Staff Working Paper: ICANN Cost Recovery Structure for Domain Name Registries (10 November 2000)

Note: This working paper has been prepared by the ICANN staff and is posted here to prompt public comment. It has not been adopted by the Board.

10 November 2000

ICANN Cost Recovery Structure for Domain Name Registries

A. Introduction

This staff working paper is being published for public comment with the intention that it contribute to accomplishment of three objectives:

(1) Provide an updated cost recovery structure for Top Level Domain Name Registries that can be used in completing agreements with the organizations selected to operate the new registries.

(2) Provide a basis for discussion with the country code top level domain registry community leading to completion of registry agreements with those organizations.

(3) Provide a means to simplify and harmonize the existing revenue structure, which was adopted in 1999, particularly with reference to DNS scaling and registry business model issues.

Comment is welcome on all aspects of this paper, but in particular, comments and possibly alternative approaches and formulations are sought on the following points:

• application of a common structure to all top level domain name registries/registrars that are comparably situated in the DNS, as measured by their business model, volume and level of service, etc.
  
• the appropriate division of the annual fee structure between a fixed and a variable component, as discussed in sections C, D, and E.
  
• the granularity and levels of fixed annual fees presented in sections E.1 and E.4.
  
• the continued and expanded use of the proportionate registry size formula for calculating the variable annual fee that is contained in section E.3.

In addition to public comment, ICANN is obligated under current Board policy to consult directly with representatives of the Domain Name and IP address registries in matters affecting the budget, and will do so with respect to the recommendations and proposals in this staff paper.

B. Background

The present budget structure for ICANN was adopted by the Board in November, 1999, following completion of the work of the Task Force on Funding (TFF). The complete TFF report may be accessed at: <http://www.icann.org/en/committees/tff/tff.htm>

The ICANN Board, in directing the creation of the TFF, charged it with "formulating recommendations on cost-recovery mechanisms that fairly apportion ICANN's funding needs, as reflected in the budget that has been adopted, among the Internet name and address registry administrators and registrars and possibly other parties..."

The subsequent report contained a number of recommendations, of which the one most pertinent to the topic of cost recovery structure is:

"The TFF recommends that for the foreseeable future the basic funding needs of ICANN be supported by IP address registries and domain name registries and registrars. As articulated in the White Paper, ICANN constituents benefiting from ICANN's technical coordination and policy development activities should contribute to its budget, whether individually or through intermediary fee aggregating organizations."

Following the above points, the goals of the revenue structure may be stated as,

• to produce the funding necessary to support ICANN's mission and programs,
  
• to allocate fairly the responsibility for providing that funding,
  
• to develop a cost recovery, i.e. revenue, structure that is understandable and that can be administered without excessive costs

The revenue structure developed in support of these goals and recommended in the TFF report has been only partially implemented as a result of delays in executing agreements with country code Domain Name Registry organizations. With respect to the ccTLD agreements, part of the delay is related to disagreement on an appropriate structure for contributions to support ICANN's funding requirements. (An explanation of the details of the current structure appears in Note 1 below.)

This staff working paper does not deal with the issue of the appropriate balance between revenue contributions from Domain Name registries and from IP Address registries, which currently stands at 90%-10% based on last year's Task Force on Funding (TFF) recommendation. All of the sections below assume 10% of the total annual budgeted revenue requirement continues to be met by the Address registries.

C. Revisions to the Domain Name Registry/Registrar Revenue Structure

After reviewing the pertinent background material and the operating experience of the past year, the staff believes the following general precepts ought to be applied to the development of an updated domain name registry/registrar revenue structure.

(1) Scope of Application. In the interests of consistency and harmonization, the new structure should apply uniformly to all registries and registrars. In effect, ICANN should shift from its current practice of treating registries in terms of who or what they are, to a new policy in which the basic financial relationship is modulated by the business model of the registry. See section E below for more elaboration on this point.

(2) Registry & Registrar Relationships. In general, the revenue arrangements should be executed with and administered by the registry operator. This appears to be the most flexible and administratively efficient approach. For the time being, ICANN should continue to deal separately with registries and registrars, where that is the locally preferred or required arrangement, with the intention of working toward a registry centered relationship.

(3) Fixed and Variable Components. The structure should continue to have both a fixed and a variable component to reflect the diversity of economic circumstances prevailing among the domain name registries worldwide. Commercial registry operators, who provide more than 80% of ICANN's domain name registry revenue under the existing structure, have recommended that the variable component of the revenue structure should provide a substantial proportion of the total needed revenue, since this is believed to most equitably apportion the funding burden.

