Internet Cost Structures and Interconnection Agreements

As a commercial service, an ISP offers its customers a bundle of services that typically includes hardware, software, customer support, network connectivity, and access to specific information resources. In any market, there are dozens of service providers that provide a wide variety of service options - and in most instances, these services cannot be unbundled (a customer cannot decline the "fee" server space for a personal Web site to decrease the monthly cost for internet access).

Internet Services and their Costs

Each of the services an ISP provides has a different cost basis.

To provide network access, a provider must purchase a terminal server, a modem pool, multiple dial-up telephone lines, and a connection to the backbone network. Each of these costs is incrementally variable (you can buy one modem at a time, one server at a time, etc.), but do not scale downward easily (you can buy a new modem, but once you have it, you're stuck with it).

The cost of providing customer support is also largely incremental: aside of a call center, you need a number of operators, each of whom needs certain equipment and training to get up to speed. The costs to adjust your capacity to suit demand are likewise chunked, and it is similarly difficult to scale down once you have scaled up (you can dismiss an operator and save their salary, but their equipment cannot be as easily liquidated and their training costs are simply lost).

Customer support costs also vary by the nature of the customer, not merely the quality of customers served (novice users need more support than experienced ones). It will also vary according to the bundle of services provided (if you help them publish a personal home page, that will require additional support to just having access to surf).

The cost of providing access to the network also varies: providing access to a leased network requires you to contract with a network access provider, and the terms of that contract fix a price for an amount of bandwidth, and cannot be scaled without breaching that agreement. If you opt to build out your own network, this constitutes a fixed overhead expense (you must maintain your network for one customer or a thousand), though the cost of upgrading capacity is incremental and cannot easily be scaled back down.

Finally, the cost of value-added content (content that is exclusive to your customers, not available elsewhere on the internet). In most instances, subscription-based services are separate businesses and their cost is borne by the customers rather than the ISP.

EN: at the time the book was written, ISPs negotiating bulk deals to provide access to subscription service as a value-add was in fashion, but have since become rare, to the point where their impact on an ISP's own expenses is largely moot.


There is an issue of interconnection: if a user visits a Web site, both the access provider and hosting provider may have networks that take the user from point A to point B - but whose wires should the packets travel across?

In the early days of a single backbone, the option was a technical one rather than en economic one: traffic followed the route that had the most capacity to bear it. When traffic increases and resources become scarce, there is an economic incentive for an ISP to dump traffic off their network onto others whenever possible.

The problem is largely theoretical, as the capacity of the actual networks has been expanded well in advance of the level of demand - and in instances where bottlenecks occurred, the decision as to which ISP should expand capacity is largely determined by whose customers are the most affected, and it has largely fallen to the access providers, who must increase the bandwidth of their networks to appease their customers' demand for quality service, as the cost of increasing capacity has traditionally been less than the revenue that would be lost when customers switch to a provider with adequate capacity.

And so, the problem of interconnectivity has thus far been resolved positively (by building network capacity) rather than negatively (dumping traffic on other providers' networks), as a virtue of the greater elasticity of demand and economies of scale.