The Digital Handshake: Connecting Internet Backbones

Michael Kende[^1]

*Director of Internet Policy Analysis*

*Office of Plans and Policy*

mkende@fcc.gov

Office of Plans and Policy

Federal Communications Commission

Washington DC 20554

September 2000

OPP Working Paper No. 32

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> The Digital Handshake: Connecting Internet Backbones

Table of Contents

Executive Summary [1](#__RefHeading___Toc494542137)

I. Introduction [2](#introduction)

II\. Background [2](#background)

A. Introduction [2](#introduction-1)

B. Network Externalities [3](#network-externalities)

C. Peering and Transit [4](#peering-and-transit)

D. The Backbone as an Unregulated Service
[9](#the-backbone-as-an-unregulated-service)

E. Growth of the Internet Industry
[13](#growth-of-the-internet-industry)

III\. Interconnection Issues [15](#interconnection-issues)

A. Internet Backbone Market Power Issues
[16](#internet-backbone-market-power-issues)

B. Internet Balkanization Issues [26](#internet-balkanization-issues)

IV\. International Interconnection Issues
[32](#international-interconnection-issues)

A. Principles of International Telecommunications Regulation
[32](#principles-of-international-telecommunications-regulation)

B. International Cost-Sharing Issue
[33](#international-cost-sharing-issue)

C. Marketplace Solutions [38](#marketplace-solutions)

V. Conclusion [39](#conclusion)

#  {#section .unnumbered}

Table of Figures

Figure 1: Peering [40](#__RefHeading___Toc494542153)

Figure 2: Network Access Point [40](#_Ref466343214)

Figure 3: Private Peering [41](#__RefHeading___Toc494542155)

Figure 4: Transit [41](#__RefHeading___Toc494542156)

Figure 5: Hot-Potato Routing [42](#__RefHeading___Toc494542157)

Figure 6: Example of Free Riding [43](#__RefHeading___Toc494542158)

Figure 7: Number of National Internet Backbone Providers
[44](#__RefHeading___Toc494542159)

Figure 8: Number of Internet Service Providers
[44](#__RefHeading___Toc494542160)

Figure 9: Number of Devices Accessing the World Wide Web
[45](#__RefHeading___Toc494542161)

Figure 10: Number of World Wide Web pages
[45](#__RefHeading___Toc494542162)

Figure 11: Fiber System Route Miles [46](#__RefHeading___Toc494542163)

Figure 12: Number of Users Online Worldwide
[46](#__RefHeading___Toc494542164)

The Digital Handshake: Connecting Internet Backbones

[]{#__RefHeading___Toc494542137 .anchor}Executive Summary

This paper examines the interconnection arrangements that enable
Internet users to communicate with one another from computers that are
next door or on the other side of the globe. The Internet is a network
of networks, owned and operated by different companies, including
Internet backbone providers. In order to provide end users with
universal connectivity, Internet backbones must interconnect with one
another to exchange traffic destined for each other's end users.
Internet backbone providers are not governed by any industry-specific
interconnection regulations, unlike other providers of network services;
instead, each backbone provider bases its decisions on whether, how, and
where to interconnect by weighing the benefits and costs of each
interconnection. Interconnection agreements between Internet backbone
providers are reached through commercial negotiations in a "handshake"
environment. Internet backbones interconnect under two different
arrangements: peering or transit. In a peering arrangement, backbones
agree to exchange traffic with each other at no cost. The backbones only
exchange traffic that is destined for each other's end users, not the
end users of a third party. In a transit arrangement, on the other hand,
one backbone pays another backbone for interconnection. In exchange for
this payment, the transit supplier provides a connection to all end
users on the Internet.

The interconnection policies that have evolved in place of
industry-specific regulations are examined here, in order to determine
the impact of these policies on the markets for Internet services. In
the past several years, a number of parties in the United States and
abroad have questioned whether larger backbone providers are able to
gain or exploit market power through the terms of interconnection that
they offer to smaller existing and new backbone providers. In the
future, backbones may attempt to differentiate themselves by offering
certain new services only to their own customers. As a result, the
concern is that the Internet may "balkanize," with competing backbones
not interconnecting to provide all services. This paper demonstrates
how, in the absence of a dominant backbone, market forces encourage
interconnection between backbones and thereby protect consumers from any
anti-competitive behavior on the part of backbone providers. While it is
likely that market forces, in combination with antitrust and competition
policy, can guarantee that no dominant backbone emerges, if a dominant
backbone provider should emerge through unforeseen circumstance,
regulation may be necessary, as it has been in other network industries
such as telephony.

The paper also examines an international interconnection issue. In
recent years, some carriers, particularly those from the Asia-Pacific
region, have claimed that it is unfair that they must pay for the whole
cost of the transmission capacity between international points and the
United States that is used to carry Internet traffic between these
regions. After analyzing the case presented by these carriers, the paper
concludes that the solution proposed by these carriers, legacy
international telecommunications regulations, should not be imposed on
the Internet. To date, there is no evidence that the interconnection
agreements between international carriers result from anti-competitive
actions on the part of any backbones; therefore, the market for Internet
backbone services is best governed by commercial interactions between
private participants.

# Introduction

The Internet is not a monolithic, uniform network; rather, it is a
network of networks, owned and operated by different companies,
including Internet backbone providers. Internet backbones deliver data
traffic to and from their customers; often this traffic comes from, or
travels to, customers of another backbone. Currently, there are no
domestic or international industry-specific regulations that govern how
Internet backbone providers interconnect to exchange traffic, unlike
other network services, such as long distance voice services, for which
interconnection is regulated.[^2] Rather, Internet backbone providers
adopt and pursue their own interconnection policies, governed only by
ordinary laws of contract and property, overseen by antitrust rules.
This paper examines the interconnection policies between Internet
backbone providers that have evolved in place of industry-specific
regulations, in order to examine the impact of these policies on the
markets for Internet services.

The paper first examines the current system of interconnection, and then
examines several recent developments. In the past few years, a number of
parties in the United States and abroad have questioned whether larger
backbone providers are able to gain or exploit market power through the
terms of interconnection that they offer to smaller existing and new
backbone providers. In addition, backbones may attempt in the future to
differentiate themselves from their competitors by not interconnecting
at all to exchange traffic flowing from innovative new services. The
paper shows how competition, governed by antitrust laws and competition
enforcement that can prevent the emergence of a dominant firm, can act
to restrain the actions of larger backbones in place of any
industry-specific regulations, such as interconnection obligations.

Section two of this paper examines the history of Internet
interconnection and describes current interconnection policies between
Internet backbones. The paper next examines several current and
potential pressures on the domestic system of interconnection in section
three, while section four examines international interconnection issues.
The conclusion is in section five.

# Background

## Introduction

This paper examines the interconnection arrangements that enable each
Internet user to communicate with every other Internet user.[^3] For
simplicity, the paper focuses on the interactions between four groups of
Internet participants: end users, content providers, Internet service
providers (ISPs), and Internet backbone providers (backbones). End users
communicate with each other using the Internet, and also access
information or purchase products or services from content providers,
such as the Wall Street Journal Interactive Edition, or e-commerce
vendors, such as Amazon.com. End users access the Internet via Internet
service providers such as America Online (AOL) or MindSpring
Enterprises. Small business and residential end users generally use
modems to connect to their ISP over standard telephone lines, while
larger businesses and content providers generally have dedicated access
to their ISP over leased lines.[^4] Content providers use a dedicated
connection to the Internet that offers end users twenty-four hour access
to their content. ISPs are generally connected to other ISPs through
Internet backbone providers such as UUNET and PSINet. Backbones own or
lease national or international high-speed fiber optic networks that are
connected by routers, which the backbones use to deliver traffic to and
from their customers. Many backbones also are vertically integrated,
functioning as ISPs by selling Internet access directly to end users, as
well as having ISPs as customers.

Each backbone provider essentially forms its own network that enables
all connected end users and content providers to communicate with one
another. End users, however, are generally not interested in
communicating just with end users and content providers connected to the
same backbone provider; rather, they want to be able to communicate with
a wide variety of end users and content providers, regardless of
backbone provider. In order to provide end users with such universal
connectivity, backbones must interconnect with one another to exchange
traffic destined for each other's end users. It is this interconnection
that makes the Internet the "network of networks" that it is today. As a
result of widespread interconnection, end users currently have an
implicit expectation of universal connectivity whenever they log on to
the Internet, regardless of which ISP they choose. ISPs are therefore in
the business of selling access to the entire Internet to their end-user
customers; ISPs purchase this universal access from Internet backbones.
The driving force behind the need for these firms to deliver access to
the whole Internet to customers is what is known in the economics
literature as *network externalities*.

## Network Externalities

Network externalities arise when the value, or utility, that a consumer
derives from a product or service increases as a function of the number
of other consumers of the same or compatible products or services.[^5]
They are called network externalities because they generally arise for
networks whose purpose it is to enable each user to communicate with
other users; as a result, by definition the more users there are, the
more valuable the network.[^6] These benefits are externalities because
a user, when deciding whether to join a network (or which network to
join), only takes into account the private benefits that the network
will bring her, and will not consider the fact that her joining this
network increases the benefit of the network for other users. This
latter effect is an externality.

Network externalities can be direct or indirect. Network externalities
are direct for networks that consumers use to communicate with one
another; the more consumers that use the network, the more valuable the
network is for each consumer.[^7] The phone system is a classic example
of a system providing direct network externalities. The only benefit of
such a system comes from access to the network of users. Network
externalities are indirect for systems that require both hardware and
software in order to provide benefits.[^8] As more consumers buy
hardware, this will lead to the production of more software compatible
with this hardware, making the hardware more valuable to users. A
classic example of this is the compact disc system; as more consumers
purchased compact disc players, music companies increased the variety of
compact discs available, making the players more valuable to their
owners.[^9] These network externalities are indirect because consumers
do not purchase the systems to communicate directly with others, yet
they benefit indirectly from the adoption decision of other consumers.

One unique characteristic of the Internet is that it offers both direct
and indirect network externalities. Users of applications such as email
and Internet telephony derive direct network externalities from the
system: the more Internet users there are, the more valuable the
Internet is for such communications. Users of applications such as the
World Wide Web derive indirect network externalities from the system:
the more Internet users there are, the more Web content will be
developed, which makes the Internet even more valuable for its users.
The ability to provide direct and indirect network externalities to
customers provides an almost overpowering incentive for Internet
backbones to cooperate with one another by interconnecting their
networks.

## Peering and Transit

During the early development of the Internet, there was only one
backbone, and therefore interconnection between backbones was not an
issue.[^10] In 1986, the National Science Foundation (NSF) funded the
NSFNET, a 56-kilobit per second (Kbps) network created to enable
long-distance access to five supercomputer centers across the country.
In 1987, a partnership of Merit Network, Inc., IBM, and MCI began to
manage the NSFNET, which became a T-1 network connecting thirteen sites
in 1988.[^11] The issue of interconnection arose only when a number of
commercial backbones came into being, and eventually supplanted the
NSFNET.[^12]

At the time that commercial networks began appearing, general commercial
activity on the NSFNET was prohibited by an Acceptable Use Policy,
thereby preventing these commercial networks from exchanging traffic
with one another using the NSFNET as the backbone. This roadblock was
circumvented in 1991, when a number of commercial backbone operators
including PSINet, UUNET, and CerfNET established the Commercial Internet
Exchange (CIX). CIX consisted of a router, housed in Santa Clara,
California, that was set up for the purpose of interconnecting these
commercial backbones and enabling them to exchange their end users'
traffic. In 1993, the NSF decided to leave the management of the
backbone entirely to competing, commercial backbones. In order to
facilitate the growth of overlapping competing backbones, the NSF
designed a system of geographically dispersed Network Access Points
(NAPs) similar to CIX, each consisting of a shared switch or local area
network (LAN) used to exchange traffic. The four original NAPs were in
San Francisco (operated by PacBell), Chicago (BellCore and Ameritech),
New York (SprintLink) and Washington, D.C. (MFS). Backbones could choose
to interconnect with one another at any or all of these NAPs. In 1995,
this network of commercial backbones and NAPs permanently replaced the
NSFNET.

The interconnection of commercial backbones is not subject to any
industry-specific regulations. The NSF did not establish any
interconnection rules at the NAPs, and interconnection between Internet
backbone providers is not currently regulated by the Federal
Communications Commission or any other government agency.[^13] Instead,
interconnection arrangements evolved from the informal interactions that
characterized the Internet at the time the NSF was running the backbone.
The commercial backbones developed a system of interconnection known as
peering. Peering has a number of distinctive characteristics. First,
peering partners only exchange traffic that originates with the customer
of one backbone and terminates with the customer of the other peered
backbone. In Figure 1, customers of backbones *A* and *C* can trade
traffic as a result of a peering relationship between the backbones, as
can the customers of backbones *B* and *C*, which also have a peering
arrangement. As part of a peering arrangement, a backbone would not,
however, act as an intermediary and accept the traffic of one peering
partner and transit this traffic to another peering partner.[^14] Thus,
referring back to Figure 1, backbone *C* will not accept traffic from
backbone *A* destined for backbone *B*. The second distinctive
characteristic of peering is that peering partners exchange traffic on a
settlements-free basis.[^15] The only costs that backbones incur to peer
is that each partner pays for its own equipment and the transmission
capacity needed for the two peers to meet at each peering point.

Additional characteristics of peering relate to the routing of
information from one backbone to another. Peering partners generally
meet in a number of geographically dispersed locations. In order to
decide where to pass traffic from one backbone to another in a
consistent and fair manner, they have adopted what is known as
"hot-potato routing," whereby a backbone will pass traffic to another
backbone at the earliest point of exchange.[^16] As an example, in
Figure 5 backbones *A* and *B* are interconnected on the West and East
coasts. When a customer of ISP *X* on the East coast requests a web page
from a site connected to ISP *Y* on the West coast, backbone *A* passes
this request to backbone *B* on the East coast, and backbone *B* carries
this request to the West coast. Likewise, the responding web page is
routed from backbone *B* to backbone *A* on the West coast, and backbone
*A* is responsible for carrying the response to the customer of ISP *X*
on the East coast. A final characteristic of peering is that recipients
of traffic only promise to undertake "best efforts" when terminating
traffic, rather than guarantee any level of performance in delivering
packets received from peering partners.

The original system of peering has evolved over time. Initially, most
exchange of traffic under peering arrangements took place at the NAPs,
as it was efficient for each backbone to interconnect with as many
backbones as possible at the same location, as shown in the example in
Figure 2. Each backbone must only provide a connection to one point, the
NAP, rather than providing individual connections to every other
backbone. The rapid growth in Internet traffic soon caused the NAPs to
become congested, however, which led to delayed and dropped packets. For
instance, Intermedia Business Solutions asserts that at one point packet
loss at the Washington, D.C. NAP reached up to 20 percent.[^17] As a
result, a number of new NAPs have appeared to reduce the amount of
traffic flowing through the original NAPs. For example, MFS, now owned
by WorldCom, operates a number of NAPs known as Metropolitan Area
Exchanges (MAEs), including one of the original NAPs, the Washington,
D.C. NAP known as MAE-East, as well as MAE-West in San Jose, and other
MAEs in Los Angeles, Dallas, and Chicago.

Another result of the increased congestion at the NAPs has been that
many backbones began to interconnect directly with one another.[^18]
This system has come to be known as *private peering*, as opposed to the
public peering that takes place at the NAPs. In Figure 3, backbones *A*
and *B* have established a private peering connection through which they
bypass the NAP when exchanging traffic for each other -- they both only
use the NAP when exchanging traffic with backbone *C*.[^19] This system
developed partly in response to congestion at the NAPs, yet it may often
be more cost-effective for the backbones.[^20] For instance, if
backbones were to interconnect only at NAPs, traffic that originated and
terminated in the same city but on different backbones would have to
travel to a NAP in a different city or even a different country for
exchange.[^21] With private peering, in contrast, it can be exchanged
within the same city. This alleviates the strain on the NAPs. At one
point it was estimated that 80 percent of Internet traffic was exchanged
via private peering.[^22] There are recent indications, however, that as
NAPs begin to switch to Asynchronous Transfer Mode (ATM)[^23] and other
advanced switch technologies, the NAPs will be able to provide higher
quality services and may regain their former attraction as efficient
meeting points for peering partners.[^24] Unless specified, discussions
of peering below refer to both public and private peering.