(4) Use of Proportional Registry Size. The algorithm for determining the variable part of the individual organizational shares in the domain name revenue component of the ICANN budget should continue to be based on proportional registry size as measured by number of domain names registered. The present procedure, adopted by the Board in November, 1999, at the recommendation of the Task Force on Funding, calculates the proportional shares once each quarter based on registry data. Although there has been some debate about using other measures, such as gross revenues or net profits of registry companies, or economic measures associated with countries in which registries are located, or self-identification of amounts to be treated as voluntary donations toward revenue needs, none of them meets the tests of being administratively feasible and of meeting an overall fairness criterion.

(5) Simplify Calculation. The TFF recommended revenue structure has a two tier, two step process in which the approved expense level to be recovered from Name and Address Registries and Registrars is first divided into "macro" shares and then subsequently recovered through a second formula within each of the three macro contributors - Address Registries, gTLD registries/registrars, and ccTLD registries/registrars. During its deliberations, the TFF members agreed that a fair apportionment of the macro shares, based on conditions prevailing in the summer and fall of 1999, was 10% - 55% - 35% for the Address community, gTLD community, and ccTLD community respectively. Subsequently, these macro divisions have been challenged on the grounds that they lack substantive rationale and hence are only the subjective opinions of a small and not necessarily representative committee of registry and registrar executives. The staff believes that the recommendations of the TFF were sound under the circumstances of the task force work, but that improvements are desirable. To that end, this staff paper proposes that all of the domain name portion of the revenue calculation be based on the fixed and variable structure proposed in section D below. As noted above, there are issues related to the division of ICANN's budget support between Address Registries and Name Registries that are not dealt with in this paper.

(6) Provide for Special Registry Circumstances. At the same time that some simplifying assumptions are adopted as proposed above, a number of exception or waiver conditions should be considered by the Board in order to allow the staff to deal with financial hardship and other special situations where needed.

D. Revenue Versus Expense Considerations

One of the agreements reached in the TFF process a year ago, and subsequently adopted by the Board, was that the budget should be driven from the expense side, not the revenue side. This principle essentially commits the Board, with respect to potential new revenue from the new TLDs, to using any revenue capacity in excess of reasonably projected incremental operating costs to rebalance and achieve improved consistency of revenue shares among all the domain name registries and registrars.

With respect to the costs to be recovered in the domain name portion of the revenue structure, the amount budgeted for the current fiscal year is $4.386 million. This does not reflect revisions that will be necessary to accommodate increased expenses in ICANN's budget for management and administrative costs of the new TLDs.

Although the Board has not yet had an opportunity to review staff proposals on a midyear budget revision to cover such costs, an increase in expenses of $614,000 has been assumed for the purposes of this working paper, resulting in a total domain name expense amount to be recovered of $5.000 million. This figure is used in the projections in the following section. Please note that in the actual application of the revised structure to the current fiscal year, there would be adjustments for less than twelve month's applicability.

(There are other currently unbudgeted new expenses to be considered in the mid-year financial review in January, such as the At Large membership program, and the root server system improvement program. Provision for recovery of these costs is not included in the calculations in this staff paper.)

E. Revised Revenue Structure

As noted above, the proposed revisions to the ICANN revenue structure are based on the type of business model being employed by the registry. This section of the staff paper presents a proposed business model registry classification scheme, followed by sample calculations of fixed and variable components of the fees to be assessed. The current evolution of business models for domain name registries is rapid. The classifications proposed here will benefit from public comment, and from alternative formulations by registries themselves, if offered.

E.1 Registry Business Model Classifications

In order to calculate the fixed component of the annual fee, a classification of registries is proposed, based on the business model under which the registry is operating. ( N.B. Example TLD names used in this section that do not currently exist are only illustrative of applications received by ICANN.)

The proposed classes are:

Class 1 - Commercial. (Either the registry, or the registrar, or both, are operated as for-profit entities.) Registrant categories are as follows.

1a - Worldwide availability, unrestricted as to registrants. E.g., .com, .nu, .tv, .cc

1b - Worldwide availability, restricted as to registrants. E.g., possible new TLDs such as .air.

1c - Restricted to country or territorial presence of registrant, E.g., .au, .ca

Class 2 - Noncommercial. (Both the registry and the registration activities are operated on a non-profit or not-for-profit, cost recovery basis.)

2a - Worldwide availability, unrestricted as to registrants. E.g., possible new TLDs such as .health

2b - Worldwide availability, restricted as to registrants. E.g., .int, .union

2c - Restricted to country or territorial presence of registrant.

Class 3 - Special Purpose. For registries with no cost recovery structure, or qualifying under other criteria such as demonstrated financial hardship. Currently is set at $500 per year.

