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[The Economist]

Why the Net should grow up

THE growth of the Internet has been the most astonishing technological phenomenon of the last decade of this century. In 1990 only a few academics had heard of it; now, anything up to 50m people use it. In a year's time, that figure could be 100m--so far, the network's only constant has been that the number of people tapping into it has doubled every 12 months. But up to now, only a handful of companies have made much money from the Internet. If it is to become a commercial success, rather than merely a succès d'estime, it has to change. Otherwise many of the qualities that brought it popularity will become liabilities. ÊÊÊÊÊIncreasingly, the Internet is coming under attack, and from many quarters. The telephone companies, whose networks carry much of its traffic, grumble noisily that Internet users clog their wires and bypass their long-distance rates with cheap Internet telephone calls. Frustrated regulators wail that the Internet has become a way to dodge national laws. Users are driven to distraction by the delays, the muddle and the brainless rubbish. Breakdowns of bits of the Net are hardly new, but when they happen these days a lot more people notice--as when America Online crashed in August, leaving 6m subscribers to twiddle their thumbs. Last week a group of American universities, fed up with the Net's sluggish ways, decided to set up Internet II, a new network that will allow its members to swap data more smoothly. ÊÊÊÊÊFaced with pile-ups and pollution on the prototype information superhighway, governments will be increasingly tempted to intervene. The Net's early colonisers reply that regulation will slow its growth. But is there any alternative?

Did somebody say market? The first and most pressing need is for a better way to price the use of the Internet (see page). At present, many users pay less than the true cost of carrying their messages over the network. Most pay a one-off monthly fee to the firm that offers them a Net connection; and then home users typically have the additional cost of the local telephone call every time that they log on. This system is an invitation to use the network as intensively as possible, even if it causes problems for others. Thanks to the wonders of the World Wide Web, the multimedia part of the Net, people are using the network to transmit telephone calls, film clips and other capacity-guzzling applications. The upshot is that the Net still resembles a congested city street: because users pay only for their car and its fuel, rather than for the inconvenience their presence on the road imposes on others, they have no incentive to limit the use of their car in order to avoid traffic jams. ÊÊÊÊÊCongestion is made worse by the absence of a satisfactory way for firms running the Net to charge for carrying each other's traffic. Sticking to the informal style that was characteristic of the Net's early days, they have tended to use a rough-and-ready barter system. That worked when there were just a handful of firms whose own networks formed the Net, but today there are thousands. Some admit that they now carry as much traffic from freeloaders as from their own customers. When they cannot afford to spend enough to keep up with this demand, they become bottlenecks. ÊÊÊÊÊTo some extent, the market will develop answers for itself. Indeed, to the dismay of the most ardent Internet enthusiasts, companies are increasingly building private Internets either to connect their internal users, or to ensure fast communications with other firms. These private networks will solve other Internet problems: they offer quality-of-service guarantees, and better security against hackers. Geeks will grumble that they risk causing the balkanisation of the Net. Customers will be delighted by the absence of delays. ÊÊÊÊÊThe subsidy from the telephone network is a different matter, and usually reflects political pressures: governments, keen to see competition when it benefits customers, do not much like measures that drive up the cost of a local call. One of the welcome effects of the Internet will be to make political meddling in telephone prices harder to sustain, because inexpensive telephone calls over the Internet will help to undermine excessive margins on long-distance telephone tariffs. Indeed, the interests of surfers and telephone callers are ultimately identical: where competition thrives and regulation does not suppress it, people will communicate through whichever channel is best for their particular needs. ÊÊÊÊÊGovernments can leave the market to sort out the way transmission over the Net is priced. Their proper role is to decide how far to try to regulate the material that passes through it. Many people dislike the way the Net is used by law-breakers to bypass national laws on decency, libel, racism, intellectual property, and so on. Because the Internet whisks content around the world, it is harder to police than a national television channel or a newspaper. ÊÊÊÊÊPolicing, mind you, is not impossible. The government of Myanmar has outlawed the unauthorised possession of networked computers on pain of 15 years in prison. For governments that care a jot for liberty (let alone for the health of their communications-based economies), matters are more complicated. None of the abuses complained of can be stamped out without gross invasion of privacy, any more than people can be prevented from sending racist letters to each other in the ordinary mail or making obscene telephone calls or from pirating home videos. But all can be discouraged more vigorously than most countries have yet done. Governments need to force Internet service providers, many of which will in future be big telephone companies, to take responsibility for what they knowingly carry on their sites. ÊÊÊÊÊThe Internet will always allow the really determined user access to unpleasant or illegal material. The telephone does the same. The important thing is that governments should not treat the Internet differently from other communications media, merely because it is new. The faster the Net grows up, the easier it will be to follow that rule.

