Because the Internet telephony scenario does not represent the ISP becoming a long- distance phone company, there are no usage-based charges, such as a per-minute charge of Internet telephony use. Hence, there are no additional billing costs that are due to the ISP needing to record activity of individual subscribers.
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The allocation of billing costs are straight forward because they are calculated independently for each type of subscriber.
percentage of revenue based on their commission. Similarly, the model quantifies sales and marketing costs by basing them on a percentage of revenue.
This percentage is derived from an average of sales and marketing costs that is extracted from various companies’ 10k reports that are submitted to the US Securities and
Exchange Commission. In the “Consolidated Statements of Income” section of the 10k reports, Sales and Marketing Costs and Revenues are listed. The desired number for each company is the ratio of the sales and marketing costs to the revenues. This number is then averaged over the ratio of several companies.
The model parameter that represents this average is:
• sales and marketing (% rev).
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Based on 1994, 1995, and 1996 data for several companies (Netcom, PSInet, Uunet, AOL and US Robotics), the average ratio of sales and marketing costs to revenue is 25%. As an indication of how industry/company specific this value is, the standard deviation of the data is 13%.
Over the three-year period, the value for the ISPs ranged from 16% (Uunet, 1996) to 62%
(PSInet, 1995). AOL was approximately 20% for all three years and US Robotics varied from 14% to 17%.
Because this model is not a business plan for an ISP, many of whom are investing heavily to expand and, thus, are operating temporarily at a loss, but is rather a model of the cost of end-to-end Internet service, a default value of 20% is chosen to represent the sales and marketing (% rev) parameter (Table 37). This value can be considered conservative for the ISP industry, but somewhat liberal for other industries. 84
84 For comparison, the ratio of sales and marketing costs to total operating costs, for the same companies as above, is, on average, 21% with a standard deviation of 4%. Hence, in a competitive industry where costs are close to revenue, using the ratio of sales and marketing costs to revenue or to total operating costs will yield similar results.
Maintaining the same value for the Internet telephony scenario is based on reasoning that the ISP is not necessarily trying to actively promote a new service (or become a long distance phone company), but rather that the ISP’s subscribers have chosen to embrace the new application of Internet telephony. Hence, the parameter is held constant for both scenarios.
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Because the sales and marketing costs are based on revenue, they are allocated in the same distribution as the revenue obtained from the various types of subscribers.
3.5.2. General and Administrative
General and administrative (G&A) expenses consist primarily of salaries and occupancy costs for administrative, executive, legal, accounting, and finance personnel.
Determining G&A costs is not as straight forward as determining other costs such as modem or transport costs; there is no simple formula for sizing the number and cost of G&A employees, such as VPs, lawyers, accountants, and support staff.
In order to quantify such costs, an average of G&A costs is extracted from various companies’ 10k reports that are submitted to the US Securities and Exchange Commission. In the Consolidated Statements of Income section of the 10k reports, General and Administrative and Total Operating Costs are listed. The desired number for each company is the ratio of the G&A costs to the total operating costs. This number is then averaged over the ratio of several companies.
The model parameter that represents this average is:
• general and administrative (% costs).
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INPUT PARAMETER BASELINE IT
sales and marketing (% rev) 20% 20%
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Using the 1996 values from the 10k reports of multiple companies, G&A costs represent, on average, 11% of total operating costs (Table 38). The standard deviation of the data is 2.6%.85
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Because G&A costs scale with the size of the ISP, they are allocated in the same manner that the total costs are distributed.
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In this chapter a description of a cost model of Internet service providers is presented. The model puts the ISP’s costs into five categories:
• capital equipment
• transport
• customer service
• operations
• other expenses (sales/marketing and general/administrative).
The model is evaluated with two scenarios: 1) the baseline scenario which represents an ISP today where its subscribers use primarily the web; 2) the Internet telephony scenario, where the ISP sees a significant rise in the use of computer-to-computer Internet
telephony. This scenario is in contrast to another potential Internet telephony scenario where an telephone service provider desires to replicate the PSTN using Internet telephony technology.
Chapter 4 presents the results of the two scenarios along with sensitivity analysis.
Subsequently, the cost model is applied to two additional scenarios of ISP regulation and of yield management.
85 Companies included in this calculation are: Netcom, PSInet, Uunet, and AOL.
INPUT PARAMETER BASELINE IT
general and admin (% costs) 11% 11%
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