E.2 Allocation Between Fixed and Variable Component

During the negotiations leading to registry/registrar agreements for .com/net/org in 1999, a formula containing both fixed and variable components was selected. In the current fiscal year, $3.636 million ($2.140 M from gTLDs and $1.496 M from ccTLDs) of the total $4.386 million of domain name revenue is shown to be from variable sources, for a ratio of 83% variable to 17% fixed. However, treating all of the ccTLD budgeted revenue share of $1.496 million as variable per the amounts invoiced by ICANN does not reflect the view among some ccTLD managers that a large share of the support for ICANN should be based on an annual fixed amount.

For the sake of illustration, an allocation of 60% variable and 40% fixed revenue to be recovered in the revenue structure is used here. This results in an amount of $3.000 million for the variable component and $2.000 million for the fixed component. It should be noted that in an environment of strong growth in the registration of commercial domain names, which has been the trend in recent years, a reliance on a high annual fixed component disadvantages the non-commercial or otherwise slow growing registries, whose relative share in the calculation of total revenue would otherwise decline quarter by quarter based on registry data.

E.3 Calculation of Variable Component

The variable category of the revised revennue structure is required to recover $3.000M under the assumptions in this staff paper. This is accomplished using an algorithm first constructed by the TFF to deal with registry and registrar activity in .com/net/org. It is extended here to all Domain Name Registries. According to the most recent announcement from Net Names, domain name registrations currently stand at:

.com=18M names, .net/org=5M names, and all cc's together = 7M names, for a total of 30M names worldwide.

The existing formula for calculating the variable component of domain name registry/registrar fees would become, under the revised new structure:

Quarterly Fee = .25E x n/N

Where:

.25E = division into quarterly payments of the approved expense cost recovery budget

n = number of domain name registrations attributable to a given registry at the close of the quarter

N = total number of domain name registrations at the close of the quarter

Example - using data from previous section:

.25E = .25x$3.000 million = $750K
n = .com = 18M
N = total registrations = 30M

18M/30M = 60% share of total registrations = $450,000 per quarter or $1.800M per year if the 60% registry share did not change

For 1% share of total registrations = 300,000 names = $7,500 per quarter or $30,000 per year

For 1/10th of 1% share of total registrations = 30,000 names = $750 per quarter or $3,000 per year

E.4 Determination of Fixed Component

Within the fixed category, which under the assumptions in this paper needs to recover $2.000M, a range of annual fixed amounts is established, which are matched to the business model classifications of section E.1. Please note that the examples here assume that one TLD string = one registry. There are four steps in Classes 1 and 2, assigned as follows, with estimated number of registries per class per step shown. For the noncommercial registries, a 50% discount from the level of the commercial fees is assumed to reflect their different economic circumstances.

Class 1a - Commercial, worldwide, unrestricted (10 @ $100K/yr =$ 1000 K)

Class 1b - Commercial, worldwide, restricted (5 @ $50K/yr = 250 K)

Class 1c - Commercial, country (35@ $10K/yr = 350 K)

Class 2a - Noncommercial, worldwide, unrestricted (2@ $50K = 100 K)

Class 2b - Noncommercial, worldwide, restricted (2@ $25K= 50 K)

Class 2c - Noncommercial, country (35 @ $ 5K = 175 K)

Class 3 - Special Purpose (150 @ $500 = 75 K)

Total $ 2000 K

Notes:

Note 1 - Current Registry/Registrar Revenue Structure

Briefly summarized, ICANN's current revenue structure for domain name registries and registrars has four components:

(1) Verisign (formerly NSI) Registry pays a fixed annual fee of $250,000, which includes the three .com/net/org registries.

(2) The .com/net/org registrars, including NSI Registrar, pay a variable fee based on their proportionate share of the total registrations in .com/net/org which amounts to a total of $2.140 M in the current fiscal year budget. The shares are recalculated quarterly based on data from Verisign Registry and invoices issued accordingly.

(3) The ccTLD registries have been billed a total of $1.496M based on their estimated proportionate share of total ccTLD name registrations. Some ccTLD registries have objected to this formula but have not made an alternative proposal.

(4) The .com/net/org registrars pay an annual fixed fee of $5,000 in connection with their registrar agreements. We previously "fenced" this in the one time category of our revenue budget because we expected a registrar group of 20-30 companies and the resulting fees to be totally absorbed in administrative costs of processing agreements, etc. Subsequently, we have accredited well over a hundred companies and we have also committed to the registrar group an aggressive support program for them. Thus, we believe this funds component should be moved into the continuing revenue category and integrated into the general registry/registrar revenue structure.

In addition, items (1) through (3) are subject to a TFF recommended division of revenue shares among gTLDs, ccTLDs and IP Address Registries of 55%/35%/10%.