From: Jeff Davis <eagle@deeptht.armory.com>
Date: Wed, 4 May 94 10:10:29 PDT
To: cypher <cypherpunks@toad.com>
Subject: Varian Synopsis
Message-ID: <9405041007.aa22236@deeptht.armory.com>
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TAXPAYER ASSETS PROJECT - INFORMATION POLICY NOTE
May 3, 1994

This is a note about an important issue:  the future pricing of Internet 
services.  Please repost freely.

     -    University of Michigan Economist Hal Varian says the
          Internet is likely to face some type of usage based
          pricing in the future.

     -    Varian says increasing demands on Internet by
          multimedia applications and commercial bypass of
          telephone networks will lead to significant increases
          in demands on Internet resources, and create pressures
          for usage based pricing models.

     -    Varian proposes a system of congestion based pricing,
          that will allow free off-peak usage, but speculates
          that other outcomes are possible, and

     -    Predicts eventual demise of CIX model of flat rate (no
          settlements) pricing for Network Service Providers.


              NOTES ON PROFESSOR HAL VARIAN'S APRIL 21 TALK 
                          ON INTERNET ECONOMICS

                    by James Love (love@essential.org)
                               May 3, 1994

     On April 21, the Telecommunications Policy Roundtable (TPR)
held its first workshop on the future of democratic discourse on
the Internet.  Hal Varian, a professor of economics and finance
from the University of Michigan, presented "Economic FAQs about
the Internet," a paper co-authored with Jeffery K. Mackie-Mason. 
The Workshop was held at the Carnegie Institution in Washington,
DC, and attended by about 60 persons.

     There was considerable interest in the topic.  TAP had
received more than 400 requests for copies of the paper
(including about 350 requests by electronic mail).  The paper is
available for anonymous ftp, gopher, or World Wide Web at
gopher.econ.lsa.umich.edu, or by sending an email message to
ndaly@essential.org.  

     Professor Varian's prepared talk followed the paper fairly
closely, with a number of facts and antidotes thrown in to
illustrate his main points.  Among economists Varian is known as
a superb expositor, and his presentation was as clear and
accessible as the paper.  Varian spent the first part of his talk
describing such topics as who "owns" various components of the
Internet (backbones, midlevel networks, etc), technical aspects
of Internet routing, and the growth of traffic on the Internet. 
I won't bother to go over all the points which are explained in
the paper, but a few items are worth mentioning.

     Varian disclosed that Internet data packets contain an
unused "priority bit," that was originally designed to allow
Military brass to assign priorities in data routing.

     The costs of routers (workstations) had fallen much faster
than the long distance transport costs, and the long distance
backbone facilities were often the bottleneck.

     Varian also spent a good amount of time explaining how
Internet usage is changing, and that while electronic mail is the
service most widely used, it constitutes only about 8 percent of
the bits sent over the network.  New applications, such as the
multimedia Mosaic, Internet Fax, and Internet radio are rapidly
becoming large users of Internet resources, and these new uses of
the Internet are creating huge pressures to change the way
Internet services are priced.  To illustrate his point, Varian
talked about the new Power PCs, which will allow a single user (a
college student talking to his parents) to hook up a video
camera, and send about 1 megabyte of data per second to the
Internet, nearly tying up an entire T-1 line.  Varian indicated
that the power of workstations connected to the Internet is
increasing much faster than the capacity of the Internet to carry
traffic.  Moveover, a number of commercial users of the Internet
are rapidly finding ways to bypass the higher priced telephone
networks, both domestically and internationally.

     Varian was focused largely on the increased congestion cause
by the new demands on the Internet.  Interestingly, his own
research indicated that peak demands shifted from day to day, and
peak and off-peak usage could not be easily predicted by the
time-of-day, as it is for telephone service.

     In the United States the Internet is unregulated, and there
are no internal prices for Internet usage.  Network service
providers typically buy bandwidth, or capacity, and face zero
marginal costs for usage.  End users face a variety of  charges,
depending upon how their service providers resell access to the
network.  Some foreign countries, such as New Zealand and Chile,
charge Internet users for traffic, as measured by bits.

     Different uses for Internet services have different
requirements in terms of routing priorities.  Electronic mail
generally does not require an immediate claim on network
bandwidth, and can be managed to travel "off peak."  On the other
hand, some services, such as video conferencing, Internet "talk,"
or running Mosaic, generally allow the user to command bandwidth
at a particular time.

     Varian was quite clear that he believes that the problem of
congestion on the Internet will become a much larger problem as
the Internet becomes used for a more diverse set of applications
(and the growing power of desktop computers to generate data).

