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July 07, 2006

Price – Splitting the Pie – Access Charges

Understanding the debate over Net Neutrality means understanding how money flows between the many telecommunications providers who may handle a single packet. Smart readers of my post on the cost of pricing complexity like Aswath Rao and Rajesh Raut have commented that “bill and keep” – the usual model for connection between Internet backbone providers – is not the only possible model and may not be the best one.

This subject is unfortunately complicated.  But, if you read on, I promise you’ll understand both why it is nonsense say that Google is using at&t’s pipes “for free” and why at&t CEO Ed Whitacre and other traditional telco execs think this is exactly what is happening.

When you access Internet content or make a phone call – particularly an international call – many companies and many networks are involved in getting photons back and forth between you and the web site you’re accessing or between you and the person you’re calling.  Not unreasonably, the companies want to make money from their networks.

The revenue sharing models used on the Internet evolved  on the telephone network long before there was an Internet.  The four basic models are:

  1. access charges
  2. net settlement
  3. bill and keep
  4. facility rental including line sharing

To add further complexity, there are both access and backbone networks although most access networks include some backbone. Access networks connect to individual subscribers – residential or business.  In the US your local landline is part of an access network operated most likely by your local RBOC (regional bell operating company) but possibly operated by one of the thousands of ILECs (independent local exchange carriers) which serve mainly rural areas.  The towers of your mobile provider are another access network.  And whatever physical connection you have to the Internet is a third unless it’s DSL in which case it shares the physical copper which makes the RBOC or ILEC access network.  Told you this was complicated.

The court ordered breakup of AT&T in the 1980s separated the former monopoly into a host of regional access companies (the RBOCs) and backbone carrier AT&T.  MCI in its early days was a competitor of the backbone carrier.  One of the purposes of the breakup was to allow competition at the backbone level (“long distance” as we called it when distance still mattered).  When AT&T controlled both access and backbone, the reasoning went, it was impossible for a competitive backbone carrier to get any business.  Good thinking.

Formerly, we’d paid a bill to a single phone company – almost always Ma Bell.  Now we each had to choose a long distance (backbone) company as well.  If you didn’t choose, you got assigned to a long distance company just to keep things fair.  Initially, the RBOCs were not allowed to sell long distance and AT&T was not allowed to provide local residential service (access).

From the beginning, the RBOC networks provided both access and backbone since local and regional calls stayed totally on their network.  But, if Bell Atlantic was your RBOC and MCI your long distance carrier and you were calling someone in California (Pacific Bell), your call traversed all three networks.  MCI billed you for these long distance calls and paid “access charges” out of the proceeds to both Bell Atlantic who you used as an access network and Pacific Bell, the access network of the person you called.

Initially, when domestic long distance was still very expensive, the pennies per minute paid for access were a very small part of the cost of a call.  But competition at the backbone level worked.  Prices of long distance calling began to fall.  Access charges didn’t fall, however, since you still had no way to access your long distance carrier except through Bell Atlantic and AT&T had no way to get the call to the person in California except through Pac Bell.

There was no competition in access.  Sound familiar?

Although they were thought of as dowdy compared to the backbone carriers, these were actually great days for the RBOCs with their local monopolies.  The more the price of long distance went down, the greater the number of long distance calls and the greater the access revenue.  Almost every penny of access revenue went right to the bottom line of the RBOCs.  They had no marketing cost for the long distance calls that AT&T and MCI were advertising and discounting heavily.  They were already charging us a fixed price per month to rent us our access lines but now they were receiving ever greater access charge revenues from us indirectly whenever we used our lines for long distance calls.

Politically, access charges became very important.  RBOC rates were (and still are to some extent) regulated at the State level.  The monthly cost for a local line, which generally includes unlimited or a healthy amount of local calls, is very visible and politically sensitive.  It was hard for the RBOCs to get increases approved.  But the access charges are invisible; they’re paid by the long distance provider and are part of your long distance bill but never broken out.  So access charge revenue per line went up (stable monopoly prices, more volume) while the cost of a basic line rose more slowly. 

To some extent, long distance subsidizes local service through access charges.  The RBOCs effectively lobbied with this argument and the social corollary that poor people benefit from the subsidy since richer people make more long distance calls than poor people.  (However, calls made on business lines didn’t and don’t pay access charges by the minute.)

I was at AT&T when the dime a minute long distance plan was offered.  The cost of carrying the call over AT&T’s backbone was estimated at about one cent a minute.  Typically three cents per minute went to pay access charges.  Customer care and billing cost abut four cents per minute – remember, the RBOCs had neither customer care or billing expenses for these long distance minutes.  The remaining two cents had to cover marketing and AT&T’s bloated corporate overhead.  Don’t feel sorry for AT&T.  Most customers were not and are not on the most efficient calling plan.  It’s still easy to pay more than a dime a minute (or less) for domestic long distance.

OK.  Enough for today’s lesson.  Just remember the telco execs were brought up in system in which they both rented you an access line AND got to charge you again (this time indirectly) when you used it or when someone used your access line to call you.  It’s not surprising they’d like to charge twice for Internet access.

Next lesson is net settlement and a special case called reciprocal compensation. Also how the Telecommunications Reform Act of 1996 didn’t break the RBOCs local monopolies but how the Internet almost did.

BTW, I’m going into so much detail because the issues in the Net Neutrality debate in the US are important.  How they’re dealt with will affect both the quality of our online life and our national competitiveness.

The first post in this series on price is about the cost of complexity.

The second post is about FON, the WiFi sharing scheme, as a great experiment in pricing.

The third post is about “freeloaders”.

The fourth post is on unseating an incumbent with disruptive pricing.

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