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[Special feature] [The Economist]

Too cheap to meter?

The fact that the Internet seems free to many of its users has been one reason for its success. Now it may have to change. But how?

READ about the Internet, and thrill to the notion of a world wired at the speed of light, with all the information anyone could want just a mouse-click away. But actually use the cursed thing, and a more prosaic picture quickly emerges. Delay, break-downs and glacial transmissions are part of everyday Internet life. New users are amazed: surely this tepid data trickle is not the fabled "information superhighway"? Veterans shake their head wearily: the Internet has always been swamped, and as long at it doubles in size each year, it seems likely always to remain so. ÊÊÊÊÊTrue? That question--whether the Internet can grow out of stumbling adolescence and become as delay-free and reliable as the telephone network--ultimately comes down to one of economics. Today's Internet works with a financial model that has hardly changed from the days, a decade ago, when the network was a non-commercial communications link for universities and research labs. Multi-million dollar networks still trade data on the barter principle, or the roughest approximations of real cost. Not surprisingly, these intersections between networks are usually where the traffic backs up (see map). ÊÊÊÊÊBypassing these bottlenecks is not as easy as it might seem. The Internet is made up of many networks, operated by many different firms. Customers can pay a fortune for "industrial strength", rather than "student strength" service, but that service only lasts as far as the firm's network reaches. Sooner or later, Web surfers find themselves in some congested backwater, where no amount of money can make a swamped Web server serve: the Internet treats all transmissions alike, whatever their price. ÊÊÊÊÊNo wonder, then, that more and more users are simply bypassing the public Internet. Companies are setting up private "intranets" within single locations and "extranets" with branches and partners. A group of American research universities plan to build "Internet II", dedicated to academic traffic and free of commercial users, much as the Internet itself was just a few years ago. This month, President Clinton promised to seek $500m over five years to help them. ÊÊÊÊÊBuilding a second Internet (and many smaller rivals) might seem an expensive alternative to simply eliminating the economic failings of the first. But the question of how--or whether--the Internet's economic model should be changed is difficult. One of the reasons the Internet has been able to grow so quickly is that its builder avoided the complex accounting and time-and-distance charging of the telephone networks. Yet now that the Internet is carrying as much traffic as the voice networks over some routes, some charging by use is already taking place (when traffic was not so heavy, the approximations of flat-fee charges and bartering were good enough; now they can be expensive mistakes). ÊÊÊÊÊSo which model is best? Or, more fundamentally, what should it cost to communicate? At present, the answer depends on how you do it. Pick up the telephone, and you pay by the mile and the minute. Send a message across the Internet to the same destination (or use special software to make an Internet telephone call) and--even though the message will travel across the same lines--you pay, at most, the price of a local telephone call. ÊÊÊÊÊIn part the cheapness is because the Internet sends messages more efficiently than local telephone networks: it breaks them down into small digital "packets" that can then be slotted in with other packets travelling over the same network. By contrast, a telephone call requires a whole electronic circuit to itself for the duration of the call. ÊÊÊÊÊBut in long distance and international transmissions, the technology is similar: both voice and data are sent as a digital stream along fibre-optic cable. Indeed, nearly all of the Internet runs along lines leased from the telephone companies. ÊÊÊÊÊBoth telephone companies and the myriad firms that run the Internet therefore have a similar pattern of costs: their big expense comes in installing switches (or "routers") and providing lines. The cost of carrying one extra item is as near to zero as makes no difference--"too cheap to meter", as some would have it. ÊÊÊÊÊ But if the costs of the telephone companies and the Internet are similar, why are their methods of pricing different? The answer is that telecoms charges bear little relation to costs. The telephone industry is regulated nearly everywhere and in most countries prices are set by bureaucrats and commissions; real costs are hidden by a layer of cross subsidies. The Internet, on the other hand, is essentially unregulated. ÊÊÊÊÊ ÊÊÊÊÊ At present, telephone companies typically make less than half their revenue from fixed charges rather than from the price of each call. Tim Kelly, of the International Telecommunication Union in Geneva, reckons that the share of revenue from connection charges and monthly rentals has risen in the past decade from about 33% to 40%; he expects an increase to around 60% over the next ten years. ÊÊÊÊÊThe companies are not keen on such "rebalancing", since it usually involves reducing lucrative call charges rather than increasing fixed charges. But without it, they are vulnerable to competition, including competition from the Internet, which can offer rival services far less expensively. ÊÊÊÊÊThe competition, however, may have its silver lining: the Internet encourages telephone use, and in most countries this is charged by the second for local calls--including the ones, sometimes lasting for hours, made by the net-surfers. Add to that the income from installing extra lines, ordered by a surfer's frustrated relations in their desire to make ordinary telephone calls. Add lastly the prospect that the telephone companies will start offering services in competition with the Internet-- once the Internet has tested the prices consumers are willing to pay. ÊÊÊÊÊWhat seems reasonably certain, however, is that the impact of the Internet and the spreading deregulation of the telecoms industry will bring prices closer to real costs. The telephone companies will have the biggest pricing adjustment to make. But the Internet too may have to change--perhaps by moving closer to the method of the telephone companies, namely a mix of fixed tariffs and ones based on usage. Economists such as Hal Varian, from the University of California at Berkeley, and Jeff Mackie-Mason, of Michigan University, fret that the present structure of Internet pricing does not reflect its "social costs".