Because each bilateral peering arrangement only allows backbones to
exchange traffic destined for each other's customers, backbones need a
significant number of peering arrangements in order to gain access to
the full Internet. UUNET, for instance, claims to "peer with 75 other
ISPs globally."[^25] As discussed below, there are few backbones that
rely solely on private or public peering to meet their interconnection
needs. The alternative to peering is a transit arrangement between
backbones, in which one backbone pays another backbone to deliver
traffic between its customers and the customers of other backbones.

Transit and peering are differentiated in two main ways. First, in a
transit arrangement, one backbone pays another backbone for
interconnection, and therefore becomes a wholesale customer of the other
backbone. Second, unlike in a peering relationship, with transit, the
backbone selling the transit services will route traffic from the
transit customer to its peering partners. In Figure 4, backbone *A* is a
transit customer of backbone *C*; thus, the customers of backbone *A*
have access both to the customers of backbone *C* as well as to the
customers of all peering partners of backbone *C*, such as backbone *B*.
If backbone *A* and backbone *C* were peering partners, as in Figure 1,
backbone *C* would not accept traffic from backbone *A* that was
destined for backbone *B*.

Many backbones have adopted a hybrid approach to interconnection,
peering with a number of backbones and paying for transit from one or
more backbones in order to have access to the backbone of the transit
supplier as well as the peering partners of the transit supplier. Those
few large backbones that interconnect solely by peering, and do not need
to purchase transit from any other backbones, will be referred to here
as *top-tier backbones*. Because of the non-disclosure agreements that
cover interconnection between backbones, it is difficult to state with
accuracy the number of top-tier backbones; according to one industry
participant, there are five: Cable & Wireless, WorldCom, Sprint, AT&T,
and Genuity (formerly GTE Internetworking).[^26]

It is useful to compare Internet interconnection arrangements with more
familiar, traditional telephony interconnection arrangements. The
practice of peering is similar to the practice of bill-and-keep or
sender-keeps-all arrangements in telephony.[^27] Transit arrangements
between Internet backbones are somewhat similar to resale arrangements
between, for instance, long distance carriers; the Internet backbone
providing transit service acts as the wholesaler, and the backbone
buying transit acts as the reseller of Internet backbone services. There
are notable differences in the way Internet and telephony arrangements
are regulated, however. The interconnection between Internet backbones
is not governed by industry-specific regulations, while the
interconnection of traditional telephone carriers is currently regulated
both domestically and internationally. Furthermore, unlike telephony,
there is no difference between domestic and international Internet
interconnection arrangements; backbones treat each other the same
regardless of the country of origin or location of customer base.[^28]

There is no accepted convention that governs when two backbones will or
should decide to peer with one another, nor is it an easy matter to
devise one. The term "peer" suggests equality, and one convention could
be that backbones of equal size would peer. However, there are many
measures of backbone size, such as geographic spread, capacity, traffic
volume, or number of customers. It is unlikely that two backbones will
be similar along many or all dimensions. One may have fewer, but larger,
customers than the other, another may reach into Europe or Asia, and so
forth. The question then becomes, how the backbones weigh one variable
against another. Given the complexity of such judgments, it may be best
to use a definition of equality proposed by one industry participant \--
that companies will peer when they perceive equal benefit from peering
based on their own subjective terms, rather than any objective
terms.[^29] In sum, peering agreements are the result of commercial
negotiations; each backbone bases its decisions on whether, how, and
where to peer by weighing the benefits and costs of entering into a
particular interconnection agreement with another backbone.

The paper now examines why there are no industry-specific regulations
governing interconnection between Internet backbone providers today,
before turning to a study of the interactions between backbone providers
in this unregulated market.

## The Backbone as an Unregulated Service

The Federal Communications Commission maintains a policy to "focus on
sustaining competitive communications markets and protecting the public
interest where markets fail to do so."[^30] As an example of this
policy, for many years the FCC has recognized a categorical distinction
between regulated telecommunications services and unregulated
computer-based services.[^31] To understand why Internet backbone
services are, and should continue to be, treated as unregulated
services, it is important to highlight two basic policies. First, it is
important to understand the basis for the regulation of network
industries. For the telecommunications network, like the railroad and
the telegraph before it, to grow into a healthy and vibrant universally
available network, striking a "common carrier" bargain with telephone
companies was a beneficial government intervention. In addition, given
the economies of scale inherent in the construction of the
telecommunications network, natural monopoly regulation was necessary to
ensure reasonable price and quality levels. Second, it is important to
understand why certain services are not regulated as common carrier
services. Soon after their introduction, the FCC determined that the
computer-based services market would remain competitive, and therefore
should not be regulated, so long as an essential input to such services
-- telecommunications capability -- was available to providers of such
services on a nondiscriminatory basis. Thus it was not necessary to
impose common carrier regulations on the users of those
telecommunications services as well as the providers. The following is a
brief overview of relevant domestic telecommunications regulations.[^32]

### Common Carrier Regulation

The traditional rationale for regulating network industries, such as
telecommunications, was the almost overwhelming economies of scale in
the provision of such services.[^33] Economic theory and practice
suggests that a natural monopolist is likely to arise in such
industries; this is considered efficient to the extent that duplicative
facilities are not installed.[^34] However, without competitors, a
natural monopoly can harm consumers in a variety of ways, which fall
generally into three categories: 1) the monopolist can directly raise
retail prices and/or reduce retail service quality; 2) the monopolist
can leverage market power into related markets that would otherwise be
competitive;[^35] and 3) the monopolist can deny access to its network
and thus bar entry into its core markets.

Governments worldwide traditionally chose to operate or regulate natural
monopolies in order to benefit from the efficiencies inherent in having
a single provider, while not incurring the corresponding harms that the
natural monopolies could inflict on consumers. In the United States,
certain telecommunications providers have been subject to natural
monopoly regulation; this meant a government grant of monopoly (the
monopoly granted to local telephone companies, for example, was lifted
by Congress in 1996), along with rate and service quality regulation. In
addition, all telecommunications providers, even those not subject to
natural monopoly regulation, are regulated as common carriers, as
described below. It should be noted that the goals of regulation are
similar to those of antitrust policy \-- both seek to protect consumers
from firms with market power. Indeed, in the United States, federal
antitrust actions preceded the imposition of telecommunications
regulation, and have since served to supplement those regulations.
Broadly speaking, in the United States regulatory approaches have been
used to control firms' actions while taking the market structure as
given; antitrust policy has been used to control firms' actions by
acting on the market structure itself, such as by reviewing mergers that
would increase market concentration, inducing a divestiture aimed at
reducing concentration, or preventing firms from taking actions that
cripple market mechanisms.[^36] For the public, the sum of these
approaches brought the beneficial construction of a nationwide
telecommunications network while ensuring affordable access to that
network for all users.

Government involvement in the nascent telephone market began at the turn
of the 20^th^ century. Even before the passage of the Communications Act
in 1934, the Supreme Court ruled that telegraph companies had a duty --
arising out of the common law -- to serve all customers in a
nondiscriminatory manner as a common carrier.[^37] In addition,
thirty-four states determined that mandating interconnection obligations
was the best way to resolve disputes that had arisen between 1894 and
1906 between the Bell System, the largest telephone company at the time,
and smaller independent telephone companies. It was not until 1910 that
the Mann-Elkins Act extended the jurisdiction of the Interstate Commerce
Commission to include telephone companies.[^38] In 1913, in response to
a threatened antitrust case, AT&T entered into an agreement, known as
the Kingsbury Commitment, to interconnect with independent local
telephone companies for long distance calls.[^39] In 1934, Congress
established the Federal Communications Commission to regulate
telecommunications common carriers.[^40]

Today, pursuant to the Communications Act, as amended, communications
common carriers must offer service on demand to the public at large
without unreasonable discrimination.[^41] Common carriers with market
power are subject to additional regulations that restrict rates and
govern service quality levels. In order to prevent common carriers with
market power from leveraging this market power into related competitive
markets, including long distance and the manufacture of consumer premise
equipment (CPE), there have a been a wide range of regulations,
including outright divestiture and prohibition on entering these related
markets. Where the entering of such markets is permitted, it is often
subject to regulations that ensure non discrimination between affiliates
of the carrier with market power and unaffiliated providers. As
competition is introduced into formerly monopolized telecommunications
markets such as local telephony, regulation is nevertheless required in
order to encourage the incumbent monopolist to open its network fully to
potential entrants.

Over the years, technological advances have altered the cost structure
upon which natural monopoly regulation rested. The regulatory response
in the United States has been to relax regulation in markets where
competition has eliminated the need for regulation, while protecting
these markets from firms with market power in related segments of the
industry.[^42] As an example, after upstarts such as MCI demonstrated
that competition was possible in the provision of long distance
services, an antitrust case brought by the Department of Justice
culminated in the breakup of the Bell System into AT&T, providing long
distance services in a competitive market, and the seven Regional Bell
Operating Companies (RBOCs) providing local services in exclusive
regions.[^43] The RBOCs were prohibited from entering long distance
markets in order to prevent the discrimination towards unaffiliated long
distance carriers that lead to the breakup of the Bell System in the
first place. Recently, as competition became possible in local markets,
Congress passed the Telecommunications Act of 1996 (1996 Act), requiring
incumbent Local Exchange Carriers (LECs), such as the RBOCs and GTE, to
open their local markets to competition by a variety of means.[^44]
These requirements are crucial to the development of a competitive
telecommunications network, and the Federal Communications Commission
rules implementing these requirements will be relaxed as competition
renders them unnecessary.[^45]

In summary, telecommunications providers are subject to common carrier
regulations that ensure nondiscriminatory access to end users; together
with antitrust enforcement, these regulations serve to protect against
anti-competitive behavior by telecommunications providers with market
power. In markets where competition can act in place of regulation as
the means to protect consumers from the exercise of market power, the
Commission has long chosen to abstain from imposing regulation. For this
reason, providers of services that combine telecommunications with
computer services are not regulated as common carriers.

### Basic versus Enhanced Services

For more than thirty years, the Commission has sought to avoid imposing
unnecessary common carrier regulation on providers of computer services
that rely on the nation's telecommunications infrastructure for
transmission of those services, but do not themselves provide
telecommunications services to the public. The absence of market power
in the computer services industry led the Commission to conclude that
imposing common carrier regulation was unnecessary and might discourage
innovation and distort the nascent data marketplace. The Commission
instead focused on ensuring that the providers of the underlying
telecommunications services made these services available on a non
discriminatory basis and did not themselves leverage their market power
into the provision of these complementary computer services. As a
result, the competitive enhanced services market was able to flourish
without onerous regulations impeding its growth.

In 1966, the Commission opened the *Computer Inquiry* proceeding that
explored the regulatory and policy issues raised by the nascent
interdependence of computer and communication technologies. In
announcing the inquiry, the Commission foreshadowed the incredible
attributes of computer networks that would make the Internet such a
valuable tool.

> The modern day electronic computer is capable of being programmed to
> furnish a wide variety of services, including the processing of all
> kinds of data and the gathering, storage forwarding, and retrieval of
> information -- technical, statistical, medical, cultural, among
> numerous other classes. With its huge capacity and versatility, the
> computer is capable of providing its services to a multiplicity of
> users at locations remote from the computer. Effective use of the
> computer is, therefore, becoming increasingly dependent upon
> communication common carrier facilities and services by which the
> computers and the user are given instantaneous access to each
> other.[^46]

In the early 1970s, the Commission determined that there were "no
natural or economic barriers to free entry into the market for
\[computer\] services."[^47] The Commission therefore decided that the
policies and objectives of the Communications Act would best be served
by allowing computer services to operate in an environment free from
industry-specific regulation. In addition, the Commission devised rules
that require common carriers to grant nondiscriminatory access to their
networks to enhanced service providers. Mandating such
nondiscrimination, the Commission concluded, was necessary because the
computer-based service industry "cannot survive, much less develop
further, except through reliance upon and use of communications
facilities and services."[^48]

In order to facilitate the implementation of its computer services
policy, the Commission created the categories of "basic" and "enhanced"
services.[^49] The basic services category denotes common carrier
services subject to Title II of the Communications Act.[^50] The
enhanced services category denotes those services

> offered over common carrier transmission facilities used in interstate
> communications, which employ computer processing applications that act
> on the format, content, code, protocol, or similar aspects of the
> subscriber's transmitted information, provide the subscriber
> additional, different, or restructured information; or involve
> subscriber interaction with stored information.[^51]

Thus, a basic service is a communications pathway, like a telephone
line, while an enhanced service is a computer-enhanced offering that
operates via that communications pathway. Present day examples of
unregulated enhanced services include voicemail services, gateway
services, electronic publishing, and Internet services. In these
markets, competition between firms, rather than any industry-specific
regulations, ensures that consumers enjoy low prices and innovative
services.

## Growth of the Internet Industry

In the past five years, the Internet has experienced unprecedented
growth rates. The market for Internet backbone services has grown since
privatization in 1995 into a market with a multitude of competing
providers.[^52] Figure 7 shows that, according to *Boardwatch* magazine,
there are forty-two national backbones, a number that has been rising
steadily since the Internet was privatized.[^53] *Boardwatch* defines a
national backbone to be one "maintaining a hub city in at least five
different states, spanning both coasts, and peering at the major
NAPs."[^54] The list of national backbones includes the top-tier
backbones that only peer with other backbones, as well as other smaller
national backbones that peer with some backbones and purchase transit
from others. Due to the non-disclosure agreements covering contracts
between backbones, it is impossible to know the exact breakdown between
the number of top-tier backbones and other national backbones, although
there are suggestions that there are five top-tier backbones.[^55]

The list of national backbones includes a number of backbones that
pre-date the privatization of the Internet, as well as a number of newer
players that have entered partly on the strength of their new fiber
facilities.[^56] Many of the older backbones have been swept into the
merger wave that is now transforming the general communications
industry, and, combined with their merger partners, remain among the
largest backbones. WorldCom now owns UUNET and ANS Communications, two
of the earliest backbones, along with GridNet, Unicom-Pipex, InNet, NL
Net, and Metrix Interlink.[^57] UUNET, in turn, owns MFS Communications,
which runs the NAPs known as MAEs, including one of the original NAPs,
MAE East. According to the Department of Justice, UUNET is now "by far
the largest provider of Internet backbone services in the world, whether
measured by traffic or revenues."[^58] In 1997, GTE Internetworking,
since renamed Genuity, purchased BBN, the developer of a precursor to
the modern day Internet, and was then spun off as a separate public
corporation.[^59] AT&T's role in the backbone market has grown with its
purchases of CERFnet, another early backbone, along with IBM's Global
Network business. Cable & Wireless entered the ranks of the largest
backbones when it purchased MCI's Internet backbone, which was divested
during the MCI WorldCom merger proceeding.[^60] Finally, PSINet, an
early backbone that has remained independent, also remains among the
list of the larger backbones.

The increase in the number of backbones has been facilitated by the
recent dramatic increases in the availability of fiber optic capacity.
Figure 11 shows that, not only have the fiber networks owned by the
incumbent carriers \-- AT&T, Sprint, and MCI WorldCom \-- all grown in
recent years, a more significant increase in capacity comes from four
entrants \-- Qwest, Broadwing (formerly IXC), Williams, and Level 3 \--
that have built or are building nationwide fiber optic networks.[^61]
Not only are these four companies themselves national Internet
backbones, but a number of other backbones have in turn bought or leased
capacity from them. For instance, PSINet purchased sixteen fibers
covering 14,000 miles from the former IXC Communications.[^62] Backbones
also lease fiber capacity from facilities-based carriers. The
development of dense wavelength division multiplexing (DWDM)
technologies, which divide each strand of fiber into multiple channels,
is further increasing the availability of fiber capacity by multiplying
the capacity of existing and new networks. Entry into the backbone
market is facilitated by this increasing availability of fiber capacity
from a growing number of providers.

The growth in private Internet backbones has coincided with the
introduction of the World Wide Web, which has popularized the Internet
for millions of consumers. The result is a virtuous cycle that is
typical of industries characterized by network externalities. In this
case, users, drawn to the Internet by applications such as the World
Wide Web, encourage the creation of more Web content, which in turn
encourages additional users to log on to the Internet. Figure 9 shows
the recent growth in the number of devices in the United States that can
access the Web, while Figure 10 shows the corresponding increase in the
number of Web pages. New users, and new providers of content, require
Internet access, encouraging the creation of more ISPs, which in turn
encourages the entry of more Internet backbone providers and fiber
providers to transport the additional data. These ISPs compete to
attract new users and content providers in a continuation of the
virtuous cycle that has led to the unprecedented growth level that
characterizes the Internet.

