How many tiers? Pricing in the internet transit market

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 to structure them. Although 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. Our goal is to analyze whether current tiered pricing practices in the wholesale transit market yield optimal profits for ISPs and whether better bundling strategies might exist. In the process, we offer 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 bundling strategies. Our results show that 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.