A Model for Interconnection of IP Networks

Internet Service Providers (ISPs) must interconnect in order to realize the network externality benefits of being able to reach all users. Market power determines whether and how much one provider pays another for interconnection. Recently, antitrust authorities have expressed concern about the potential abuse of market power with respect to network interconnection in the scope of the Internet. This paper develops models for understanding when, where and using what mechanisms, ISPs will choose to interconnect. By solving these models with the appropriate inputs one could observe the optimal interconnection strategies for ISPs and understand how the topology of the Internet might evolve. Analyses of the various sources of costs for interconnection are provided as parameters for these models. Between January 1999 and July 2002, bandwidth prices have decreased at an average monthly rate of about 5%. Transit prices have decreased by 50% from May 1999 to October 2001. The movement of these prices in the same direction hampers understanding whether providers will likely rely more or less on peering agreements. The former would decrease the potential for the emergence of dominant providers.