In recognition of the role of regulatory abstention in the development
of the Internet, the 1996 Act states that "\[t\]he Internet ... \[has\]
flourished, to the benefit of all Americans, with a minimum of
government regulation."[^63] Yet the commercial backbone market is
relatively young, and industry observers are questioning whether the
government can, or should, maintain a fully hands-off approach to
backbone providers. The next section shows how competition, hand-in-hand
with antitrust laws and competition enforcement, can act to restrain any
anti-competitive actions in place of industry-specific regulations.

#  Interconnection Issues

This section examines the market outcomes that result from unregulated
interconnection agreements between backbone providers. There have been a
number of allegations, discussed below, that the entire system of
interconnection between backbones is at risk due to the actions of
several larger backbones. At least one industry observer argued that the
emerging system of private peering enables the larger backbones to act
in an anti-competitive manner by excluding smaller backbones from
private peering arrangements and then raising prices.[^64] While
universal connectivity is the norm today, as new real-time services
begin to be offered over the Internet, there are fears that in the
future backbones may choose to differentiate themselves by not
interconnecting for purposes of offering these new services. The paper
examines whether there is any possible market failure in the Internet
backbone market that could not be governed adequately by existing
antitrust laws.

## Internet Backbone Market Power Issues

### Background

Internet backbone providers face conflicting incentives. On one hand,
they have an incentive to cooperate with one another in order to provide
their customers with access to the full range of Internet users and
content. On the other hand, these same backbones have an incentive to
compete with one another for both retail and wholesale customers. The
need for backbone *A* to interconnect with backbone *B* in order to
provide its customers access to backbone *B*'s customers creates what
might be termed a *competitive network externality*; this
interconnection also enables backbone *B* to provide its customers
access to backbone *A'*s customers. As long as *A* and *B* are
relatively equally sized, there is a strong incentive for them to
cooperate with one another in spite of competitive network
externalities; if either unilaterally stops interconnecting, it has no
guarantees that it will benefit from such an action. This situation
seems to characterize the early days of the commercial Internet, when a
number of backbones were relatively similar in size, and readily agreed
to peer with one another. Recently, however, there have been allegations
that as certain backbones grew they began to engage in uncooperative, if
not anti-competitive, practices.[^65]

In early 1997, UUNET, followed by several other large backbones,
attempted to end peering with a number of smaller backbones and instead
charge them for transit.[^66] In another example, GTE Internetworking,
since renamed Genuity, announced that it would no longer privately peer
with Exodus Communications, as did PSINet more recently.[^67] When
WorldCom, which had purchased UUNET and several other backbones,
announced a merger agreement with MCI, there was concern that the
combined backbone would become the dominant backbone with the ability to
exercise market power against smaller competitors in a variety of
ways.[^68] In particular, merger opponents argued that the merged firm
would refuse to peer with smaller backbones. For instance, Level 3
argued that both MCI and WorldCom were refusing to peer with Level 3,
and that the merger would increase the merger partners' incentives to
discriminate against rivals seeking to interconnect.[^69] These concerns
were echoed in the recent MCI WorldCom/Sprint merger proceeding.[^70]
During this proceeding, Level 3 argued that Sprint was refusing to peer
with Level 3, a refusal that "cannot be explained by competitive market
forces."[^71] Likewise, when Exodus was refused peering by PSINet, Adam
Wegner, general counsel for Exodus stated that "\[Exodus\] view\[s\]
\[PSINet's\] action as anti-competitive."[^72]

This section considers whether a backbone's refusal to peer with another
backbone is likely to be anti-competitive. Anti-competitive is defined
to mean the ability of a firm (or firms) to maintain prices profitably
above the level that would otherwise result from a competitive market.
The search for anti-competitive actions focuses on actions that harm
consumers, but do not necessarily harm competitors, for actions that
harm competitors may not in fact harm consumers.[^73]. For instance, a
merger may increase the efficiency of a firm and result in lower retail
prices. While this may harm competitors, if many rivals remain in the
market the merger is not anti-competitive, because lower prices benefit
consumers. If a market failure is found that leads to anti-competitive
actions on the part of one or more Internet backbone providers, a
determination must then be made whether antitrust laws would provide a
sufficient remedy, or if industry-specific regulation is required.

The effect of a backbone's refusing to peer with another backbone
depends on the degree of competition in the backbone market. In a
competitive market, a backbone may refuse to peer with a smaller rival
for legitimate, rather than anti-competitive, reasons.[^74] The paper
shows that, in a competitive market, backbones that have been denied
peering can nevertheless enter the backbone market, because competition
among the larger top-tier backbones gives them an incentive to provide
transit arrangements to smaller backbones in place of peering. If, on
the other hand, there was a dominant backbone, the dominant backbone
might be able to disadvantage actual or potential rivals in an
anti-competitive manner by, for instance, not peering or not providing
transit to smaller backbones.

### Analysis

#### Competitive Backbone Market

An important determinant of the competitiveness of any market is whether
new firms can enter the market, and smaller firms can expand, thereby
constraining any potential exercise of market power by the existing
larger firms. In order to enter or expand, Internet backbones need to
interconnect with existing backbones in order to enable their customers
to exchange traffic with the customers of existing firms, and they need
access to fiber capacity to carry their traffic. As described above,
fiber capacity is readily available, and thus this section will focus on
the ability of smaller Internet backbones to interconnect with larger
ones. Much of the current debate focuses on the effects of one backbone
refusing to peer with another backbone. This paper attempts to inform
such discussions by showing that, in a competitive backbone market,
there may be a number of legitimate reasons for one backbone to refuse
to peer with another backbone. Therefore, such a refusal may not
constitute a barrier to entering the backbone market. As long as transit
arrangements are available on a competitive basis, smaller backbones can
enter and ensure that the backbone market remains competitive.

One reason a backbone may refuse to peer is that it believes that
peering would enable the other backbone to free ride on its
infrastructure investments. Figure 6 illustrates this situation. In the
figure, backbone *B*, a national backbone, has a presence on both
coasts. Backbone *A*, in contrast, is a regional backbone with a
presence only on the East coast. If the two backbones peered on the East
coast, when a customer of backbone *A* requests a web page from a
customer of backbone *B* whose server is on the West coast, then
backbone *B* would carry the request from the East coast to the West
coast and also carry the response back to the East coast. The national
backbone may thus refuse to peer on the grounds that it would otherwise
bear the expense for a national infrastructure from which the regional
carrier could then benefit at no cost. As a result of such
considerations, a number of backbones require that peering partners be
willing and able to interconnect at a number of geographically diverse
locations.[^75] This consideration seems to have motivated UUNET's
decision to change its peering policy in 1997.[^76]

The "hot-potato routing" that characterizes peering arrangements may
also lead to actual or perceived free-riding, as a result of the
decision on the part of some backbones to specialize in providing
service mainly to one type of customer, such as content providers. This
situation can be illustrated by referring back to Figure 5. Suppose that
ISP *Y*, a customer of backbone *B*, provides service mainly to content
providers, while ISP *X*, a customer of backbone *A*, provides service
mainly to end users. Given hot-potato routing, when a end user customer
of ISP *X* requests content that is hosted by ISP *Y*, backbone *B* will
carry the request from the East coast to the West coast, while backbone
*A* would carry the requested content back from the West coast. As a
rule, content such as Web pages involve more bits of data than the
corresponding requests for the content. Therefore, backbones such as *A*
that carry the Web pages would transport more traffic than would
backbones such as *B* that carry the requests for these Web pages.
Backbones may thus refuse to peer with backbones hosting a high
proportion of content providers on the grounds that they are bearing the
expense for more capacity than the backbone that is actually hosting the
content that utilizes this capacity.[^77] This consideration may have
motivated GTE Internetworking (now Genuity) and PSINet to refuse to peer
with Exodus, a company that provides network services to content
providers.[^78]

The preceding paragraphs show that, in order to prevent free-riding, a
large backbone may refuse to peer with a smaller backbone. In a
competitive market, these refusals may not have any anti-competitive
intent or effect; indeed, such refusals may in fact have a
pro-competitive result. A smaller backbone, denied peering on the
grounds of free-riding, may then have an incentive to invest in
infrastructure and compete for a varied mix of new customers in order to
qualify for peering -- resulting in an increased number of competing
national backbone providers. As discussed below, this is only possible
as long as a smaller backbone that has been denied peering is able to
enter the market with a transit relationship.

The next example examines the situation of a backbone that is refused
peering because it has a small customer base. There are indications that
a backbone may refuse to peer with a smaller backbone based on the
amount of traffic generated by the smaller backbone. For instance, the
published peering policies of UUNET, Sprint, and Genuity all contain a
requirement that a peering candidate be able to exchange a certain
minimum amount of data at the beginning of the peering
relationship.[^79] An MCI spokesperson was quoted as saying that, for
this reason, Level 3 was denied peering by MCI.[^80] One justification
given by the larger backbones is that it is difficult and costly to
allocate necessary resources to potential peers with low current volumes
that may or may not grow rapidly in the future. Nevertheless, this
requirement may place backbones with low volumes in a Catch-22
situation; without a large number of customers generating traffic
volume, it is not possible to negotiate peering arrangements with the
large backbones, yet without peering, it may be difficult to gain the
large number of customers necessary to generate the traffic volume to
qualify for peering. In order to determine whether the latter statement
is valid, one must examine the implications for smaller backbones of not
being able to peer with larger backbones.

It is important to differentiate between larger backbones refusing to
*interconnect* with smaller backbones, versus the larger backbones only
refusing to *peer* with smaller backbones. Instead of peering with the
smaller backbones, the larger backbones may offer them a transit
arrangement.[^81] For instance, if backbone *A* is refused peering by
backbone *B*, then backbone *A* could use a transit arrangement in order
for its customers to have access to backbone *B*'s customers. Backbone
*A* could take transit directly from backbone *B*, or it could become a
transit customer of a third backbone *C* that is interconnected with
backbone *B,* as in Figure 4. The paper first argues that in a
competitive market, larger backbones that refuse to peer have an
incentive to offer smaller backbones transit, and then shows that
transit is likely to be offered on a competitive basis.

Having denied peering to smaller backbones, one might question whether
the larger top- tier backbones providing transit would either refuse to
provide transit to smaller backbones or simply increase the cost of
transit in order to squeeze out the smaller rivals. There are two
reasons that this would be unlikely in a competitive backbone market.
The first reason is unique to the Internet. In negotiating peering, one
important bargaining chip is the number of customers to which a backbone
provides access; this includes the number of transit customers.
Therefore, backbones will compete with each other to win transit
customers to use as leverage when negotiating peering relationships with
other backbones. The second reason is traditional, that the large
backbones will compete for the transit business of smaller backbones in
order to increase their revenues, which will keep transit prices down.
In a growing market such as the Internet market, in particular, one
would not expect it to be profitable for a competitive backbone to raise
price, and thereby restrict sales, and growth in sales. Therefore, in a
competitive backbone market, no backbone provider is likely to find it
profitable to use a price squeeze to disadvantage smaller rivals.

As a transit customer, it may be possible for a smaller backbone
provider to grow and later qualify to peer with backbones that initially
refused peering, including the transit supplier. Nevertheless, a smaller
backbone may prefer peering rather then being a paying transit customer,
either for quality or cost reasons. The paper next examines whether, in
a competitive market, a smaller backbone that only interconnects via a
transit arrangement is likely to be at a competitive disadvantage.

Because transit does not involve the same service as peering, refusing
peering in favor of transit is not simply a means of charging for a
service that was otherwise provided free of charge. In a transit
relationship, one backbone must pay another for access to the Internet.
For instance, at the time that UUNET changed its peering policy in 1997,
it announced that wholesale connectivity started at \$2,000 per month
for a T-1 connection and \$6,000 for a fractional T-3 connection.[^82]
Transit customers receive benefits in return for these payments; when
backbones pay for transit they benefit from the infrastructure
investments of national or global backbones without themselves having to
make or utilize their own investments. In addition, as noted above,
transit gives a backbone access to the entire Internet, not just the
customers of the peering partner. In order to provide transit customers
with access to the entire Internet, the transit provider must either
maintain peering arrangements with a number of other backbones or in
turn must pay for transit from yet another backbone. In other words, a
backbone providing transit services is providing access to a greater
array of end users and content than it would as a peer, thereby
incurring correspondingly higher costs that are recuperated in the
transit payments. In a competitive backbone market, transit prices
should reflect costs and should not put entering backbones at a
competitive disadvantage.

In terms of the quality of transit, Level 3 has suggested that, as a
transit customer of another backbone, Level 3 would depend on the
supplying backbone for delivery of IP traffic, at the very least placing
Level 3 at a marketing disadvantage.[^83] This view was affirmed in the
DOJ Complaint in the MCI WorldCom/Sprint merger proceeding.[^84]
Nevertheless, at least one backbone, SAVVIS, initially relied only on
transit connections and not peering, and was very competitive in terms
of quality.[^85] Quality may improve with transit, at least compared
with public peering at a NAP, because a transit connection may avoid the
congestion of passing through a NAP to get access to a backbone.
According to an executive at Digex, a Web-hosting company that used to
own its own backbone, "\[w\]ith free peering, the level of service is
not as good. It costs more \[to pay for access\], but the quality of
service is better."[^86] In sum, there is evidence that paying for
transit does not put a transit customer at an insurmountable
disadvantage from a quality point of view.

In conclusion, the presence of a large number of top-tier backbones can
prevent any anti-competitive actions. In a competitive backbone market,
no large backbone would unilaterally end peering with another, as it has
no guarantee that it will benefit from such an action. Furthermore,
there would be no insurmountable barrier to entry or growth of smaller
backbones. Larger top-tier backbones would continue to compete to
provide transit services to smaller backbones. These smaller backbones
would be able to resell these services to their own customers, and would
not seem to face any barrier to acquiring either the infrastructure or
customer base that could enable them eventually to join the ranks of the
larger backbones and qualify for peering. Actual, as well as potential,
entry by new backbones would act to constrain the actions of larger
incumbent backbones, keeping prices at competitive levels.

#### Backbone Market with a Dominant Firm

If, on the other hand, a single backbone were dominant, it would be able
to harm the public interest by engaging in a number of anti-competitive
actions. As discussed above, it appears unlikely that a firm may
organically grow to become dominant. Instead, the route to such
dominance would likely be achieved by consolidation between backbone
providers, or if a backbone gained market power over a key bottleneck
input, such as transmission facilities. The issue of consolidation was
at the heart of the debate surrounding WorldCom's acquisition of MCI,
and later MCI WorldCom's acquisition of Sprint.[^87] This section
discusses the potential anti-competitive harms that could be caused by a
dominant backbone. Many of these harms were raised by commenters in the
MCI/WorldCom merger proceeding, and identified in the Commission's
*MCI/WorldCom Order*.[^88]

A dominant backbone could harm the public interest in a number of ways.
First, by definition a dominant firm has the unilateral ability to
profitably raise and sustain retail prices above competitive levels. In
addition, a dominant backbone would have both the ability and the
incentive to stop cooperating with smaller backbones. Failure to
cooperate could take a number of forms, including refusing to
interconnect at all, executing a price squeeze, or degrading the quality
of interconnection by not upgrading the capacity of connections with
smaller backbones.

A dominant backbone also could abuse market power by refusing to
interconnect with smaller backbones. The network externalities
literature has shown that, in general, a larger network has less of an
incentive to become compatible or interconnect with a smaller network,
as customers of the smaller network have more to gain from being able to
communicate with customers of the larger network than vice versa.[^89]
In the context of the Internet, if a dominant backbone refused to
interconnect with a smaller one, the customers of the smaller backbone
would have an incentive to switch to the larger network in order to
enjoy the network externalities associated with the larger backbone's
customer base. Although customers of the dominant backbone would also
lose access to the smaller network's customer base, they are unlikely to
respond by switching to the smaller network. As a result, the smaller
backbone would be positioned poorly to compete for customers,
reinforcing the dominance of the largest backbone. It is noteworthy that
the advantage of dominant networks also characterizes local telephony,
where incumbent LECs must be compelled by statute to interconnect with
smaller competitive LECs.[^90]

A dominant backbone could also exercise market power by executing a
price squeeze on those smaller backbones with which it interconnects. In
a price squeeze situation, a vertically integrated firm with market
power over an essential upstream input raises the price of this input to
rivals competing in downstream retail markets. The increased cost of
this essential input forces downstream rivals to raise their retail
prices. The vertically integrated firm is then in a position to undercut
the downstream rivals in retail markets and thereby increase market
share and profits. In the backbone example, interconnection is the
essential input that smaller backbones must have from the dominant
backbone in order to compete with the dominant backbone to sell backbone
services to ISPs or directly to end users. Dominant backbones can refuse
to peer with smaller backbones, and also raise the price of transit
services charged to those same backbones. This will weaken existing
rivals, and also prevent the entry of new backbones. As a result, the
dominant backbone can raise downstream prices and increase profits.