     Varian said that he believes there will eventually be prices
for Internet usage, and the only real uncertainty will be which
pricing system is used.  A very difficult problem will be the
development of accounting systems and other mechanisms to
facilitate billing for Internet usage.  Generally speaking, it is
not simple to determine if data packets contain electronic mail,
fax transmissions, video, or other data, making content based
pricing problematic.  There are also a number of complex issues
relating to when or where traffic would be "charged" for internet
usage, since users gain access to the Internet from a highly
decentralized network of workstations and networks.  Varian also
talked about problems in determining if senders or receivers
would pay for data transmissions, which he illustrated by talking
about ftp or gopher servers  (who was the "sender" of the data, 
the person sending the query, or the file server which returns
data?).

     According to Varian, a number of persons are working on
these problems, and many important decisions will be determined
by engineers working on technical issues.  He singled out the
Internet Society's Internet Engineering Task Force as the most
important forum for groups sorting these issues out.

     Varian said that any scheme to charge for internet usage
would also involved non-trivial costs in terms of metering or
accounting, and possibly significant changes in the culture of
the Internet (the question on many persons minds is the future of
the Internet Listserves), although on a more optimistic note, he
said the costs of routing and backbone services should be low, if
calculated on a per user basis.

     Varian said little about the Commercial Internet Exchange
(CIX) in his prepared remarks, but in response to questions, he
said that he did not believe the CIX pricing model (a flat fee
for connectivity) was sustainable, and he thought that the new
Network Access Point (NAP) providers (Ameritech, Pac Bell,
Sprint, and MFS) would employ a usage based pricing approach.

     Varian also talked at some length about work underway to
create mechanisms for charging for other types of transactions,
using a variety of schemes to create "virtual cash" for use on
the Internet, such as the services recently announced by Commerce
Net using technology developed under NSF funded R&D.  Varian said
that government R&D in this area was welcomed, because it
provided neutral non-proprietary systems that couldn't be
controlled or manipulated by a single firm.

     Varian described the new Internet architecture, which is
based upon four NAPs, each controlled by a telephone company,
which Varian described as the new "cloverleaves" for the Internet
(connecting various backbones and networks), and the new vBNS
high speed backbone.  Varian said the high interest in the vBNS
contract was due largely to its strategic role in the development
of new Internet technologies, including accounting and payment
mechanisms, which may eventually be deployed to the entire
Internet.  (MCI "won" the recent NSF contract for the vBNS, but
the award is being contested by Sprint.  AT&T was also rumored to
have been an unsuccesful bidder on the vBNS).

     Varian's own preference for Internet pricing is a system
that only charges for priority routing.  As described in several
papers (written with MacKie-Mason), Varian would employ a system
whereby users would "bid" for access when congestion was a
problem, and routers would give priority to packets that had the
highest willingness to pay.  Users would pay the lowest price
that was accepted in this routing "auction," so everyone would
have an incentive to reveal their true willingness to pay.  Under
Varian's scheme, all Internet traffic which did not claim
priority status would travel for free.  Thus, for example, a
large Internet mailing list such as Humanist, PACS-L  or CPSR-
Announce could mail for "free," with an off peak priority.

     For Varian's scheme to work, it would be necessary to have
routers compare "bids" by packets, priority bidders would have to
"pay" for access to someone, and there would have to be a high
degree of consensus, so the priority packets would not face
bottlenecks or delays anywhere on the Internet.  Varian
acknowledged that it was possible that the Varian (and MacKie-
Mason) system of pricing might not be adopted, and some less
elegant system, such as pricing by the bit, may be coming.

     A number of persons wanted to know who would decide these
issues, and Varian was not too specific.  The message (the
"guess") seemed to be that the companies which controlled the
NAPs and a critical mass of the backbones would have a lot to say
about what was eventually adopted.  Varian was asked to speculate
about future telco investments in Internet providers, such as
purchases of companies like PSI or UUNET, but he was reluctant to
predict much, other than to emphasize the importance of
competitive free entry into the market for Internet services,
which would undermine monopolist practices.  Varian was asked if
it was possible that a coalition of Internet providers would have
the power to implement a pricing scheme that would have an
adverse impact on the future of Internet listserves (many of
which "send" more than 100,000 messages per day), but he was
reluctant to be very specific in his predictions, other than to
say that many outcomes were possible.

     Note:  On April 29, a follow-up workshop was held with
     Dr. Steve Wolff of NSF, Professor David Farber, and PSI
     CEO William Schrader.  Notes from that workshop and
     other information regarding Internet pricing will be
     posted to tap-info.

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