the
current value of the cutoff. The accounting information on
every 1000th packet, say, is sent to a dedicated accounting
machine that determines the equilibrium access price and
records the usage for later billing.33 However, such sam-
pling would require changes in current router technology.
Such accounting may well prove expensive. NSFNET has
modified routers to collect sampled usage data; they found
that the cost of the monitoring system is significant.
Network stability
Adding bidding for priority to the routing system should
help maintain network stability, since the highest priority
packets should presumably be the packets sent between
_________________________________________
32 It is hard to see how absolute guarantees can be made on a connec-
tionless network. However, there have been proposals to provide hybrid
networks, with some connection-oriented services in parallel to the connec-
tionless services. Connection-oriented services are well-suited for delivery
guarantees.
33 We don't discuss the mechanics of the billing system here. Obviously,
there is a need for COD, third-party pricing, and other similar services.
36
routers that indicate the state of the network. These network
``traffic cops'' could displace ordinary packets so as to get
information through the system as quickly as possible.
In fact, administrative information currently moves though
the network at a higher priority than regular traffic. This
allows the administrators to update routing tables, etc. in a
more timely manner. The fact that such prioritized routing is
already in place, albeit in a limited form, indicates that it is
at least feasible to consider extending the prioritization to a
broader set of users.
Fluctuations in the spot market price
Many readers have been unhappy with the idea that the price
of bandwidth would fluctuate in the smart market system. It
is felt by some that having predictable prices and budgets is
important to users. We have several responses to this set of
issues. First, everything depends on how much expenditures
fluctuate. If prices and uses of the network turn out to
be relatively predictable, expenditures would fluctuate very
little. Enterprises have little difficulty now dealing with
fluctuations in postage, electricity, and telephone bills from
month to month, and there is no reason to expect that network
usage would be different.
Second, it is important to remember that in the smart
market, prices only fluctuation down. The user (or the user's
application) sets the maximum he or she is willing to pay for
network access; the actual price paid will almost always be
less than this. Furthermore, the user should have virtually
instantaneous feedback about the current state of his or her
expenditures, so there should be little difficulty in budgetary
control.
37
Finally, the most important point that we need to make
is that the price set by the smart market is a ``wholesale''
price, not necessarily a ``retail'' price. If a particular user
doesn't want to bear the risk of price fluctuations, he or she
can always contract with another party who is willing to bear
that risk. This party may be the supplier of the network
service, or it may be a third party.
For example, consider an extreme case where the network
price has significant fluctuations: the price for an hour of
teleconferencing at a particular time of day could be $200
or could be $50. A third party could offer to sell bandwidth
to anyone demanding it at, say, $100 an hour. If the price
turned out to be $50, the bandwidth reseller would make a
profit; if it turned out to be $200, the bandwidth reseller
would make a loss. But the purchaser would pay a flat $100
no matter what.
If the price fluctuations are large, it may well happen that
most retail customers buy bandwidth on a contract basis at a
fixed price. But the fact that the spot market is available is
very important since it allows ``wholesale'' customers to buy
bandwidth on an ``as available'' basis, thereby encouraging
efficient use of bandwidth.
Short term price fluctuations
Another problem arises at the other end of the time scale. It is
widely observed that packet transfers are ``bursty.'' Traffic
on the network fluctuations quite significantly over short
time periods. Can a market price keep up with this kind of
fluctuation?
We have two answers to this question. First, it is very
easy to buffer packets for short time intervals. When a
38
high-priority/high-bid burst comes along, packets with low
priority and low bid, are buffered. After the high-priority
packets are admitted, the low-priority packets move onto the
network. In network engineering this is known as priority-
based routing, and is a reasonably well-understood policy.
The second answer is a bit deeper. We conjecture that if
usage were priced in the way we advocate, network traffic
would be a lot less bursty. Said another way: bursts in
network traffic are there now because there is no charge for
bursts. If bursts were costly to the user there would be fewer
of them.