A dominant backbone also might engage in non-price discrimination
against rival backbones.[^91] During the MCI/WorldCom merger proceeding,
GTE presented a scenario in which a dominant backbone might degrade
interconnections with other backbones in order to win customers from
those backbone providers. This could most easily be done by "slow
rolling" necessary increases in the capacity of the trunks used to
interconnect with other backbones. Such capacity increases are a regular
necessity to keep pace with the rapid growth in demand for Internet
services. Under this scheme, a backbone, *A*, may degrade a connection
with a smaller backbone, *B.* As *B*'s customers begin to feel the
effects of this degradation when communicating with customers of
backbone *A*, they may switch to backbone *A* in order to improve
connections with customers of backbone *A*. It should be noted that,
with two-way interconnections, the customers of backbone *A* would also
be affected by this degradation when they attempt to communicate with
the customers of backbone *B*. For this reason, *A* must be
significantly larger than *B* so that its customers are relatively less
adversely affected than the customers of *B* and do not themselves
switch.[^92] In order to limit further the effects of non-price
discrimination on its own customers, GTE argued that backbone *A* would
engage in what it called "serial degradation" and target only one
smaller backbone at a time.

This section shows that, if a backbone were to become dominant, it could
act in an anti-competitive fashion. Such a backbone market would share
many characteristics with other network industries that traditionally
warranted regulation, and it might then be in the public interest to
apply similar regulations to the backbone market. The paper shows above
that, conversely, as long as there are a number of competing top-tier
backbone providers, entry is possible. In that case, there would be no
need for any change in the current unregulated status of the Internet.
The next section shows that, although competition between backbone
providers is unregulated, consumers nevertheless benefit from the same
protections afforded consumers of all products and services. Existing
antitrust policies, as applied in the MCI/WorldCom and MCI
WorldCom/Sprint merger proceedings by the Department of Justice and the
European Commission, along with the Federal Communications Commission's
application of the public interest standard in the MCI/WorldCom case,
can prevent the emergence of a dominant backbone in an otherwise
competitive market.[^93]

### Consumer Protection in the Backbone Market

This paper has already discussed the underpinnings of the
industry-specific regulation of network industries -- when the
underlying cost structure of an industry does not support competition,
it may be in the public interest to regulate the prices and services
offered by the resulting natural monopoly. There are only a select few
network industries in the United States for which market failures have
been considered severe enough that regulations have been imposed to
govern prices and service quality on an ongoing basis. Where competition
is possible, regulation may be relaxed or eliminated, to the extent that
market forces can govern prices and services in place of regulations.
Even where competition is possible, however, it is not guaranteed. As a
result, antitrust laws have been enacted to protect consumers from
anti-competitive behavior by a firm (or firms) that seek to acquire or
exploit market power. The antitrust laws apply to the Internet backbone
as they do to every other product and service market, and indeed they
already have been invoked in the cases of the MCI/WorldCom and MCI
WorldCom/Sprint mergers. Many of the above arguments about the potential
actions of a dominant backbone were raised during these merger
proceedings.[^94] These proceedings showed that the combined efforts of
the European Commission and the Department of Justice, enforcing
relevant antitrust statutes, as well as the Commission itself, upholding
the public interest standard, can prevent an increase in the
concentration of the backbone market that could threaten consumer
welfare.[^95]

In the MCI/WorldCom merger proceeding, MCI divested its Internet
business to Cable & Wireless in order to eliminate any overlap between
MCI and WorldCom in the Internet backbone market, and thereby satisfied
concerns expressed by the Department of Justice and the European
Union.[^96] Parties argued at the time, however, that the degree to
which MCI's Internet business was integrated with its other business
units might complicate such a divestiture, in comparison with the
divestiture of a standalone business unit such as WorldCom's UUNET
backbone.[^97] All relevant agencies approved the transaction based on
their conclusion that the terms of the divestiture contract adequately
addressed any potential complications arising from the divestiture of an
integrated unit such as MCI's Internet business.[^98] Since the
divestiture, however, Cable & Wireless filed suit against MCI, claiming
that MCI breached the divestiture contract by not transferring its
complete Internet business; according to Mike McTighe, Chief Executive
Officer of Cable & Wireless Global Operations, "MCI WorldCom's material
breaches of the \[divestiture\] Undertakings threaten to impair Cable &
Wireless's competitiveness."[^99] This suit, which was settled, shows
that the details of a divestiture may be important.[^100] A complete
divestiture of a business unit by one of the merging firms may mean that
the market share of the merged entity does not change as a result of the
merger. However, the competitive landscape may nevertheless change if
the divested unit is harmed as a result of the divestiture, and
therefore poses less of a competitive constraint to the merged
firm.[^101]

In addition to horizontal concentration in the backbone market, vertical
integration could also lead to market power. Backbones may vertically
integrate upstream into the market for the telecommunications inputs
that underlie the services that backbones provide. Indeed, many
backbones, such as WorldCom and Sprint, are already vertically
integrated, owning their own fiber optic networks. Because
telecommunications transport capacity is readily available today from a
wide variety of providers, including the vertically integrated backbones
themselves, vertical integration itself is unlikely to create a barrier
to entry. As with mergers of backbones, antitrust laws, and specifically
merger policy, should prevent undue consolidation of the
telecommunications transport market that could lead the remaining
telecommunications providers to engage in anti-competitive actions in
the downstream Internet backbone market. In addition, existing common
carrier regulations prevent vertically integrated telecommunications
carriers from refusing to provide any necessary upstream
telecommunications services sought by competing backbone providers.

There also may be concern about downstream relationships between
backbones and the Internet service providers for whom backbone services
are a vital input. In addition to vertical integration, backbone
providers could enter into exclusive dealing arrangements with ISPs,
such that the backbone provider would provide only one ISP with its
services. Likewise, backbones that already are vertically integrated
with ISPs could choose to not provide backbone services to unaffiliated
ISPs. In the growing Internet market, such an exclusionary arrangement
is unlikely, however, because backbones have incentives to increase the
number of customers that they have as bargaining chips in peering
negotiations. In addition, given the availability of telecommunications
inputs and transit arrangements, the possibilities of entry into either
the ISP market or the backbone market could not be foreclosed by such a
vertical arrangement.

Thus, the lack of industry-specific regulation of Internet backbones
does not expose consumers to economic risks that are different than
those faced by consumers of other, non-network products and services.
Internet markets are subject to the same antitrust regulations that act
to govern other industries in the event that competition is no longer
able to provide customers with just and reasonable prices and quality
levels.

The sections above show how, in a competitive environment without a
dominant firm, interconnection, either by transit or peering, will be
available to existing and new backbones. While consolidation is the most
obvious means for a backbone to become dominant, as discussed above,
there are other means by which a backbone could grow to become dominant.
For example, one way is for a provider to leverage market power over
last-mile access to end users into market power in the backbone market
-- an important issue that is best left to an analysis of the market for
last- mile access. In another scenario, a new or existing backbone could
develop a proprietary technology that makes it either more efficient or
more attractive to end-user customers. If this technology is a new
service, for example, the backbone may choose not to interconnect with
other backbones for the provision of this new service. As customers
switch to this backbone in order to benefit from the new service, the
backbone may grow to become dominant.

If a dominant backbone provider were to emerge, this backbone provider
could engage in a variety of anti-competitive actions, as described
above, that would ultimately harm consumers. In this case,
industry-specific regulation of the dominant backbone provider may be in
the public interest. Other network industries such as telephony also
have warranted industry-specific regulation, and the resulting
regulations may provide a template for the regulations that could be
imposed on a dominant backbone provider. Such regulations could include,
for instance, interconnection obligations that would govern the peering
and transit relationships offered by the dominant backbone provider. Any
regulation of the Internet backbone market would represent a significant
shift in the unregulated status quo under which the Internet industry
has grown at unprecedented rates, and therefore would require a
corresponding significant shift in the competitiveness of the market.

## Internet Balkanization Issues

Although it may be unlikely that any backbone is able to gain sufficient
market power so as to be able to act in an anti-competitive fashion,
today's environment of universal connectivity among backbones
nevertheless may not be stable in the long run. Firms in all markets
attempt to differentiate their products from other companies for one or
more of the following reasons: to help attract new customers; to
increase their hold over existing customers; or to be able to profitably
raise retail prices. Internet backbones may thus attempt to
differentiate themselves from each other by offering certain new or
existing services only to their own customers. As a result, the Internet
may "balkanize," with competing backbones not interconnecting to provide
all services.[^102] This may resemble the early days of telephony, when
not all local companies were interconnected.

The dynamic nature of the Internet means that today's market structure
and relationships likely will change. New services are continually being
made available over the Internet. Many of these services, including
Internet telephony and video-conferencing, are real-time applications
that are sensitive to any delays in transmission. As a result, quality
of service (QoS) is becoming a critical issue for backbones and ISPs.
The paper considers whether or not two backbones would establish
high-quality interconnections over which they could guarantee QoS levels
to their customers wishing to communicate in real-time with customers of
the other backbone.[^103] The paper focuses on the economics behind a
decision to interconnect to guarantee QoS, while assuming that any
technical barriers to such interconnection could be overcome.[^104]
Backbones face a number of private economic considerations in making
such interconnection decisions. Any private decision by one or more
backbones not to interconnect to guarantee QoS levels for new services
may also have public consequences, however, as consumers of one backbone
may not be able to use these new services to communicate with consumers
of another backbone. The paper shows that there are strong market forces
that would lead firms to interconnect in order to exchange traffic
originating from these new services. If such interconnection does not
materialize, proponents of any industry-specific interconnection
regulation should nevertheless show why the lack of such interconnection
justifies regulatory intervention.

The decision to interconnect for the provision of QoS services would
appear to be relatively similar to the one that backbones currently make
when deciding whether to peer with one another. The backbones each
calculate whether the benefits of interconnecting with one or more other
backbones would outweigh the costs. The benefits of interconnecting to
exchange traffic flow from increasing the network of customers with whom
one can communicate; this helps attract new users, and encourages usage
from existing users. The cost comes from a competitive network
externality, as defined above; one backbone's decision to interconnect
with another backbone makes the other backbone more attractive to
customers. The widespread interconnection available today, in the form
of either peering or transit agreements, indicates that currently, the
benefits of interconnection outweigh any costs.

There is, however, a difference between current interconnection
arrangements and new interconnection arrangements for the exchange of
QoS traffic. The Internet services that interconnection enables today,
such as email and Web access, already are universally available, and no
one backbone or ISP could differentiate itself based on its unique
provision of these services. Universal connectivity, however, is a
legacy of the cooperative spirit that characterized the Internet in its
early days. In the commercial spirit that pervades the Internet today,
backbones and ISPs may view the new services that rely on QoS as a means
to differentiate themselves from their competitors. A firm that
introduces these new services may be less willing to share the ability
to provide these services with competitors, as such sharing may reduce
the ability of the firm to charge a premium to its own customers. For
instance, UUNET announced a Service Level Agreement (SLA) that
guarantees, among other things, the delivery speed (latency) of
customers' traffic on its network.[^105] This guarantee does not extend
to traffic that leaves UUNET's network, however, which encourages
customers to keep traffic on-net.

Even if backbones agree in principle to interconnect in order to be able
to offer new services that require QoS guarantees, they may face
practical difficulties in reaching a final interconnection agreement.
Aside from disagreements over the terms of interconnection, it is
possible that the backbones, or their ISP customers, must support
compatible versions of a particular new service in order to be able to
exchange traffic that originates with one backbone's end user and
terminates with another backbone's end user. Before committing to a
particular standard for this service, backbones may wish to wait for an
industry-wide standard to emerge. This presents a coordination problem
that may be difficult to resolve -- in particular, if any firms have
developed their own proprietary standards that they wish to see adopted
as the industry-wide standard. In this situation, in spite of the fact
that backbones would be willing to interconnect to exchange QoS traffic,
the end result may be the same as if they were not willing to
interconnect -- end users would not be able to communicate across
backbones using certain services.

Another potential issue relating to interconnection for QoS services is
that it may exacerbate current congestion, and therefore it may be
difficult to guarantee QoS across backbones. Assuming that
interconnection for QoS traffic is implemented under the current
settlement-free peering system, backbones will not be paid to terminate
QoS traffic. As a result, receiving backbones will have little or no
economic incentive to increase capacity to terminate this traffic. QoS
traffic that traverses networks may thus face congestion and would be
unlikely to provide satisfactory quality. Of course, similar problems
exist today with the current peering system, as described above, leading
to the current congestion, but given the high data volume characterizing
such services, the problem may be worsened. In order to provide the
proper economic incentives to be able to guarantee to customers that
they can deliver QoS traffic across networks, backbones may have to
implement a traffic-sensitive settlement system for such traffic.[^106]

If backbones are unable to overcome the economic, administrative, and
technical hurdles to interconnect to exchange traffic flowing from new
services requiring QoS, then the Internet faces the risk of
balkanization. Backbones will only provide certain new services for use
among their own customers. The result would be that network
externalities, once taken for granted, would suddenly play a major role
for consumers of Internet services. In the current environment of
universal connectivity, consumers who simply want to send and receive
email and surf on the Web can choose any retail provider without
worrying about the choices of other consumers or content providers. If
the Internet balkanizes over the offering of new services, consumers
would need to be aware of the choices of those with whom they wish to
communicate when making their own choice of Internet provider. For
instance, a consumer who wishes to view real-time streaming video may
need to be sure that the provider is connected to the same backbone to
ensure high quality viewing. Likewise, a business that wishes to use the
Internet for videoconferencing must make sure that all relevant
branches, customers, and suppliers are connected to the same backbone.
Thus any balkanization of the Internet would result in a classic example
of network externalities; the specific backbone choice of each consumer
would influence the choices of other consumers.

As a result of any balkanization of the Internet with respect to the
provision of new services, customers wishing to communicate with a wide
variety of others may end up subscribing to competing backbones, unless
customers can coordinate on the choice of one backbone. This would raise
the specter of the early days of telephony, when competing telephone
companies refused to interconnect, resulting in many businesses and even
some homes owning more than one telephone, corresponding to multiple
local telephone company subscriptions.[^107] As with the telephone
system before it, any Internet balkanization may lead to calls for some
form of interconnection regulation for backbones. This paper argues that
such regulations are unlikely to be necessary.

It is important to reiterate that network industries such as telephony,
water, and electricity, have historically been regulated based on their
cost structure, to prevent a natural monopoly from exploiting customers.
Such network industries are not generally regulated solely to provide
customers the demand-side network externalities described above.[^108]
To impose interconnection regulations on Internet backbone providers in
order to increase the benefits from network externalities for new
services would represent a break from regulatory tradition.

There are many examples of products like the Internet that provide both
direct and indirect network externalities that are not subject to
industry-specific regulations. For instance, almost every consumer
electronics product consists of a hardware/software system with indirect
network externalities. The usefulness of compact disk players, personal
computers, web browsers, and videocassette recorders depends to a great
degree, if not totally, on the availability of compatible "software."
The greater the number of users of the relevant "hardware," the more
software will be available. Likewise, fax machines and email involve
direct communications between end users with corresponding direct
network externalities. In all of these cases, the market set the adopted
standards, or ensured that various companies' products were compatible
with one another, without any government intervention.

The marketplace has been quite successful at choosing standards that
allow the products and services of different companies to be compatible
with one another. Often, this is accomplished by a standards battle,
such as the one waged between Betamax and VHS for the videocassette
recorder standard. In other cases, one firm may create an adapter that
enables its products to be compatible with the products of another firm.
Another factor leading to compatibility is that firms in nascent
industries have an incentive to cooperate on setting common standards
that will enable the industry to grow, so that later they can compete
with one another over larger slices of the growing pie.[^109]

In some cases, notably the personal computer market, more than one
standard emerges. This result has nevertheless been influenced by
consumer demand, as Apple is widely seen as meeting the demands of a
niche market, while the IBM (Intel/Windows) standard meets the more
general needs of the mass market. It is worth noting here that it has
been Internet protocols and applications, such as Web browsers and the
Java language, that have served to meet the demands of users of IBM and
Apple's respective platforms to interact seamlessly with one
another.[^110] A final example of a standard emerging as a result of
marketplace forces is the Internet itself. The protocols at the heart of
the Internet, TCP/IP, only relatively recently became the dominant
standard for networking, at the expense of a number of proprietary and
non-proprietary standards including SNA, DecNet, and X.25.[^111]

Although the marketplace is remarkably successful at generating
compatible standards, it would be a mistake to conclude that this
process is costless for consumers or firms. Purchasers of Sony's Betamax
VCRs found it impossible to rent or buy movies after the VHS standard
won the standards battle, while Sony was forced to concede and begin
selling its competitors' standard. The fax machine market was very slow
to mature without a fixed standard, delaying the widespread adoption of
a product that soon came to be regarded as almost indispensable for both
consumers and firms. In each case, the government could theoretically
have chosen a standard, thereby avoiding these costs. Nevertheless, in
the United States, consumers and firms rarely, if ever, call for
government intervention in these cases.

