Economics of Overlay Networks: An Industrial Organization Perspective on Network Economics

We use theory of Industrial Organization to demonstrate the demand and cost conditions on entry and scaling incentives of Internet overlay networks, restricting the problem to Internet content distribution. We describe the market structure, the nature of demand and the cost-allocation mechanism in both wholesale and retail markets. We show how the end-to-end coordination failures of the ISPs and content providers has resulted in wholesale market failures, inducing entry by propriety content distribution “middleboxes” that act as intermediaries, coordinating unmet demands. We also show that the intermediary has incentives to strategically use the Internet costallocation mechanism to internalize and scale using these indirect externalities from trade. The scaling incentives of such overlay markets is also briefly compared with bargaining institutions implemented by P2P content networks.