Modeling Tiered Pricing in the Internet Transit Market

TL;DR

This paper models tiered pricing in the Internet transit market, analyzing its effects on ISP profits and consumer surplus through real-world data and counterfactual simulations.

Contribution

It introduces a novel demand and cost model for tiered pricing and evaluates optimal tier structures using real network data.

Findings

ISPs profit most with 3-4 pricing tiers

Consumer surplus closely follows ISP profit with more tiers

Cost-based tiering can be suboptimal, 3-4 tiers are near-optimal

Abstract

ISPs are increasingly selling "tiered" contracts, which offer Internet connectivity to wholesale customers in bundles, at rates based on the cost of the links that the traffic in the bundle is traversing. Although providers have already begun to implement and deploy tiered pricing contracts, little is known about how such pricing affects ISPs and their customers. While contracts that sell connectivity on finer granularities improve market efficiency, they are also more costly for ISPs to implement and more difficult for customers to understand. In this work we present two contributions: (1) we develop a novel way of mapping traffic and topology data to a demand and cost model; and (2) we fit this model on three large real-world networks: an European transit ISP, a content distribution network, and an academic research network, and run counterfactuals to evaluate the effects of different pricing strategies on both the ISP profit and the consumer surplus. We highlight three core findings. First, ISPs gain most of the profits with only three or four pricing tiers and likely have little incentive to increase granularity of pricing even further. Second, we show that consumer surplus follows closely, if not precisely, the increases in ISP profit with more pricing tiers. Finally, the common ISP practice of structuring tiered contracts according to the cost of carrying the traffic flows (e.g., offering a discount for traffic that is local) can be suboptimal and that dividing contracts based on both traffic demand and the cost of carrying it into only three or four tiers yields near-optimal profit for the ISP.