The marketplace is the preferred means for setting compatible standards
in most industries and for most products for a variety of reasons.
First, an open marketplace for standards leads to healthy competition
for the rewards of owning a standard, and often "second-mover" standards
are able to overcome an industry leader by embodying their standards in
better products, or more creative marketing of these products. For
instance, VHS was able to overcome the Betamax lead to become the
industry standard by providing longer recording times, among other
things.[^112] Second, as described above, innovators such as Apple
Computer may target new products at niche markets, with consumers
benefiting from the resulting variety. Such variety and innovation may
not occur if a standard is chosen by non-market means. Therefore, while
the marketplace may increase short-run costs involved with adopting new
standards, the long-run marketplace benefits of competition and
innovation are likely to more than make up for any short-run costs.

The marketplace should provide solutions to many, if not all, of the
challenges that arise in the provision of current and new Internet
services. Consumers, with expectations of universal connectivity and
basic compatibility, are likely to demand that backbones essentially set
standards for the provision of QoS services by agreeing to interconnect
to provide these services. Backbones, in turn, may see that it is in
their interest to interconnect in order to enable the market for QoS
services to grow. If firms limit offerings of new QoS services to their
own customers, other marketplace solutions are available that may ensure
that consumers can remain connected to the full Internet. For instance,
if two backbones are unable to coordinate an interconnection agreement
enabling interconnection for QoS services, consumers may simply
interconnect to more than one backbone, a practice known as multihoming,
or turn to firms such as InterNAP that connect with all major backbones,
enabling their customers to communicate directly with the customers of
all major backbones without themselves multihoming. Marketplace demands
and market-driven innovations may alleviate the costs of any Internet
balkanization, if not preventing it altogether, in more efficient ways
than would the imposition of any interconnection regulations on the
Internet.

In summary, this paper argues that if one or more backbones choose not
to interconnect with other backbones for the provision of new services
in the future, this is likely to be a temporary phase. This phase would
end as a result of market forces that would induce backbones to
interconnect, while at the same time innovative firms might step into
the breach to provide interconnection services for end users.
Nevertheless, during this phase there may be calls to implement some
form of interconnection regulation. The paper has argued above that such
intervention would be relatively unique, as there is little precedent
for the regulation of networks such as the Internet where there are low
entry barriers on the cost-side. In addition, regulatory intervention
would be a notable shift in United States policy.[^113] As a result, any
calls to intervene in the Internet market would require a
correspondingly high burden of proof.

This paper attempts to inform any future discussion calling for
regulatory intervention in the interactions between backbones. An
affirmative case for regulatory intervention should include the
following arguments. First, an argument may be made that the lack of
interconnection would lead to market power, with adverse effects on
consumers.[^114] This argument should be accompanied by a showing that
an ongoing regulatory approach, rather than an antitrust approach, is
the appropriate solution to protect consumers from any potential adverse
effects of market power. A second argument may be that, regardless of
whether market power develops, interconnection between Internet
backbones, enabling seamless communication between all Internet users,
is in the public interest. In this case, a showing should be made that
both identifies the benefits and the costs of mandating interconnection,
and shows that the benefits outweigh the costs. The benefits stem from
the network externalities that backbones will be able to deliver to end
user customers; the costs of mandated interconnection could include a
lowered incentive to innovate in providing new services, less variety of
new services, and any regulatory costs incurred by firms and the
regulatory agency. Finally, the realities of mandated interconnection
would need to be addressed -- who determines the terms of
interconnection, the principles governing these terms of
interconnection, and how these terms should be enforced. Given the
complicated nature of interactions between backbones, intervention may
be complex; however, as described above, it is likely to be unnecessary,
as long as competition governs the interactions between backbones.

#  International Interconnection Issues

In recent years, some non-U.S. carriers, largely from the Asia Pacific
region, have complained that current international interconnection
arrangements for the exchange of Internet traffic are not fair. The cost
of international transmission capacity used for Internet traffic is
typically not shared between carriers or backbones in connected
countries; rather, one carrier generally pays for the entire circuit.
The non-U.S. carriers claim that since traffic flows from international
points to the United States are increasing, it is unfair that they pay
for the entire circuit connecting their networks to the United States.
These carriers propose that, as with international voice circuits, the
cost should be shared between carriers at both ends. The question that
this paper addresses is whether the interconnection agreements to which
these carriers object are the result of competitive market forces, or
whether there is a market failure that enables the U.S. backbones to
impose unfair or anti-competitive interconnection agreements on the
carriers outside of the United States.

## Principles of International Telecommunications Regulation

International interconnection arrangements for telephony arose from the
practicalities of interconnecting domestic telecommunications monopolies
for international calling.[^115] Until recently, domestic
telecommunications monopolies could not enter foreign markets to
terminate traffic, nor could they turn to competitors as an alternative
to the incumbent carrier in a country.[^116] As a result, completion of
an international call needed to be jointly undertaken by the domestic
monopolies at the originating and terminating ends. An arrangement
emerged in which each carrier provides half the transmission circuit
needed to route calls from one country to the other. In addition, the
international accounting rate system provides a framework in which the
originating carrier that bills customers for international calls
compensates the carrier in the called country for terminating
calls.[^117] It is worth noting for the present discussion that, as
competition increasingly emerges in countries on both sides of
international circuits, commercial negotiations between carriers are
beginning to supplant these legacy international regulations.

The Internet has not been subject to these legacy international
regulations. Instead, the Internet runs over leased or privately owned
lines that are not subject to the accounting rate system as long as they
are not used to provide public telecommunications services.[^118] In
addition, there are no provisions for sharing the cost of these leased
or privately owned lines between countries. As a result, according to a
OECD report, entitled *Internet Traffic Exchange: Developments and
Policy*, "the Internet model for financing international infrastructure
... effectively shifts the financial mid-point for traffic exchange from
oceans (as in the case of cables) and geostationary orbit (as in the
case of satellites) to Internet exchange points \[such as NAPs\]."[^119]
There are no guidelines, however, for determining the location of the
Internet exchange point where two backbones will meet to exchange
traffic, instead, the meet point results from private negotiations
between the backbones. Some carriers, particularly from the Asia-Pacific
region, have questioned whether the results of these negotiations are
fair.

## International Cost-Sharing Issue

### Background

In recent years, a number of non-U.S. carriers have objected to the
interconnection agreements governing the flows of Internet traffic
between international points and the United States.[^120] Telstra, an
Australian domestic and international carrier, has claimed that "to
access U.S.-based Internet sites ... U.S. carriers have insisted that
foreign carriers pay for both of the required international
half-circuits, i.e., for 100% of the cost of the international
link."[^121] Telstra claims that roughly 30 percent of Internet traffic
flowing between the United States and Australia is flowing from
Australia to the United States, "due mainly to U.S. Internet users
increasingly drawing on Australian Internet content."[^122] Because
Telstra pays for the entire link between Australia and the United
States, Telstra claims it is effectively subsidizing U.S. carriers and
U.S. ISPs whose customers are accessing Australian content. In 1999,
Telstra estimated that "Australian ISPs will incur costs of around \$175
million to support provision of internet services by US ISPs to their US
customers."[^123] Telstra also argued that the current pricing
arrangements "appear to be unjust and unreasonable in violation of
Section 201(b) of the Communications Act."[^124] Similarly, in January
of 1999, a number of other Asia-Pacific carriers sent a letter on this
subject to a number of U.S. backbone providers, and business,
government, and Internet organizations,[^125] in which they claim that
"the increasing demand for information from the \[Asia-Pacific\] region
and the bi-directional traffic make the \[ISPs\] in the US in effect
free-riding on the circuits and gateways/ports provided by the
\[Asia-Pacific\] region ISPs."[^126]

As a remedy to their perceived problems with the current system, Telstra
proposes that "under an equitable regime the cost-allocation of Internet
capacity must reflect the traffic flows."[^127] Similarly, in their
letter, the Asia-Pacific carriers requested that U.S. backbones "share
the cost of international Internet backbone between the US and the AP
region according to their usage or benefits" and urge a study of the
"actual traffic as the basis of usage-based or cost-oriented charging
and settlement arrangements."[^128]

A couple of international organizations are currently studying the
international Internet cost-sharing issue raised by the non-U.S.
carriers. The Asia Pacific Economic Cooperation (APEC) forum has raised
this issue, under the rubric of international charging arrangements for
Internet services (ICAIS), in 1998 at a Ministerial meeting on the
Telecommunications and Information industry in Singapore. The
Ministerial Declaration called for "the study, and, if and when
appropriate, development, by the next APEC Ministerial Meeting on
Telecommunications and Information Industry, of compatible and
sustainable international charging arrangements for Internet
services...."[^129] The Terms of Reference for this study solicited,
"\[i\]f and when appropriate, and based on the findings of the study,
proposals on the kinds of market and cost-based commercial and/or
regulatory responses necessary to create more compatible and sustainable
international charging arrangements for Internet services to promote the
further development of and access to the Asia-Pacific Information
Infrastructure (APII)."[^130] The United States, in a background paper
to the APEC Telecommunications Working Group, maintained that "there is
no need for government intervention into relationships between Internet
Service Providers."[^131] The United States further contended that "cost
efficient arrangements for Internet traffic will continue to be worked
out most quickly if the market is not hampered by government
regulation."[^132]

The ICAIS study commissioned by APEC was recently completed; while the
authors discuss various Internet charging mechanisms, they do not make
recommendations or express opinions about the imposition of such
charging mechanisms.[^133] However, they made several relevant findings.
First, the authors found that "\[t\]rans-Pacific and intra-Asian
capacity is more expensive and less competitive than is the case within
North America, on trans-Atlantic routes, or within Europe."[^134]
Second, they found that "North American and other backbone carriers are
expanding rapidly in the Asia-Pacific region."[^135] Finally, they found
that "the rapid deployment of new capacity will dramatically reduce the
unit cost of international charges \[for Internet services\],
irrespective of the structure of the charging arrangements."[^136]

Based on the instructions adopted at the 1998 APEC Ministerial Meeting,
the ICAIS issue was again on the agenda at the APEC Ministerial Meeting
on Telecommunications in Cancun, Mexico from May 24-26, 2000. At this
meeting, the Ministers reaffirmed "the importance of mutually beneficial
arrangements on \[ICAIS\], to allow a continued expansion of the Asia
Pacific Information Infrastructure."[^137] The Cancun Ministerial
Declaration stated that "Governments need not intervene in private
business agreements on International Charging Agreements for Internet
Services achieved in a competitive environment, but where there are
dominant players or de facto monopolies, governments must play a role in
promoting fair competition."[^138] However, the Programme of Action
resulting from the Ministerial notes that the APEC Telecommunications
Working Group (TEL) should continue to discuss charging arrangements,
noting that these arrangements should account for traffic flow
patterns.[^139]

Several reports on this issue have not supported any active government
role in regulating international interconnection arrangements. The
Organization for Economic Co-operation and Development (OECD) argued
that "\[a\]t this stage, the best way forward is for industry to
initiate discussion on the financing of Internet traffic exchange, for
example, via the Asia-Pacific Internet Association's call for comments
and other industry forums. The role of government is to stay abreast of
these discussions and support industry-led solutions."[^140] In December
1999, the International Telecommunications Union (ITU)
Telecommunications Sector Study Group 3 (ITU-T/SG3) issued a report
arguing that "the PSTN costing model is inappropriate for the Internet,"
but the group was otherwise "unable to develop an agreed set of
principles on the equitable cost compensation between circuit
providers."[^141]

The first step towards changing the international Internet charging
arrangement status quo came from the ITU-T/SG3 during a meeting in
Geneva that concluded on April 18, 2000.[^142] The study group adopted a
proposal, raised by the Asia and Oceania Region tariff group,
recommending that "administrations involved in the provision of
international Internet connection negotiate and agree bilateral
commercial arrangements applying to direct international Internet
connections whereby each administration will be compensated for the cost
that it incurs in carrying traffic that is generated by the other
administration."[^143] This draft recommendation will be submitted to
the ITU World Telecommunications Standardization Assembly (WTSA) for
approval. The WTSA meets in Montreal in September 2000. The
recommendation did not explain its departure from contrary conclusions
that emerged after two years of study by a rapporteur's group
established by Study Group 3 itself. The United States has submitted to
the WTSA meeting formal contributions in opposition to both the
substance of this recommendation and the procedures used in its
adoption.

### Analysis

It is important to note at the outset that there is no discrimination
against non-U.S. carriers in interconnection arrangements. U.S. Internet
backbones treat domestic and foreign backbones the same when negotiating
the meet point for Internet exchange. In response to Telstra's specific
claims raised above, in the *MCI/WorldCom Order*, the Commission did not
agree that the merging backbones' practices violated section 201(b) of
the Communications Act. The Commission found that "the record does not
demonstrate that WorldCom or MCI provides services subject to Title II
regulation on rates, terms, and conditions that are unjust or
unreasonably discriminatory, in violation of the Communications
Act."[^144] No indication has been provided by the Asia-Pacific carriers
that prove that the interconnection agreements to which they object
reflect anti-competitive actions on the part of U.S. backbones.

The Asia-Pacific carriers base their objection to current
interconnection agreements on the relative flow of traffic between the
United States and international points; however, traffic flows are not a
good indicator of the relative benefits of an Internet interconnection
between backbones, and therefore provide a poor basis for allocating any
costs. First, unlike a phone call, it is impossible to determine who
originally initiated any given transmission on the Internet. For
instance, a packet flowing from the United States to Japan either may be
part of a transmission such as an email that was initiated by a user in
the United States, or part of a Web page being sent in response to a
request initiated by a user in Japan. It is therefore not clear who
should pay for the cost of transmitting a given traffic flow from the
United States to Japan. In addition, if a transmission is a Web page, it
is not clear who received more benefits from the transmission -- the
customer that requested the Web page or the content provider that
supplied the information. In fact, both benefit from the ability to use
the Internet to initiate cross-border transactions that may never have
occurred but for the Internet.[^145]

In the specific case raised by the Asia-Pacific carriers, it is also
difficult to assign benefits or costs from Internet interconnections
based on traffic flows because the United States acts as a hub for
Asia-Pacific intra-regional traffic.[^146] Thus, some of the traffic
flowing to the United States from the Asia-Pacific region may
immediately return to another part of the Asia-Pacific region; this
traffic does not represent a benefit for which customers of United
States backbones should pay any share. In sum, it is not possible to
determine the value of an Internet connection between the United States
and the Asia-Pacific region or elsewhere based solely on the Internet
traffic flows between these regions.

The Asia-Pacific carriers have argued that, based on their equation of
traffic flows to benefits, U.S. backbones should share the cost of the
transmission capacity between the Asia-Pacific region and the United
States, a system that would essentially impose legacy international
regulations on the Internet.[^147] The Internet is a worldwide network,
however, whose value cannot be split over only one section of
transmission capacity. For example, while a backbone in the Asia-Pacific
region may provide the transmission capacity to connect with a backbone
provider at one point in the United States, it may thereby receive
access to the latter backbone's extensive national network within the
United States, and increasingly to the backbone's investments in
connections to Europe and other parts of the world. It is difficult
therefore to conclude that there is a net subsidy going from the
customers of the Asia-Pacific backbone to those of the U.S.
backbone.[^148]

The meet point for Internet exchange is determined as a result of
commercial negotiations that take into account more than just traffic
flows between two networks.[^149] Traffic flows on the Internet do not
necessarily provide a good indication of the benefits of an Internet
interconnection. In addition, as discussed above, backbones negotiating
an interconnection arrangement consider, among other things, relative
infrastructure investments as well as the composition and location of
customers and content providers. According to all publicly available
information, there is therefore no indication that any U.S. backbones
are exercising market power with respect to non-U.S. carriers. Legacy
international regulations should therefore not be imposed on backbones.