World Wide Wait Those are not, as you might think, the conversation-deadening impact of hours spent surfing, but the congestion that periodically occurs on the network. My Internet video call may hold up your electronic mail, imposing a cost on you that I do not notice. Use-based pricing, they argue, is essential to encourage the rational allocation of scarce transmission capacity. ÊÊÊÊÊThe dangers of congestion have undoubtedly increased in the past year or two, as the Internet has moved from being a government-financed playground for academics to a cornucopia of entertainment, commerce and information. As a result the use of the Internet is growing faster than the number of subscribers: traffic through one of the main connection points has been doubling every six months, says Tony Rutkowski, once head of the Internet Society and now with General Magic, a software firm, while the number of subscribers is doubling only every year. ÊÊÊÊÊMoreover, the Internet is no longer being used almost exclusively to send text. Instead, thanks partly to the development of the World Wide Web, people can listen to music, make telephone calls and look at film clips. These uses, which are the ones growing most quickly, gobble up far more capacity than text: to send 15 seconds of high quality video munches as much bandwidth as the text of a 700-page book. ÊÊÊÊÊA second change means that the costs of congestion are becoming higher. It may not matter if some parts of an electronic letter take a second or two longer than the others to reach their destination. But more and more of the material sent over the Internet needs to arrive immediately to be effective. If some of the bits that make up a video call or a telephone conversation are held up en route, the results are jerky and garbled. ÊÊÊÊÊDo these congestion-driven arguments imply the need for new settlement mechanisms? In the case of telephone companies, a system exists so that the company with which a call starts--which bills the caller-- can hand some of the proceeds to the company through which the call ends. ÊÊÊÊÊSuch settlements are a source of endless argument: America's long-distance carriers complain that local telephone companies overcharge them. Moreover, they transfer huge sums of money between countries: in 1994, carriers based in the United States handed over a net $4.3 billion to foreign carriers. Because countries in which telephoning is cheap (such as America) tend to ring countries where calls are dearer, American carriers grumble that they are subsidising the inefficient and uncompetitive. Gradually, therefore, telephone companies are moving towards a "sender-keeps-all" system, where they will charge each other a flat fee for access to a certain amount of transmission capacity, rather than bill each other on the basis of use. ÊÊÊÊÊThat would bring them increasingly into line with what happens on the Internet, where settlement is rudimentary. There are payments between each of the Internet's hierarchy of links: access providers pay their regional network and regional networks pay the companies that operate the high-capacity long-distance parts, the backbone of the system. But such payments are mostly based on the availability of capacity, not its use: service providers simply agree to carry each other's traffic without totting up precise bills. ÊÊÊÊÊThis encourages a "hot-potato" approach: Internet access providers hand traffic on as quickly as possible to the carrier taking it to its ultimate destination. That benefits small service providers and irritates big ones, who say they get little reward for the effort of carrying the traffic for most of its journey. In turn, this lessens their incentive to invest in new capacity. ÊÊÊÊÊThe problem of settlement is worse for access providers outside America. Led by Singapore Telecom and Australia's Telstra, they complain that they have to pay all the cost of leasing lines between their country and the United States. "The rest of the planet subsidises the United States," argues Barry Greene, who works for Cisco, a maker of routers, but was previously with Singnet, the Internet arm of Singapore Telecom. The high cost of leasing international lines means that upgrading them to ease congestion can cost a non-American company ten times more than in America.