Of course, this is not only because the user would change
behavior---the bursts are at a much higher frequency than
the users control. Rather, the users would have an incentive
to use applications that smoothed the network traffic flow.
In countries where electricity is priced by time of day, water
heaters are smart enough to heat water in the middle of the
night when rates are low. If a refrigerator can be that smart,
think what a workstation could do---if it know the right
prices.
Routing
As we have mentioned several times, the Internet is a connec-
tionless network. Each router knows the final destination of a
packet, and determines, from its routing tables, what the best
way is to get from the current location to the next location.
These routing tables are updated continuously to indicate the
current state of the network. Routing tables change to reflect
failed links and new nodes, but they do not change to reflect
congestion on various links of the network. Indeed, there
39
is no standard measurement for congestion available on the
current NSFNET T-3 network.
Currently, there is no prioritization of packets: all packets
follow the same route at a given time. However, if each packet
carried a bid price, as we have suggested, this information
could be used to facilitate routing through the Internet. For
example, packets with higher bids could take faster routes,
while packets with lower bids could be routed through slower
links.
The routers could assign access prices to each link in
the net, so that only packets that were ``willing to pay'' for
access to that link would be given access. Obviously this
description is very incomplete, but it seems likely that having
packets bid for access will help to distribute packets through
the network in a more efficient way.
Distributional aspects
As we mentioned earlier, the issue of pricing the Internet is
highly politicized. One nice feature of smart market pricing is
that low-priority access to the Internet (such as e-mail) would
continue to have a very low cost. Indeed, with relatively
minor public subsidies to cover the marginal resource costs,
it would be possible to have efficient pricing with a price of
close to zero most of the time, since the network is usually
not congested.
If there are several competing carriers, the usual logic of
competitive bidding suggests that the price for low-priority
packets should approach marginal cost---which, as we have
argued, is essentially zero. In the plan that we have outlined
the high priority users would end up paying most of the costs
of the Internet.
40
Price uncertainty
Several readers have objected to the use of the smart market
since it adds an element of price uncertainty: the user won't
necessarily know the price for access to the network unless
he inquires beforehand. We don't think that this would be
a big problem for several reasons. First, it is important to
remember that the user (or the application) has complete
control over the maximum price that he or she is willing
to pay. Second, we imagine that there would be reasonably
predictable patterns in usage so that users would have a
good idea when congestion is likely to occur. Third, if
there is some uncertainty about the current price, the user
could simply query the router. Finally, we think that if the
congestion prices are used to guide investment decisions,
the demand of the users and the supply of network capacity
should be closely enough matched so that the congestion
prices would normally be rather small.
It is also worthwhile to note that the fluctuations in price
represent a real resource cost---congestion costs. If the user
doesn't bear that cost, then someone else will have to: the
other users who find their packets delayed or dropped. Of
course, there is no reason why the risk of price fluctuations
couldn't be borne by third-parties. One could imagine a
futures market for bandwidth in which third-parties offer to
absorb the risk of price fluctuations for a fee.
Interruptible service
Implementing the smart market mechanism for pricing con-
gestion on the Internet would involve adding new information
to the TCP/IP headers. It will take a considerable amount of
41
discussion and debate to accomplish this. However, there is
a partial way to handle congestion pricing that requires very
little change in existing protocols.
Suppose that providers of Internet services had two
classes of service: full service and interruptible service.
Users would pay a flat fee based on the size of their pipeline
for the type of service they preferred and full service would
cost more than interruptible service.
When the load on the routers used by the Internet provider
reached a certain level, the users who had purchased inter-
ruptible service would be denied access until the congestion
subsided. All that is needed to implement this rationing
mechanism is a simple change to the routing algorithms.
The defect of interruptible service is that it is rather
inflexible compared to the smart market solution: it applies
to all participants in a single administrative billing unit and
cannot be overridden by individual users. On the other hand
it is very simple to implement. See Wilson (1989) for a
detailed study of the analytics of interruptible service.