## Marketplace Solutions

As with domestic interconnection arrangements, backbone providers
negotiate international interconnection terms in a competitive
environment, and base their decisions on whether, how, and where to
interconnect by weighing the benefits and costs of such interconnection.
As the Internet industry evolves in the United States and abroad,
competitive market forces continue to influence the nature of
interconnection agreements between U.S. and foreign backbone providers.
As shown in Figure 12, the number of Internet users outside the United
States has been growing faster than the number of users within the
United States, and, the number of users in the rest of the world now
exceeds that in the United States. In the long term, this growth may
have two effects on Internet cost-sharing arrangements. First, the
amount of content available in the rest of the world is likely to
increase to meet this increased demand, providing foreign backbone
providers with more content, resulting in more leverage for
interconnection negotiations with U.S. backbones. Indeed, there are
reports that at least one Asian company, Internet Initiative Japan Inc.,
already connects with U.S. backbones on an equal basis owing to the
large amount of content that it aggregates from Japanese companies and
ISPs.[^150] Second, U.S. backbones are responding to the increased
demand in the rest of the world by investing in both international
transmission capacity and networks in other countries. For instance,
Level 3 has invested in capacity to Europe and within Europe, and is
part of a consortium building transmission capacity to Japan.[^151] U.S.
backbones that have invested in international transmission capacity can
then exchange traffic with foreign backbones directly in the foreign
country, increasing the options available to foreign backbones that do
not wish to pay for transmission capacity to exchange traffic with U.S.
backbones in the United States.[^152]

Other market-based solutions may further reduce the transport costs
incurred by Asia-Pacific carriers.[^153] As with domestic backbones
seeking to reduce traffic flows and alleviate congestion, backbones
outside the United States can use caching and mirror sites to reduce the
amount of traffic flowing from the United States to international points
and thereby reduce the need for transmission capacity. Additionally,
increased competition within the Asia-Pacific region will lower the cost
of leased lines between countries in the Asia-Pacific region, enabling
more direct intra-regional Internet traffic exchange and correspondingly
reducing the costs associated with using the United States as a hub for
this purpose.[^154] Telegeography recently noted that "in Europe, where
telecom liberalization has been the greatest and country-to-country
bandwidth prices have dropped the fastest, two thirds of international
Internet connectivity remains in-region." The explanation is that "the
move away from a U.S.-centric architecture depends on well-developed
local infrastructure, and a regulatory environment which neither
prohibits connectivity nor prices it out of reach."[^155]

Finally, another market-based solution is suggested by Peter Coroneos,
the Director of the Internet Industry Association of Australia.
Complaining about the practices of U.S. backbones, he argues that "you
can only have the market upset for a period of time before they start
looking for ways to avoid the pain." As a result, "alternative solutions
will emerge which will leave those currently acting monopolistically
with a diminishing market share."[^156] As discussed earlier in this
paper, it is exactly the presence of alternatives for backbones seeking
interconnection that prevents monopolistic actions by other backbones.
To the extent that the carriers outside the United States find
alternatives to the U.S. backbones, these U.S. backbones are likely to
respond to this reduced demand by providing cost-sharing arrangements
that the non-U.S. carriers find acceptable. Such competitive pressures
and responses are the hallmark of competition in the Internet industry
and make any international regulation for Internet interconnection
unnecessary.

# Conclusion

In the past several years, a number of Internet backbones, in the United
States and abroad, have questioned whether the commercial
interconnection negotiations between backbone providers can yield fair
outcomes for all parties. In addition, backbones may attempt in the
future to differentiate themselves from their competitors by not
interconnecting to provide certain new services. As a result, there may
increasingly be calls to impose domestic and/or international
interconnection obligations on Internet backbone providers. The paper
shows how the market outcomes of a competitive Internet backbone market
can differ from the network industries characterized by market power
that historically warranted interconnection regulations. In addition,
antitrust and competition protections can prevent any anti-competitive
consolidation among Internet backbone providers. In sum, this paper
argues that any traditional telecommunications regulation of Internet
backbone interconnection is made unnecessary by a competitive backbone
market, a conclusion that is consistent with section 230 of the 1996
Act.[^157] The paper recognizes that future circumstances may arise that
lead parties to renew calls to impose industry-specific regulations on
the Internet backbone market, and argues that these parties bear the
burden of identifying the anti-competitive harms that would be remedied,
as well as identifying the best means for resolving these harms.

[]{#__RefHeading___Toc494542153 .anchor}Figure 1: Peering

![](media/image1.wmf){width="5.051388888888889in"
height="3.5104166666666665in"}

[]{#_Ref466343214 .anchor}

Figure 2: Network Access Point

![](media/image2.wmf){width="5.0472222222222225in"
height="3.5118055555555556in"}

[]{#__RefHeading___Toc494542155 .anchor}Figure 3: Private Peering

![](media/image3.wmf){width="5.0472222222222225in"
height="3.5118055555555556in"}

[]{#__RefHeading___Toc494542156 .anchor}Figure 4: Transit

![](media/image4.wmf){width="5.052777777777778in"
height="3.511111111111111in"}

[]{#__RefHeading___Toc494542157 .anchor}Figure 5: Hot-Potato Routing

![](media/image5.wmf){width="8.675in" height="5.872222222222222in"}

[]{#__RefHeading___Toc494542158 .anchor}Figure 6: Example of Free Riding

![](media/image6.wmf){width="8.675in" height="5.861111111111111in"}

[]{#__RefHeading___Toc494542159 .anchor}Figure 7: Number of National
Internet Backbone Providers

![](media/image7.wmf){width="5.920833333333333in"
height="2.8097222222222222in"}

Source: Boardwatch Magazine's Directory of Internet Service Providers

[]{#__RefHeading___Toc494542160 .anchor}Figure 8: Number of Internet
Service Providers

![](media/image8.wmf){width="5.922916666666667in"
height="2.810416666666667in"}

Source: Boardwatch Magazine's Directory of Internet Service Providers

[]{#__RefHeading___Toc494542161 .anchor}Figure 9: Number of Devices
Accessing the World Wide Web[^158]

![](media/image9.wmf){width="5.929861111111111in"
height="3.236111111111111in"}

Source: International Data Corporation's *Internet Commerce Market
Model,* version 5.1, March 1999.

[]{#__RefHeading___Toc494542162 .anchor}Figure 10: Number of World Wide
Web pages[^159]

![](media/image10.wmf){width="5.929861111111111in"
height="2.8090277777777777in"}

Source: International Data Corporation's *Internet Commerce Market
Model,* version 5.1, March 1999.

[]{#__RefHeading___Toc494542163 .anchor}Figure 11: Fiber System Route
Miles

![](media/image11.wmf){width="5.927777777777778in"
height="2.9451388888888888in"}

Source: FCC Fiber Deployment Update (1998) and Company Estimates

\*The FCC Fiber Deployment Update reports MCI's fiber separately from
WorldCom's.

[]{#__RefHeading___Toc494542164 .anchor}Figure 12: Number of Users
Online Worldwide

![](media/image12.wmf){width="5.923611111111111in"
height="2.8756944444444446in"}

Source: IDC, Merrill Lynch

[^1]: ^^ An earlier version of this paper was presented at the 27^th^
    annual Telecommunications Policy Research Conference in Alexandria,
    VA on September 27, 1999, and I am indebted to Jason Oxman, of Covad
    Communications, for his contribution to that version prior to
    leaving the Commission. I would also like to thank Robert Pepper,
    Thomas Krattenmaker, Dale Hatfield, Stagg Newman, David Farber, Doug
    Sicker, Gerald Faulhaber, Howard Shelanski, Donald Stockdale, Robert
    Cannon, Rebecca Arbogast, Jackie Ruff, Helen Domenici, Dorothy
    Attwood, Michelle Carey, Johanna Mikes, Jennifer Fabian, John
    Berresford, and Christopher Libertelli for their comments and
    thoughts on this paper. The views expressed in this paper are those
    of the author, and do not necessarily represent the views of the
    Federal Communications Commission, the Chairman, any Commissioners,
    or other staff.

[^2]: For purposes of this paper, industry-specific regulations are
    defined to be rules, applied by an expert agency, that govern the
    behavior of companies in a particular industry. These regulations
    supplement the antitrust laws and ordinary common law rules that
    apply to all industries in the United States. In general,
    industry-specific regulations correct for market failures that
    antitrust laws and ordinary common laws cannot resolve or prevent.
    In this paper, an "unregulated" industry is one that is not subject
    to any industry-specific regulations.

[^3]: For further discussion of the structure of the Internet, *see*
    Kevin Werbach, "Digital Tornado: the Internet and Telecommunications
    Policy" (OPP Working Paper Series No. 29, 1997)(Digital Tornado) at
    10-12. *See also* Jean-Jacques Laffont and Jean Tirole, *Competition
    in Telecommunications* (MIT Press, 2000) at 268-272*;* J. Scott
    Marcus, *Designing Wide Area Networks and Internetworks: A Practical
    Guide*, (Addison Wesley Longman, 1999)(*Designing Wide Area
    Networks*) at 274-289.

[^4]: A leased line is an access line rented for the exclusive use of
    the customer; with dedicated access to an ISP, the customer can be
    logged on to the Internet twenty-four hours a day. New broadband
    access technologies, such as xDSL and cable modems, are increasingly
    replacing traditional dial-up modems, enabling residential and small
    business customers to receive the same high-speed "always-on" access
    to the Internet enjoyed by dedicated access customers.

[^5]: *See* Michael L. Katz and Carl Shapiro, "Systems Competition and
    Network Effects," *Journal of Economic Perspectives*, Vol. 8, No. 2,
    Spring 1994, at 93-115; Nicholas Economides, "The Economics of
    Networks," *International Journal of Industrial Organization*, Vol.
    14, No. 2, March 1996.

[^6]: Metcalfe's law, which states that the value of a network grows in
    proportion to the square of the number of users of the network, is a
    specific expression of network externalities. *See* Harry Newton,
    *Newton's Telecom Dictionary* (Flatiron Publishing, (14^th^ ed.),
    1998)( *Newton's*) at 447-448.

[^7]: *See* Michael L. Katz and Carl Shapiro, "Network Externalities,
    Competition, and Compatibility," *American Economic Review*, Vol.
    75, June 1985 ("Network Externalities") at 424-440.

[^8]: *See* Jeffrey Church and Neil Gandal, "Network Effects, Software
    Provision, and Standardization," *Journal of Industrial Economics*,
    Vol. 40, March 1992, at 85-104.

[^9]: For an empirical description of the interplay between compact disc
    hardware sales and the availability of compact discs, *see* Neil
    Gandal, Michael Kende, and Rafael Rob, "The Dynamics of
    Technological Adoption in Hardware/Software Systems: The Case of
    Compact Disc Players," *Rand Journal of Economics*, Vol. 31, No. 1,
    Spring 2000, at 43-61.

[^10]: *See* Werbach, "Digital Tornado" at 13-16 for a brief history of
    the Internet. *See also* Robert H'obbes' Zakon, Hobbes' Internet
    Timeline v4.1,"
    <http://www.isoc.org/guest/zakon/Internet/History/HIT.html>.

[^11]: A T-1 network carries 1.544 megabits of data per second (Mbps).

[^12]: *See* Janet Abbate, *Inventing the Internet*, (MIT Press, 1999)
    at 191-200.

[^13]: For a discussion of the FCC's role in the Internet, *see* Jason
    Oxman, "The FCC and the Unregulation of the Internet," (OPP Working
    Paper Series No. 31, 1999)(Unregulation of the Internet).

[^14]: *See, e.g.,* Intermedia Communications "Peering White Paper,"
    1998, [http://www.intermedia.com](http://www.intermedia.com/)
    (Intermedia White Paper) at n.1, for a definition of peering.

[^15]: This is similar to bill-and-keep or sender-keeps-all
    arrangements. *See infra* n. Error: Reference source not found.

[^16]: *See* J. Scott Marcus*, Designing Wide Area Networks*, at
    283-285.

[^17]: Intermedia White Paper at 2.

[^18]: *See* J. Scott Marcus, *Designing Wide Area Networks*, at
    280-282.

[^19]: Private peering may take place in the same physical location as
    the NAP. If two carriers wishing to peer privately already have
    transport going to a NAP, they may simply bypass the NAP's switches
    and interconnect directly at the same location.

[^20]: For instance, Intermedia states that its "dual peering policy,"
    combining open public peering with private peering, "will create a
    win-win solution for everyone and a better management approach to
    the Internet." Intermedia White Paper at 3.

[^21]: Prior to the establishment of a NAP in Rome, for example,
    backbones often exchanged domestic Italian Internet traffic in the
    United States. Sam Paltridge, Working Party on Telecommunication and
    Information Services Policies, "Internet Traffic Exchange:
    Developments and Policy," OECD, 1998 (OECD Report) at 22-23.

[^22]: Michael Gaddis, chief technical officer of SAVVIS Communications,
    gave this estimate. Randy Barrett, "ISP Survival Guide,"
    <inter@ctive> week online, December 7, 1998.

[^23]: ATM is a "high bandwidth, low-delay, connection oriented,
    packet-like switching and multiplexing technique." *Newton's* at
    67-69.

[^24]: *See* J. Scott Marcus, *Designing Wide Area Networks*, at 278.
    Marcus states that "\[I\]n 1998, MCI WorldCom upgraded its MAE
    facilities ... to offer modern ATM switches as a high-capacity
    alternative to the FDDI/gigaswitch architecture." *See also* Letter
    from Attorneys for MCI WorldCom and Sprint to Magalie Roman Salas,
    Secretary, FCC, Attach. at 20-21 (filed January 14, 2000 in CC
    Docket No. 99-333, *Application for Consent to the Transfer of
    Control of Licenses from Sprint Corporation to MCI WorldCom,
    Inc.*)(MCI WorldCom Sprint Jan. 14, 2000, *Ex Parte*)("In short, the
    deployment of ATM switches has expanded the capability of NAPs to
    handle the demand for public peering by increasing the number of
    ports as well as the capacity available at NAPs.")

[^25]: MCI WorldCom Sprint Jan. 14, 2000, *Ex Parte*, Attach at 20, n.
    48.

[^26]: J. Scott Marcus, *Designing Wide Area Networks*, at 280. Marcus
    is the Chief Technology Officer of Genuity. Genuity was formerly GTE
    Internetworking. In order to comply with Section 271 of the
    Telecommunications Act of 1996, and thereby obtain Commission
    approval to merge with Bell Atlantic, GTE agreed to sell most of its
    equity in Genuity to the public through an initial public offering.
    "Bell Atlantic and GTE Chairmen Praise FCC Merger Approval," GTE
    Press Release, June 16, 2000. In addition, according to Marcus,
    "somewhere between six and perhaps thirty other ISPs could also be
    viewed as backbone ISPs." *Id.* Marcus states that "the ability to
    reach all Internet destinations without the need for a transit
    relationship ... is a strong indicator that an ISP should be viewed
    as a backbone ISP." *Id.* at 279. This is similar to the definition
    used in this paper of a top-tier backbone.

[^27]: In a bill-and-keep or sender-keep-all arrangement, each carrier
    bills its own customers for the origination of traffic and does not
    pay the other carrier for terminating this traffic. In a settlement
    arrangement, on the other hand, the carrier on which the traffic
    originates pays the other carrier to terminate the traffic. If
    traffic flows between the two networks are balanced, the net
    settlement that each pays is zero, and therefore a bill-and-keep
    arrangement may be preferred because the networks do not have to
    incur costs to measure and track traffic or to develop billing
    systems. As an example, the Telecommunications Act of 1996 allows
    for incumbent local exchange carriers to exchange traffic with
    competitors using a bill-and-keep arrangement. 47 U.S.C. § 252
    (d)(2)(B)(i). *See also infra* at n. Error: Reference source not
    found.

[^28]: *See infra* at Section IV, International Interconnection Issues.

[^29]: Geoff Huston, "Interconnection, Peering and Settlements," January
    1999, <http://www.telstra.net/gih/peerdocs/peer.html> at 3-4. *See
    also* J. Scott Marcus, *Designing Wide Area Networks* at 279. ("Over
    time, it came to be recognized that peers need not be similar in
    size; rather, what was important was that there be comparable value
    in the traffic exchanged.").

[^30]: "A New FCC for the 21^st^ Century," *Draft Strategic Plan*
    (August 1999), <http://www.fcc.gov/21st_century>, at 3.

[^31]: *See e.g.* Jason Oxman, "Unregulation of the Internet."

