An ISP is how you access the Internet, whether you are a business or a residential customer. Phone companies, cable companies, and satellite companies all work to service given areas for Internet access.
Tier 1 Eg Hibernia Networks, Cogent Communications, Level 3 Communications
A tier 1 ISP is an Internet provider who exchanges Internet traffic with other tier 1 providers. These ISPs exchange traffic strictly through peering agreements.
Tier 1 Internet providers are the networks that provide the backbone of the Internet. We call them backbone Internet providers. These providers build infrastructure such as the Atlantic Internet sea cables. They provide traffic to all other Internet providers, not end users.
Without tier 1 Internet providers, Internet traffic could not be exchanged between continents and countries.
Tier 2 Eg British Telecom, Vodafone, Easynet
A tier 2 ISP is a service provider who connects between tier 1 and tier 3 Internet service providers. Tier 2 providers will exchange Internet traffic through peering agreements, as well as purchase Internet transit.
Tier 2 and tier 3 internet providers are sometimes used interchangeably. A tier 2 supplier tends to find it easier to purchase transit than to work out a peering agreement with a tier 1 provider. The reason for this is the level of transit. The tier 2 provider may not have enough transit, or capabilities, for it to make sense to peer with the tier 1 provider.
Tier 3 Eg Comcast, Deutsche Telekom, Verizon Communications
A tier 3 ISP is a provider who strictly purchases Internet transit. A tier 3 provider is the last mile provider who delivers Internet access to residential homes and businesses.
Although the tier 3 ISP is becoming a blurred definition, it is safe to say they operate strictly on a purchasing model.
Internet service providers are how you gain access to the Internet. Downloading documents from a server in California to a user in Germany means all three levels of ISPs have to work together. This is done through a combination of peering and paid Internet transit agreements.