8. Role of public and private sector
As we have seen, current private providers of access to
the Internet generally charge for the ``size of the pipe''
connecting users to the net. This sort of pricing is probably
not too bad from an efficiency point of view since the ``size
of the pipe'' is more-or-less proportional to contemplated
peak usage.
The problem is that there is no pricing for access to
the common backbone. In December of 1992, the NSF an-
nounced that it would stop providing direct operation funding
42
for the ANS T-3 Internet backbone. It is not yet clear when
this will actually happen, although the cooperative agree-
ment between NSF and Merit has been extended through
April 1994. According to the solicitation for new proposals,
the NSF intends to create a new very high speed network
to connect the supercomputer centers which would not be
used for general purpose traffic. In addition, the NSF would
provide funding to regional networks that they could use to
pay for access to backbone networks like ANSnet, PSInet
and Alternet.
The NSF plan is moving the Internet away from the
``Interstate'' model, and towards the ``turnpike'' model.
The ``Interstate'' approach is for the government to develop
the ``electronic superhighways of the future'' as part of an
investment in infrastructure. The ``turnpike'' approach is that
the private sector should develop the network infrastructure
for Internet-like operations, with the government providing
subsidies to offset the cost of access to the private networks.
Both funding models have their advantages and disad-
vantages. But we think that an intermediate solution is
necessary. The private sector is probably more flexible and
responsive than a government bureaucracy. However, the
danger is that competing network standards would lead to an
electronic Tower of Babel. It is important to remember that
turnpikes have the same traffic regulations as the Interstates:
there is likely a role for the government in coordinating
standards setting for network traffic. In particular, we think
that it makes sense for the government, or some industry
consortium, to develop a coherent plan for pricing Internet
traffic at a packet level.34
_________________________________________
34 One of the recent bills submitted by Representative Boucher to begin
43
It is worth remarking on the history of standards for voice
networks. U.S. voice communications are now provided by
a mesh of overlapping and connected networks operated by
multiple, competing providers (ATT, MCI and Sprint being
the largest). This is quite a bit like the situation we expect to
emerge for data networks. However, over the decades when
switching and billing standards were being designed and
refined, the only significant provider was ATT, so it could
impose a single, coordinated standard that later providers
accepted. International voice networks, by contrast, have
always required interconnection and traffic handoff between
various (mostly national) providers. Standards were designed
and imposed by a public body, the CCITT.
A pricing standard has to be carefully designed to contain
enough information to encourage efficient use of network
bandwidth, as well as containing the necessary hooks for
accounting and rebilling information. A privatized network
is simply not viable without such standards, and work should
start immediately on developing them.
_________________________________________
implementing the NREN requires uniform protocols for interconnection
between providers. It is not clear whether the bill will also mandate uniform
standards for providing management information like accounting data.
44
Appendix 1: Some analytics of pricing a congestible
resource
The classic ``problem of the commons'' describes a
situation where property that is held in common will tend
to be overexploited. Each user is aware of his private costs
incurred by accessing the common property but neglects the
costs he imposes on others. In the context of the Internet we
have seen that the scarce resource is the switching capacity
of the routers. When the network is highly congested, an
additional user imposes costs on other users to the extent
that his use of switching capacity prevents, or at least slows
down, the use of the same capacity by other users.
Efficient use of the switch capacity requires that users
that are willing to pay more for access should be admitted
before users with lower willingness-to-pay. The price for
admission to the switches should be that price that reflects
the social cost of an additional packet.
Here we briefly examine some of the analytics of a
standard (static) congestion model.35 Arnott, de Palma,
and Lindsey (1990) have argued strongly that congestion
models should examine dynamic microbehavior in a more
detailed way than the standard model does. Although we
agree with this point, and think that modeling congestion
behavior for computer networks is a promising avenue for
future research, we here consider only the simplest textbook
case of congestion.