[^32]: *See also* Gerald R. Brock, *Telecommunications Policy for the
    Information Age: from Monopoly to Competition* (Harvard University
    Press, 1994)(*Telecommunications Policy*); Ingo Vogelsang and
    Bridger M. Mitchell, *Telecommunications Competition: The Last Ten
    Miles* (The MIT Press and The AEI Press, 1997)(*Telecommunications
    Competition*).

[^33]: Economies of scale arise when the cost per unit of providing
    service decreases as output increases. In wireline telephony there
    are enormous economies of scale resulting from the network of copper
    loops that serve homes and businesses. The cost of having one
    company serve a particular area was historically much lower than
    having two or more companies with partial or full overbuilds of each
    other's networks. Lately, new technologies have altered the
    traditional cost structures in a number of network industries such
    as telephony, which enabled the pro-competitive, deregulatory
    provisions of the Telecommunications Act of 1996.

[^34]: *See* Robert S. Pindyck and Daniel L. Rubinfeld,
    *Microeconomics*, (Prentice Hall, 4^th^ ed. 1998) at 352-358.

[^35]: For instance, local wireline services are necessary inputs in the
    provision of wireless and long distance services; a carrier with
    market power over local services could leverage this market power
    into these related markets.

[^36]: In the United States, two agencies have overlapping jurisdiction
    to enforce federal antitrust policy \-- the Federal Trade Commission
    (FTC) and the Department of Justice (DOJ). In telecommunications,
    the Federal Communications Commission, the federal agency charged
    with regulating interstate communications by wire and radio, has
    authority pursuant to the Communications Act to determine whether
    transactions involving the transfer of certain licenses or
    authorizations serve the public interest. *See Applications of
    Ameritech Corp., Transferor, and SBC Communications Inc.,
    Transferee, For Consent to Transfer Control of Corporations Holding
    Commission Licenses and Lines Pursuant to Sections 214 and 310(d) of
    the Communications Act and Parts 5, 22, 24, 25, 63, 90, 95 and 101
    of the Commission's Rules*, CC Docket No. 98-141, Memorandum Opinion
    and Order, (rel. Oct. 8, 1999) at paras. 46-54. The Commission also
    shares concurrent antitrust jurisdiction with DOJ under the Clayton
    Act to review mergers between common carriers. *Id.* at para. 53.

[^37]: *See Western Union Tel. Co. v. Call Publishing Co.*, 181 U.S. 92,
    99-104 (1901).

[^38]: Mann-Elkins Act, Pub. L. No. 61-218, 36 Stat. 539 (1910).

[^39]: *See* Vogelsang and Mitchell, *Telecommunications Competition*,
    at 64.

[^40]: The Communications Act of 1934, the Federal Communication
    Commission's enabling statute, created the Commission "for the
    purpose of regulating interstate and foreign commerce in
    communication by wire and radio \..." and established "the public
    interest, convenience, and necessity" as the principles that guide
    Commission decisionmaking. The Communications Act defines a common
    carrier as "any person engaged as a common carrier for hire." 47
    U.S.C. § 153(h).

[^41]: In exchange, there is protection from certain types of liability.
    *See, e.g.,* *Richman Bros. Records v. FCC*, 124 F.3d 1302 (D.C.
    Cir. 1997).

[^42]: *See, e.g.,* *Policy and Rules Concerning Rates for Competitive
    Common Carrier Services and Facilities Authorizations Therefor,*
    First Report and Order, 85 FCC 2d 1 (1980) ("Application of current
    regulatory procedures to non-dominant carriers imposes unnecessary
    and counterproductive regulatory constraints upon a marketplace that
    can satisfy consumer demand without government intervention."). *See
    also* *Motion of AT&T Corp. to be Reclassified as a Non-dominant
    Carrier*, Order, 11 FCC Rcd 3271 (1995) (determining that AT&T
    should be declared non dominant).

[^43]: *See* *United States v. American Tel. & Tel. Co.*, 552 F. Supp.
    131 (D.D.C. 1982). *See also* Vogelsang and Mitchell,
    *Telecommunications Competition,* at 67-69; Brock,
    *Telecommunications Policy for the Information Age,* at Chpt. 9.

[^44]: The 1996 Act provides for three types of competition:
    facilities-based competition, competition using network elements
    unbundled (leased) from the incumbent at cost-based rates, and
    competition reselling the incumbent's service. To ensure that the
    customers of the competitors remain plugged into the network,
    section 251 of the 1996 Act requires that incumbent LECs offer
    nondiscriminatory interconnection terms and conditions to
    competitors. *See* 47 U.S.C. § 251. Absent such a requirement,
    incumbents would be able to deny competitors access to their
    monopoly networks.

[^45]: Upon a showing that local markets are open to competition, the
    RBOCs are granted authority to enter the market for long distance
    services, pursuant to section 271 of the 1996 Act. 47 U.S.C. § 271.

[^46]: *First Computer Inquiry*, 7 FCC 2d 11, para. 1.

[^47]: *First Computer Inquiry*, Tentative Decision, 28 FCC 2d at para.
    18.

[^48]: *First Computer Inquiry*, Final Decision and Order, 28 FCC 2d at
    7.

[^49]: The 1996 Act introduced new provisions referring to
    "telecommunications service" and "information service." For
    definitions of these services, *see* 47. U.S.C. § 153(46) and
    153(20), respectively. The Commission has concluded that these
    definitions correspond to the categories of basic and enhanced
    services, respectively. For a general discussion, *see In the Matter
    of Federal-State Joint Board on Universal Service*, CC Docket No.
    96-45, Report to Congress, 13 FCC Rcd 11501 (1998).

[^50]: Basic services are defined as a common carrier offering of a pure
    "transmission capacity for the movement of information." *Amendment
    of Section 64.702 of the Commission's Rules and Regulations (Second
    Computer Inquiry)*, 77 FCC 2d 384, 419 (1980) (*Computer II Final
    Decision*).

[^51]: 47 C.F.R. § 64.702(a).

[^52]: The analysis contained in this paper is based solely on publicly
    available information. As in most markets, information about
    Internet backbone prices and costs is proprietary. In addition,
    information about the nature of relationships between Internet
    backbone providers is protected by non-disclosure agreements. The
    effects of these non-disclosure agreements on this analysis are
    described below.

[^53]: In 1999, *Boardwatch* actually listed forty-three national
    backbones, however, for purposes of this paper we count as one
    backbone the two backbones listed as owned by MCI WorldCom \--
    Advanced Networks and UUNET. In addition, *Boardwatch* does not
    include in its list five other national backbones, Williams
    Communications, Bell Canada/Bell Nexxia, Network Two, ITC DeltaCom,
    and RoadRunner, because these backbones would not release their
    prices. For consistency with *Boardwatch*'s previous lists, these
    backbones are not accounted for here. *Boardwatch Magazine's
    Directory of Internet Service Providers*, 11^th^ ed., 1999, at 5.

[^54]: *Boardwatch Magazine Directory of Internet Service Providers*,
    Vol. 2, Fall 1997, at 27.

[^55]: *See supra* at n. Error: Reference source not found.

[^56]: *See* *Boardwatch Magazine's Directory of Internet Service
    Providers*, 11^th^ ed., 1999, for a complete list and description of
    national backbone providers.

[^57]: *See United States of America v. WorldCom, Inc. and Sprint
    Corporation*, Complaint (DOJ WorldCom Sprint Complaint), June 27,
    2000, p. 6.

[^58]: *Id.* at pp. 4-5.

[^59]: *See supra at* n. Error: Reference source not found.

[^60]: *See infra at* n. *Error: Reference source not found*.

[^61]: IXC Communications merged with Cincinnati Bell to become
    Broadwing Inc.

[^62]: "With Series of Deals, PSINet seeks to become 'Super Carrier',"
    *Communications Daily*, Oct. 20, 1999.

[^63]: Furthermore, "\[it\] is the policy of the United States to
    preserve the vibrant and competitive free market that presently
    exists for the Internet...." 47 U.S.C. § 230 (a)(4), (b)(2).

[^64]: Jack Rickard, "Yet another unique moment in time. Peering redux
    -- back to the future and the essentials of a competitive Internet,"
    Editor's Notes, May 1998, *Boardwatch Magazine*.

[^65]: For instance, Level 3's Chairman, James Crowe, claimed that MCI
    and WorldCom's refusal to peer with Level 3 constituted
    "monopolistic behavior." Joan Engebretson, "Level 3: Whiner or
    Visionary," *Telephony Magazine*, May 25, 1998 at 7. *See also* John
    J. Keller, "Level 3 Assails the WorldCom-MCI Deal," *The Wall Street
    Journal*, May 20, 1998, at B10.

[^66]: Because interconnection agreements are generally confidential due
    to the widespread use of non-disclosure agreements, it is not
    commonly known whether this attempt was successful. *See id.*

[^67]: Kate Gerwig, "Service Providers Still in Peering Dither,"
    *InternetWeek*, August 27, 1998,
    <http://www.internetwk.com/news0898/news082798-2.htm>. Martin Kady
    II, "Peer Pressure: Dissolution of PSINet, Exodus Network-Sharing
    Agreement May be Sign of Things to Come," *Washington Business
    Journal,* June 2-8, 2000 ("Peer Pressure") at 1.

[^68]: *See* *Application of WorldCom, Inc.* *and MCI Communications
    Corporation for Transfer of Control of MCI Communications
    Corporation to WorldCom, Inc.,* CC Docket No. 97-211, Memorandum
    Opinion and Order, 13 FCC Rcd 18025, 18103-18115, paras. 142-156
    (1998)(*MCI/WorldCom Order*). In order to satisfy antitrust concerns
    regarding increased concentration in the Internet backbone market,
    MCI sold its Internet assets to Cable &Wireless. *See* European
    Commission Press Release, "Commission Clears WorldCom and MCI Merger
    Subject to Conditions," July 8, 1998 (European Commission MCI
    WorldCom Press Release); DOJ Press Release, "Justice Department
    Clears WorldCom/MCI Merger After MCI Agrees to Sell its Internet
    Business," July 15, 1998 (DOJ MCI WorldCom Press Release);
    *MCI/WorldCom Order*, 13 FCC Rcd at 18109-18115, paras. 151-156. The
    Federal Communications Commission did conclude, however, that
    "peering is likely to remain an issue that warrants monitoring."
    *Id*. at 18115, para. 155.

[^69]: *See* Letter from Terrence J. Ferguson, Senior Vice President and
    General Counsel, Level 3 Communications, to Magalie Roman Salas,
    Secretary, FCC, Attach. (filed May 29, 1998 in CC Docket No. 97-211,
    *Application of WorldCom, Inc.* *and MCI Communications Corporation
    for Transfer of Control of MCI Communications Corporation to
    WorldCom, Inc*.) (Level 3 May 29 1998, *Ex Parte*).

[^70]: DOJ WorldCom Sprint Complaint, pp. 14-21.

[^71]: Reply Comments of Level 3 Communications, at 11 (filed March 20,
    2000 in CC Docket No. 99-333, *Application for Consent to the
    Transfer of Control of Licenses from Sprint Corporation to MCI
    WorldCom, Inc.*).

[^72]: Martin Kady II, "Peer Pressure," at 3.

[^73]: *See, e.g., Continental T.V., Inc. v. GTE Sylvania Inc.,* 433
    U.S. 36, 59 (1977).

[^74]: Here we focus on reasons to deny peering that have their roots in
    economic considerations. Peering may also be denied for technical
    reasons, as a peer could be exposed to significant harms resulting
    from errors on the part of peering partners. A backbone with little
    technical competence may find willing peering partners scarce for
    technical reasons alone.

[^75]: For instance, UUNET's North American Peering Policy states, among
    other things, that "a peering candidate needs to meet UUNET at
    minimally four geographically diverse locations across the US," with
    a minimum requirement of an East coast location and a West coast
    location, with, "ideally" two Midwest locations. The stated
    intention is "to minimize the backhaul of traffic across both
    networks." Letter from Valerie Yates, counsel, MCI WorldCom, to
    Magalie R. Salas, Secretary, FCC, Attach., (filed April 13, 2000 in
    CC Docket No. 99-333, *Application for Consent to the Transfer of
    Control of Licenses from Sprint Corporation to MCI WorldCom,
    Inc.*)(UUNET Peering Policy). Sprint's Bi-Lateral Peering Policy
    contains a similar provision, that peering partners must be able to
    support peering arrangements "at 4 geographically diverse domestic
    U.S. locations." Letter from Michael G. Jones, counsel, Sprint, to
    Magalie R. Salas, Secretary, FCC, Attach., (filed April 13, 2000 in
    CC Docket No. 99-333, *Application for Consent to the Transfer of
    Control of Licenses from Sprint Corporation to MCI WorldCom,
    Inc.*)(Sprint Peering Policy). Finally, Genuity recently published
    its Internet Interconnect Guidelines. Genuity Press Release,
    "Genuity Announces Public Posting of Interconnect Guidelines,"
    September 8, 2000. One of the criteria for public peering with
    Genuity is a presence at three or more Shared Interconnection Points
    (NAPs) where Genuity has a presence, two of which must be MAE-East
    and MAE-West. "Internet Interconnection Guidelines for Genuity,"
    <http://www.genuity.com/infrastructure/interconnection.htm> (Genuity
    Interconnection Guidelines).

[^76]: At the time, the president and CEO of UUNET, John Sidgmore,
    argued that "a few years ago all ISPs were generally the same size
    and used each other's infrastructures to a more or less equal
    extent... that situation no longer exists and consequently there are
    many cases where peering is not appropriate." UUNET Press Release,
    "UUNET Details Peering Strategy," May 12, 1997,
    <http://www.us.uu.net/press/1997/peering.shtml> (UUNET May 12, 1997
    Press Release).

[^77]: UUNET, for one, argues that companies that provide "web server
    farm" services and request peering with UUNET are "seeking to use
    UUNET's network for free, after UUNET has spent hundreds of millions
    of dollars to create its infrastructure." *Id.*

[^78]: John Curran, then Chief Technical Officer of GTE Internetworking,
    was quoted as saying that the traffic exchange with Exodus was
    "'wildly asymmetrical,'" and that as a result Exodus was getting a
    free ride from GTE Internetworking. Genuity now specifically states
    in its Internet Interconnection Guidelines that one of the criteria
    for traffic exchange with Genuity is, "\[f\]or domestic ISPs,
    roughly balanced traffic." Genuity Interconnection Guidelines. Kate
    Gerwig, "Service Providers." Similarly, Bob Leahy, Vice President of
    Marketing for PSINet, stated of Exodus that "\[w\]e were tired of
    carrying their load. They are a pure hosting play. What makes them
    meritorious to get free peering?" Martin Kady II, "Peer Pressure."

[^79]: UUNET expects a peering candidate "to exchange at least 40
    Megabits of traffic total average utilization." UUNET Peering
    Policy. Sprint's peering policy has a provision that the "average
    monthly traffic exchange between Sprint and the peering network must
    be justifiable." Sprint Peering Policy. One of the criteria for
    traffic exchange with Genuity is a "minimum Internet traffic
    exchange of 1 Mbps with Autonomous System 1." Genuity
    Interconnection Guidelines.

[^80]: Joan Engebretson, "Level 3: Whiner or Visionary?"

[^81]: *See*, *e.g.*, Rob Frieden, "Without Public Peer: The Potential
    Regulatory and Universal Service Consequences of Internet
    Balkanization," *Virginia Journal of Law and Technology*, Fall 1998,
    Vol. 3, No. 8, ("Without Public Peer") at 1522-1687, para. 16.

[^82]: UUNET May 12, 1997 Press Release. A T-1 connection is a digital
    transmission link with a capacity of 1.544 Mbps. A fractional T-3
    connection is a portion of a T-3 (44.7364 Mbps) digital transmission
    link. Letter from Terrence J. Ferguson, Senior Vice President and
    General Counsel, Level 3 Communications, to Michelle Carey, Common
    Carrier Bureau, FCC, (filed August 7, 1998 in CC Docket No. 97-211,
    *Application of WorldCom, Inc.* *and MCI Communications Corporation
    for Transfer of Control of MCI Communications Corporation to
    WorldCom, Inc*.) (Level 3 Aug. 7 1998, *Ex Parte*), Attach. at 4.

[^83]: Level 3 May 29 1998, *Ex Parte* at 4.

[^84]: DOJ WorldCom Sprint Complaint at 13.