Free lunches all round Economists, famously sceptical about free lunches, have thought up various ingenious schemes to charge Internet users in ways that more accurately reflect costs. Several versions will appear in a forthcoming tome on Internet Economics, edited by Lee McKnight and Joseph Bailey of MIT. The main suggestion is to attach to messages some indication of their priority (high for a film clip, low for an e-mail message and so on). Users might pay in advance for high priority traffic; or their payments might vary with the level of congestion. ÊÊÊÊÊThe means for such fancy solutions will increasingly become available. A new protocol, or standard, called RSVP will soon allow people to specify the quality of service they want and, in theory, to be billed for it. Asynchronous transfer mode, or ATM, a technology that breaks the Internet's many sorts of digital signals into packets of a standard size, will allow a reliable quality of service and make it easier to keep accounts, if it ever becomes widely used. ÊÊÊÊÊUndoubtedly, charges would have an effect on the way the Internet is used. A study of "Information Infrastructure Convergence and Pricing: The Internet" by the OECD, published in June, showed that Internet access was far greater in competitive telecommunications markets than in uncompetitive ones. The reason is almost certainly that the average price for leased lines in countries with monopolies was 44% higher than in competitive ones (see chart). There was also a close correlation between Internet use and the structure of local call charges: surfing for hours is free or almost free in the United States and Canada, but most OECD countries charge local callers for the time they spend on the line. ÊÊÊÊÊFearful that use-based pricing would be a dampener, many Internet aficionados cross their fingers that the Internet can muddle on with its present, mostly flat-fee structure. After all, the capacity of the Internet's backbone has increased more than 10,000 times in the past decade; and that has been financed by the enormous increase in the number of subscribers. ÊÊÊÊÊIn addition, various technical solutions have emerged to slow the growth in traffic, such as the practice of "caching": storing material that one person has looked at close to the point of use, so that the next user need not go all the way to the original site to look at it. ÊÊÊÊÊFlat-raters point also to the low cost of a flat-rate sender-keeps-all system. After all, for some telecoms companies to bill a customer for a call costs more than to transmit it. Moreover, the present system suits the idiosyncracies of the Internet. Each message may hop across a dozen different carriers. Should each be paid something? And the person who initiates an Internet "conversation" may send out a tiny message and receive a huge one. How should the costs be divided? ÊÊÊÊÊOne way or another, as the Internet expands in both content and usage, a change is surely inevitable. Some of the larger telecoms carriers, such as BT/MCI, are building parallel global Internets of their own on which customers, for a premium payment, will be guaranteed a more reliable service than the public Internet can now offer. They will, says Barbara Dooley, managing editor of CIXtra, a newsletter, have an incentive to carry customers' traffic for as much of the way as possible, to keep control of the quality of service. Once they carry traffic around the world, they will have little incentive to make settlement payments; they will probably agree to accept a certain volume of traffic from each other free. ÊÊÊÊÊAnd what of the public Internet? Its users will face a choice. If they want to surf for free, they will have to put up with the occasional congestion. This will be partly self regulating: if too many people try to hold video conferences with their children, the quality will become so awful that the youngsters will give up in disgust and congestion will lessen. The wonderful thing about the Internet is that it still reflects what its users want, not what some large telecommunications company believes they ought to have.

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