We suppose that a representative user has a utility func-
tion u(xi)-D, where xi is the number of packets sent by user
_________________________________________
35 The treatment is intended for economists; it is probably too terse for
non-economists.
45
i and D is the total delay experienced by the user. The delay
depends on the total utilization of the network, Y = X=K
P n
where X = i=1 xi is the total usage and K is network
capacity.36 This specification implies that if usage X is
doubled and capacity K is doubled, then network utilization
Y = X=K and delay D(Y ) remain the same.
If there is no congestion-based pricing, user i will choose
xi to satisfy the first-order condition37
u0(xi) = 0:
The efficient utilization of the network maximizes the sum
P n
of all users' utilities, i=1 u(xi) - nD(X=K). This yields
the n first-order conditions
u0(xi) - _n__KD0(Y ) = 0:
One way to achieve this efficient outcome is to set a conges-
tion price per packet of
p = n___KD0(Y ); (1)
so that user i faces the maximization problem
maxx u(xi) - D(Y )) - pxi:
i
The first-order condition to this problem is
u0(xi) = p = n___KD0(Y ) (2)
which is easily seen to lead to the optimal choice of xi. The
price has been chosen to measure the congestion costs that
i's packets impose on the other users.
_________________________________________
36 We could also make the utility of packets depend on the delay by writing
utility as u(xi; D). We choose the additively separable specification only
for simplicity.
37 We assume that the user ignores the fact that his own packets impose
delay on his own packets; we can think of this effect as being built into the
utility function already. There is no problem in relaxing this assumption;
the calculations just become messier.
46
Optimal capacity expansion
Suppose now that it costs c(K) for capacity K and that we
currently have some historically given capacity. Should the
capacity be expanded? The welfare problem is
X n
W (K) = maxK u(xi) - nD(Y ) - c(K):
i=1
Since xi is already chosen so as to maximize this expression,
the envelope theorem implies that
W 0(K) = nD0(Y ) X____K2- c0(K):
Substituting from equation (1)
W 0(K) = p X___K- c0(K): (3)
Suppose that the marginal cost of capacity expansion is
a constant, cK = c0(K). Then we see that W 0(K) is
positive if and only if pX - cK K > 0. That is, capacity
should expanded when the revenues from congestion fees
exceed the cost of providing the capacity.
A competitive market for network services
Suppose that there are several competing firms providing
network access. A typical producer has a network with
capacity K and carries X packets, each of which pays a
packet charge of p. The producer's operating profits are
pX - c(K).
Let p(D) be the price charged by a provider that offers
delay D. In general, if the delay on one network is different
than on another the price will have to reflect this quality
47
difference. The utility maximization problem for consumer i
is to choose which network to use and how much to use it:
maxx u(xi) - D - p(D)xi
i;D
which has first-order conditions
u0(xi) - p(D) = 0
-1 - p0(D)xi = 0:
The first equation says that each user will send packets until
the value of an additional packet equals its price. The second
equation says that the user will choose a network with a
level of delay that such that the marginal value to the user of
additional delay equals the marginal cost of paying for the
delay (by switching suppliers). Adding up this last first-order
condition over the consumers yields
n = -p0(D)X: (4)
A competitive producer offering delay D(Y ) wants to
choose capacity and price so as to maximize profits, recog-
nizing that if it changes its delay the price that it can charge
for access will change. The profit maximization problem is
maxX;K p(D(Y ))X - c(K);
which gives us first-order conditions
p0(D)D0(Y )Y + p(D) = 0
(5)
-p0(D)D0(Y )Y 2 - c0(K) = 0:
Combining these two conditions and using equation (4) gives
us two useful expressions for p(D):
p(D) = n___KD0(Y )
:
= c0(K) K___X
48
Comparing the first equation to (2) we see that the compet-
itive price will result in the optimal degree of congestion.
Comparing the second equation to equation (3) we see that
competitive behavior will also result in optimal capacity.