[^85]: Doug Mohney, "SAVVIS Shifts Gears and Ownership," *Boardwatch*,
    April 1999.
    \<<http://boardwatch.internet.com/mag/99/apr/bwm66.html>\>. In 1997,
    SAVVIS Internet was rated the highest quality backbone provider by
    Keynote Systems. Jack Rickard, Editor's Notes, *Boardwatch
    Magazine*, May 1998. At the time, SAVVIS created private NAPs,
    bought transit from the largest backbones, and didn't peer at all,
    though Rickard notes that this is expensive.

[^86]: Martin Kady II, "Peer Pressure," at 3, quoting Bobby Patrick,
    Vice President of Strategy at Digex.

[^87]: The issue of backbone consolidation during the MCI/WorldCom
    merger proceeding was resolved when MCI divested its Internet
    business to Cable & Wireless. *See supra* at *n.* Error: Reference
    source not found. Later, as a result of the backbone consolidation,
    as well as other concerns, both the European Commission and the
    Department of Justice acted to block the MCI WorldCom/Sprint merger.
    *See* "Justice Department Sues to Block WorldCom's Acquisition of
    Sprint," Department of Justice Press Release, June 27, 2000;
    "Commission prohibits merger between MCI WorldCom and Sprint,"
    European Commission Press Release, June 28, 2000 (European
    Commission WorldCom Sprint Press Release).

[^88]: *MCI/WorldCom Order*, 13 FCC Rcd at paras. 149-150. Similar
    issues were raised by the Department of Justice in the course of the
    MCI WorldCom Sprint proceeding. *See* DOJ WorldCom Sprint Complaint
    at n. Error: Reference source not found.

[^89]: Katz and Shapiro, "Network Externalities;" Jacques Cremer,
    Patrick Rey, and Jean Tirole, "Connectivity in the Commercial
    Internet," May 1999, mimeo ("Connectivity").

[^90]: *See* 47 U.S.C. § 251.

[^91]: *See* Cremer, Rey, and Tirole, "Connectivity." These authors
    advised GTE on the non-price discrimination issue during the MCI
    WorldCom proceeding, and formalized their analysis in that paper.

[^92]: GTE and its experts note that in a situation in which there is no
    dominant backbone, there would be no incentive for any backbone to
    attempt a serial degradation strategy in order to become dominant.
    *Id*., Section 6.

[^93]: *See MCI/WorldCom Order*, 13 FCC Rcd at paras. 8-14.

[^94]: *See, e.g.*, DOJ WorldCom Sprint Complaint at 9-21.

[^95]: *See supra* at n. *Error: Reference source not found*.

[^96]: *See supra* at n. Error: Reference source not found.

[^97]: *See* Reuters English News Service, "C&W seen urging EU to be
    tough on MCI, Sprint Buy," November 29, 1999. *See also MCI/WorldCom
    Order*, 13 FCC Rcd at 18109-18115, paras. 151-156.

[^98]: *Id.* *See also* European Union MCI/WorldCom Press Release; DOJ
    MCI/WorldCom Press Release.

[^99]: Testimony of Mike McTighe before the United States Senate
    Commerce Committee, Telecommunications mergers hearing, November 8,
    1999. *See also* Denise Pappalardo, "Did Cable & Wireless Get the
    Shaft?", *Network World*, April 5, 1999.

[^100]: "MCI WorldCom and Cable & Wireless Reach Agreement over Internet
    Dispute," Cable & Wireless Press Release, March 1, 2000 ("MCI
    WorldCom has agreed to pay Cable & Wireless \$200 million in full
    and final settlement of the disputes.").

[^101]: In the recent MCI WorldCom/Sprint merger proceeding, the
    European Commission found the merging parties' proposal to divest
    Sprint's Internet business insufficient, concluding that the
    divested business would not "become a strong, viable competitor to
    prevent the merged WorldCom/Sprint from dominating Internet
    backbone." The European Commission noted that it explicitly took
    into account the issues raised by Cable & Wireless after its
    purchase of MCI's Internet assets. European Commission
    WorldCom/Sprint Press Release.

[^102]: *See* Frieden "Without Public Peer." Professor Frieden raises
    issues similar to the ones dealt with in this paper, with a focus on
    the effects of such balkanization on universal access to the
    Internet, notably in rural areas.

[^103]: *See also* Michael Kende and Douglas C. Sicker, "Slice and Dice:
    The Fragmentation of the Internet," Draft Paper, 2000.

[^104]: *See* Douglas C. Sicker, Joshua Mindel, and Cameron Cooper, "The
    Internet Interconnection Conundrum," OPP Working Paper (publication
    pending), 2000.

[^105]: *See* [http://www.uunet.com](http://www.uunet.com/).

[^106]: Settlements are payments from a carrier that originates traffic
    to another carrier for terminating this traffic. A form of
    settlement exists in local and international telephony today. In
    local telephony, the settlement system is known as reciprocal
    compensation. Although reciprocal compensation can take the form of
    bill-and-keep, which is similar to peering, this is seldom the case.
    International settlements are governed by the bilateral accounting
    rate system. A settlement system for the Internet would enable
    backbones to recoup the costs associated with terminating QoS
    traffic that originated on other backbones, giving backbones the
    proper incentive to invest in the capacity necessary to guarantee
    the timely delivery of this traffic. The technical and
    administrative costs of implementing such a system on the Internet
    are formidable, however. *See, e.g.*, Maria Farnon and Scott Huddle,
    "Settlement Systems for the Internet," in Brian Kahin and James H.
    Keller, eds., *Coordinating the Internet* (MIT Press, 1997) at
    377-403.

[^107]: As an example of this phenomenon, in 1910, Louisville, Kentucky
    was served by two local telephone companies \-- the Bell-licensed
    Cumberland Telephone and the independent Home Telephone Company.
    More than 75 percent of the large businesses and 9 percent of homes
    in Louisville subscribed to both services. *See* Milton L. Mueller,
    Jr., *Universal Service: Competition, Interconnection, and Monopoly
    in the Making of the American Telephone System,* (MIT Press and AEI
    Press, 1997) at 83.

[^108]: For instance, the 1913 Kingsbury Commitment, in which AT&T
    agreed to interconnect with independent local firms to provide long
    distance services, was made in response to a threatened antitrust
    suit, rather than calls to enable universal access for customers.
    *See supra* at n. Error: Reference source not found.

[^109]: *See* Adam M. Brandenburger and Barry J. Nalebuff,
    *Co-opetition* (Doubleday, 1996).

[^110]: *See infra at* n. Error: Reference source not found.

[^111]: Transmission Control Protocol (TCP) and Internet Protocol (IP)
    together form a "networking protocol that provides communication
    across interconnected networks, between computers with diverse
    hardware architectures and various operating systems." *Newton's* at
    708.

[^112]: Indeed, some attribute the initial advantage of VHS in the
    United States to the decision by its manufacturer to make tapes long
    enough to record a full American football game.

[^113]: The 1996 Act states that it is the policy of the United States
    to "preserve the vibrant and competitive free market that presently
    exists for interactive computer services, unfettered by Federal or
    State regulation." 47 U.S.C. § 230 (b)(2).

[^114]: It is often argued that in markets with network externalities,
    lack of interconnection or compatibility will lead to "tipping," as
    consumers quickly converge on one standard in order to enjoy the
    benefits of being compatible with the largest possible installed
    base of the product. According to a recent book, "tipping occurs
    when a product subject to increasing returns \[network
    externalities\] generates sufficient momentum in market share that
    its domination of the market becomes inevitable." Stan J. Liebowitz
    and Stephen E. Margolis, *Winners, Losers & Microsoft: Competition
    and Antitrust in High Technology* (The Independent Institute, 1999)
    at 138. After studying a number of software markets in which
    Microsoft participates, the authors conclude that there is no
    evidence of tipping in these markets. *Id*., at 228-229.

[^115]: *See* Henry Ergas and Paul Paterson, "International
    Telecommunications Settlement Arrangements; An Unsustainable
    Inheritance?," *Telecommunications Policy*, February 1991, at 29-41.

[^116]: Countries representing over 90 percent of global
    telecommunications revenues committed to remove barriers to foreign
    participation in domestic telecommunications markets by signing the
    World Trade Organization (WTO) Agreement on Basic Telecommunications
    Services that took effect in 1998. For more information on the WTO
    Agreement on Basic Telecommunications Services, see the WTO Web site
    at <http://www.wto.org/wto/services>.

[^117]: The accounting rate is meant to represent the total cost of
    completing an international call. The originating carrier
    compensates the terminating carrier based on the settlement rate,
    which is usually one half of the accounting rate.

[^118]: For more information on the distinction between public
    telecommunications services and private networks such as the
    Internet, *see* OECD Report at 35-36.

[^119]: *Id. at* 36.

[^120]: *See* J. Scott Marcus*, Designing Wide Area Networks*, at
    285-286.

[^121]: Telstra compares these arrangements with traditional telephony
    arrangements: "\[i\]n contrast, where international telephone
    service is involved, the U.S. and foreign carrier each pay for their
    own half-circuit." Telstra Corporation Comments (filed Feb. 4, 1997
    in IB Docket No. 96-261, *In the Matter of International Settlement
    Rates*)(Telstra ISR Comments) at 3. *See also* Telstra Corporation
    Reply Comments (filed Mar. 31, 1997 in IB Docket No. 96-261, *In the
    Matter of International Settlement Rates*)(Telstra ISR Reply
    Comments) at 4-5; Telstra Corporation Comments (filed Jan. 5, 1998
    in CC Docket No. 97-211, *Applications of WorldCom, Inc. and MCI
    Communications Corporation for Transfer of Control of MCI
    Communications Corporation to WorldCom, Inc*)(Telstra MCI/WorldCom
    Comments) at 8.

[^122]: Telstra ISR Comments at 3.

[^123]: Telstra Press Release, "Why are Australians Paying More than
    They Should for Internet Access to the USA?" November 30, 1999. A
    general disclaimer on Telstra's web site notes that this information
    is no longer current, and is provided for historical purposes only.
    *See* [http://www.telstra.com.au](http://www.telstra.com.au/).

[^124]: Section 201(b) states in part that "all charges, practices,
    classifications, and regulations for and in connection with
    \[interstate or foreign communication by wire or radio\], shall be
    just and reasonable...." U.S.C.

    § 201(b). Telstra MCI/WorldCom Comments at 8.

[^125]: "Statement on the Cost Sharing of the International Internet
    Interconnection Link between the U.S.A. and Asia-Pacific Region,"
    signed by representatives of The Communications Authority of
    Thailand, Chunghwa Telecom (Taiwan), Indonesia Satellite Corp., KDD
    Corp. (Japan), Korea Telecom, Philippines Long Distance Telephone
    Company, Singapore Telecommunications Ltd., and Telekom Malaysia
    Berhad (Jan. 26, 1999)(Asia-Pacific Carrier Letter). *See also*
    Newsbytes News Network, "Asian Carriers Protest High Internet
    Connection Charges," (Jan. 27, 1999)(Newsbytes Jan. 27 Article).

[^126]: Asia-Pacific Carrier Letter at 2.

[^127]: Telstra ISR Comments at 4.

[^128]: *Id.*

[^129]: *The Singapore Declaration* of the Third APEC Ministerial
    Meeting on the Telecommunications and Information Industry, 3-5 June
    1998, Singapore, <http://www.apii.or.kr/telwg/ICAIS/singapore.html>,
    at § 11.c.

[^130]: "A Study of Compatible and Sustainable International Charging
    Arrangements for Internet Services (ICAIS) Terms of Reference",
    <http://www.apii.or.kr/telwg/ICAIS/tor.html>, at § 2.e.

[^131]: U.S. Background Paper, "International Charging Arrangements for
    Internet Services (ICAIS)," submitted to APEC Telecommunications
    Working Group for discussion (Feb. 20, 1999)(U.S. ICAIS Background
    Paper), <http://www.apii.or.kr/telwg/19tel/plenary/plen-g-01.html>.
    *See also* September 1999 Appendix to the U.S. ICAIS Background
    Paper.

[^132]: *Id*.

[^133]: James Savage, Robert Frieden, and Timothy Denton, *ICAIS Module
    3 Final Report,* April 2000 (*ICAIS Module 3*), at 3-4. *See*
    http://www.tmdenton.com.

[^134]: *Id.* at 9.

[^135]: *Id.* at 10.

[^136]: *Id.* at 11.

[^137]: The Fourth APEC Ministerial Meeting of the Telecommunications
    and Information Industry (TELMIN4), *Press Conference.*

[^138]: TELMIN4, *Cancun Declaration*, May 24-26, 2000 at Annex B.

[^139]: *See id.*, Annex A, APEC Telecommunications Working Group (TEL),
    *Programme of Action*, ("the TEL should continue to discuss the
    international development of the Internet, including charging
    arrangements, noting the initial suggestions in the proposals made
    by the ICAIS Task Force that: 1. Where measurement tools are
    available and acceptable, charging arrangements should be based on
    traffic flow patterns for each type of service, taking into account
    which side has generated the traffic. 2. In the absence of efficient
    measurement tools, charging arrangements for international links
    should be based on the ration of inbound to outbound traffic
    flow.").

[^140]: *See* OECD Report at 35-44*.* The Asia Pacific Internet
    Association issued a call for papers on the ICAIS topic. "Calls for
    Papers (CFP) International Internet Infrastructure: Inequities or
    reality, is there a problem with trans-oceanic Internet backbone
    infrastructure financing?" Sept. 24, 1997,
    [http://www.apia.org]{.underline}.

[^141]: Study Group 3, International Telecommunications Union, "Final
    Report for Internet Rapporteurs Group," COM 3-77-E, October 1999, a
    report adopted by the Study Group in December 1999.

[^142]: *See Communications Daily*, "ITU Study Group Recommends
    Settlement Rate System for Internet," April 24, 2000 (April 24 *Comm
    Daily*).

[^143]: Five countries, the United States, Canada, the United Kingdom,
    Holland, and Russia, opposed this recommendation. *Id*.

[^144]: *MCI/WorldCom Order*, 13 FCC Rcd at 18117, para. 159.

[^145]: The same is often true for a telephone call that may lead to a
    transaction that benefits both parties. However, in telephony,
    explicit mechanisms exist for either the calling party or the called
    party to pay for a particular call. In general, the calling party
    pays, but the calling party may place a collect call, which the
    called party can either accept or refuse, or the called party can
    pay in advance for all incoming calls by providing a toll-free 800
    number. These mechanisms do not currently exist on the Internet, and
    therefore a system in which either a sender or receiver of
    information pays for a transmission based solely on net traffic
    flows may not be optimal.

[^146]: *See, e.g.,* Newsbytes Jan. 27 Article. ("The Internet
    infrastructure in Asia at present only allows a small percentage of
    regional traffic to stay within Asia. \[This\] forces much
    \[traffic\] to the United States, which acts as a common
    interconnection point for Asia."). *See also* OECD Report at 37-38.

[^147]: Indeed, according to Peter Coroneos, Executive Director of the
    Internet Industry Association of Australia (IIA), "this bilateral
    pricing arrangement \[applying to voice traffic\] should logically
    also apply to data markets." Newsbytes News Network, "Australian Net
    Industry To Join Asian Net Links Protest," Jan. 29, 1999 (Newsbytes
    Jan. 29 Article). Mr. Coroneos stated that "\[t\]he fact that data
    is not similarly priced \[as voice\] is more of a historical
    accident than a creature of design. If we were to develop a pricing
    model from scratch today, I would be amazed if a degree of
    reciprocity were not provided for, notwithstanding the imbalance in
    bargaining power." *Id.*

[^148]: *See also* OECD Report at 39.

[^149]: *See also* *id.* at 40.

[^150]: Newsbytes Jan. 27 Article.

[^151]: Boardwatch Magazine's Directory of Internet Service Providers,
    11^th^ Edition, 1999, at 130-133. *See also* OECD Report at 40; U.S.
    ICAIS Background Paper at para. 33.

[^152]: *See ICAIS Module 3* at 9, 10.

[^153]: *See also* OECD Report at 40-41; September 1999 Appendix to U.S.
    ICAIS Background Paper ("Alternative peering arrangements between
    ISPs are being developed.").

[^154]: *See also* U.S. ICAIS Background Paper at para. 22; *ICAIS
    Module 3* at 10.

[^155]: *See*
    [http://www.telegeography.com](http://www.telegeography.com/).

[^156]: Newsbytes Jan. 29 Article.

[^157]: *See supra* n. Error: Reference source not found.

[^158]: Data for the United States. Only users accessing the Web at
    least once per month are counted.

[^159]: The total number of Universal Resource Locators (URLs) on the
    Web. A URL is the address of an item, for instance,
    [http://www.fcc.gov/opp/workingp.html]{.underline}.