Debates over paid peering and usage fees have expanded from the United States to Europe and South Korea. ISPs argue that content providers should pay fees based on the amount of downstream traffic they generate. In contrast, content providers contend that customers already pay ISPs for delivering the content they request, and therefore that peering agreements should be settlement-free. The issue has arisen in debates in the United States, Europe, and South Korea over net neutrality, universal service, and infrastructure funding. Regulatory entities are considering whether to regulate peering prices and/or impose usage fees. A key part of the debate concerns whether the market determines the socially beneficial peering price, and if not, how much of a difference there is between the socially beneficial peering price and the market-determined peering price. Our objective here is to understand the range from a cost-based peering price to a profit-maximizing peering price.

First, we determine an ISP’s cost for directly peering with a content provider, by analyzing the incremental cost for transporting the content provider’s traffic when it directly peers with the ISP versus when it sends its traffic through a transit provider. Next, we determine the peering price that maximizes an ISP’s profit using a two-sided market model in which a profit-maximizing ISP determines broadband prices and the peering price, and in which content providers determine their service prices based on the peering price. These prices establish a range if the peering price is unregulated, from the cost-based peering price (at the low end) to the profit-maximizing peering price (at the high end). Regulatory oversight of peering prices may be warranted when there is a substantial difference between cost-based and profit-maximizing prices.

Finally, we re-examined the arguments put forth by large ISPs and large content providers. Our results show that settlement-free peering is warranted if a content provider or transit provider provides sufficient localization of exchanged traffic. Traffic is sufficiently localized if: (1) they interconnect at a reasonable number of interconnection points, (2) the locations of these interconnection points span the country, and (3) the proportion of traffic that is exchanged at an interconnection point that is relatively close to the end user is sufficiently high.