Adding capacity
Suppose now that a competitive firm is trying to decide
whether to add additional capacity K. We consider two
scenarios. In the first scenario, the firm contemplates keeping
X fixed and simply charging more for the reduction in delay.
The amount extra it can charge for each packet is
_dp__ K = -p0(D)D0(Y ) X____K:
dK K2
Using equation (5) this becomes
_p__K:
K
Since the firm can charge this amount for each packet sent,
the total additional revenue from this capacity expansion is
p X___KK:
This revenue will cover the costs of expansion if
~ ~
p X___KK - c0(K)K = p X___K- c0(K) K 0;
which is precisely the condition for social optimality as given
in equation (3).
Consider now the second scenario. The firm expands
its capacity and keeps its price fixed. In a competitive
market it will attract new customers due to the reduction in
delay. In equilibrium this firm must have the same delay
49
as other firms charging the same price. Suppose that in the
initial equilibrium X=K = Y . Then the additional number
of packets sent must satisfy X = Y K: It follows that the
increase in in profit for this firm is given by
~ ~
pY K - c0(K)K = p X___K- c0(K) K:
Again we see that capacity expansion is optimal if and only
if it increases profits.
The relationship between capacity expansion and conges-
tion pricing was first recognized by Mohring and Hartwize
(1962) and Strotz (1978). Some recent general results can be
found in Arnott and Kraus (1992b, 1992a).
50
Appendix 2: An hypothetical one-node backbone with
smart market
Implementing any pricing scheme for backbone services
will require changes to user applications, host operating
systems, and router algorithms. Very little work has been
done on the software and protocol changes necessary to
support efficient pricing.38 To illustrate the types of changes
that will be necessary, we shall briefly describe how our
smart market might be implemented in a very simple case.
Consider a simple network fragment: two host machines,
each with multiple users, each connected to a separate local
area network. The two LANs are connected by a backbone
with a single switch (which admittedly doesn't have much
work to do!). Users have applications that send packets to
each other. How would the smart market work if users are
sending each other a steady flow of packets that is sufficient
to cause congestion at the switch if all packets were admitted?
User application
Suppose user 1 on machine 1 (u11 ) is sending e-mail to user
1 on machine 2 (u12 ). u11 needs to be able to set her bid
(maximum willingness to pay) for the packets that make up
her e-mail message. However, she prefers not to think about
a bid for every message since she usually puts the same, very
low priority price on e-mail. Thus, the e-mail software needs
to provide hooks for a user to set a default bid price, and to
override the default when desired.
_________________________________________
38 A draft technical report has proposed some semantics and a conceptual
model for network usage accounting, but this has not become a standard,
nor does it deal with billing or cost allocation; see C. Mills (1991). See
Braun and Claffy (1993) for a detailed discussion of some of the problems
facing usage accounting.
51
User system
The host machine must handle some new tasks through
systems software. First, the e-mail is packetized with one new
piece of information loaded into the header: the bid price.39
Also, since this is a multiuser machine and the network
only recognizes machine (IP) addresses, not user names, the
host machine must create a record in an accounting database
that records the user name, number of packets sent, and the
packet identification number. It is not possible to record the
price for the packets yet because of the design of the smart
market: the user specifies her maximum willingness to pay,
but the actual price for each packet may (and typically will)
be lower. However, since the TCP protocol offers positive
acknowledgement of each packet, the acknowledging packets
that are returned can contain the actual price charged so that
the host database can record user-specific charges.
Local area network
It may be desirable to implement some hooks in the local
organization network, before the packet reaches the back-
bone.40 For example, organization policy may want to
impose a ceiling on bids to restrict the maximum price that
users volunteer to pay. Also, billing from the backbone
provider may be only to the organization level since the IP
address of host machines identifies only a station, not the
_________________________________________
39 It would be natural to use the priority field to contain the bid price.
40 In practice there may be several levels of interconnected network
between the user and the backbone: departmental, organization, regional,
national. What we say here about a single local network should generally
apply at each such level.
52
responsible users. It may be that backbone providers will
provide bills that itemize by host IP address; the organization
may want to record packets sent by each host, as well as the
price extracted from the acknowledgement return.
In this example we assume that the local network is not
imposing its own charges on top of the backbone charges. If
local pricing is desired to allocate locally congested resources
(as we suspect if often will be for large organizations), the
tasks identified below for the backbone must also be carried
out by the LAN.
Backbone
As a packet reaches the backbone router, its bid price is
compared to the current smart market price for admission. If
the bid is too low, a message (presumably implemented in
the ICMP protocol) is returned to the user with the packet
number, user's bid and the current price. If the bid exceeds
the admission price, then the packet is admitted and routed.
Every packet is checked for its bid, but to control the
transactions costs of pricing, accounting, and billing we
assume that only 1 of every N packets is sampled for further
processing. A copy of the header of the sampled packets
is diverted to a separate CPU, where it is used for several
functions.
One task is to update the state of demand on the backbone.
Packets with bids come in over time; it will be necessary to
aggregate packets over some window (the width of which
could be time- or event-driven) to construct the ``current''
state of demand. When a newly sampled packet arrives, it
53
is added to the history window of bids, and a stale bid is
removed.41
The sampled packet is logged to the accounting database:
the current price times N (since the packet represents on
average 1=N th of those sent by a particular user) and the
billing identification information. Periodically the backbone
provider will prepare and deliver bills.
Periodically the smart market price would be recalculated
to reflect changes in the state of demand. A new price
might be event-driven (e.g., recalculated every time a new
N th packet arrives, or less frequently) or time-driven (e.g.,
recalculated every T msecs). The new price would then
be sent to the gatekeeper subsystem on the router, and in a
network with multiple nodes possibly broadcast to the other
nodes.42
``Collect calls'': Pricing proxy server packets
We have assumed so far that the originator of a packet is
the party to be billed. Many of the most important Internet
services involve packets that are sent by one host at the
request of a user on another host. For example, ftp file
transfers and gopher information services take this form;
these are currently the first and seventh largest sources of
bytes transferred on the NSFnet backbone (Braun and Claffy
(1993)). Clearly most services will not offer to pay the
network charges for any and all user requests for data. We
_________________________________________
41 The market algorithm would account for the fact that each packet was
a representative for N other packets assumed to have the same bid.
42 We comment below on some of the issues for implementing a smart
market in a multiple node environment.
54
need something like collect calls, COD, or bill-to-recipient's-
account, or all of the above.
There are at least two straightforward methods to charge
the costs back to the responsible party. A traditional ap-
proach would have users obtain accounts and authorization
codes that permit the proxy server to use an external billing
system for charges incurred by user requests; this is the way
that many current commercial information services (e.g.,
Compuserve) are billed.
However, the growth of the Internet has been fueled by
the vast proliferation of information services. It is implausible
to think that a user would be willing to obtain separate charge
accounts with every service; it would also be inefficient to
have the necessary credit and risk management duplicated by
every proxy server provider. A more advanced method that
fits in well with the scheme we have described is to allow for
billing directly back to the user's backbone usage account.
To implement a system of bill-to-sender would require
some further work, however. The user's application (client
software) would presumably have to allow the user to specify
a maximum price for an entire transaction which could be
included in the request for service, since it will often be
impossible to anticipate the number of packets that are being
requested. The server could then send the packets with
a flag set in the packet header that indicates the charges
are to be levied against the destination IP address, not the
source. However, to make such a system feasible will
require authentication and authorization services. Otherwise,
unscrupulous uses could send out packets that were not
requested by the recipients but charge them to the destination
55
address; likewise malicious pranksters could modify their
system software to generate forged requests for data that is
unwanted by but charged to another user.43
_________________________________________
43 There may also be a way to steal network services by having them
billed to another user, but we haven't figured out how to do that yet.
56
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