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On-net and off-net pricing on asymmetric telecommunications networks.

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Presentation on theme: "On-net and off-net pricing on asymmetric telecommunications networks."— Presentation transcript:

1 On-net and off-net pricing on asymmetric telecommunications networks

2 On/Off-net Pricing on Asymmetric Telecommunications Networks Steffen Hoernig FEUNL, Lisbon; CEPR, London ICP-Anacom, 08/05/2007

3 Overview 1.Interconnection 2.Uniform tariffs versus destination-based price discrimination 3.Above-cost termination charges 4.Call externalities 5.Predation attempts

4 1.Interconnection 2.Uniform tariffs versus destination-based price discrimination 3.Above-cost termination charges 4.Call externalities 5.Predation attempts

5 Interconnected Networks Telecommunications networks were not always interconnected –Result was AT&T monopoly (until 1980s) Open Network Provision doctrine –All public telecommunications networks must give interconnection Maximize network externalities Avoid monopolization due to network externalities

6 Types of Access (1) One-way interconnection –Normally between incumbent and entrants National roaming Indirect access, resale, MVNOs –Main competition problems: Foreclosure through high access price or refusal Foreclosure through non-price discrimination or sabotage –Standard solution: regulation of access price and procedures / quality

7 Types of Access (2) Two-way interconnection –Non-rival: International calls International Roaming Fixed-mobile traffic (though increasingly rival) –Rival: (National) Termination of M2M traffic Traffic between fixed networks

8 Types of Access (3) Non-rival two-way interconnection –Main competition problem: Double marginalization due to –Independent retail and wholesale margins –Roaming customers ignorance about host network –Solution: (Retail or) Wholesale price controls (in particular relevant markets 16,17) Or voluntary limits through bilateral or multilateral agreements between operators

9 Types of Access (4) Rival two-way interconnection –Main competition problems: Non-cooperative choice of termination charges: –Double marginalization –Foreclosure of entrants Cooperative choice of (especially reciprocal) termination charges: –Collusion Leverage of network effects through tariff-mediated network effects? -> this paper

10 Literature Overview articles –Armstrong (2002), Vogelsang (2003) Books: Laffont and Tirole (2000), HBTEv1 Two-way interconnection: –classics on termination: LRT98a,b, Armstrong98 –call externalities: Kim&Lim01, Jeon et al. 04, Berger04, Cambini&Valletti05 –on/off-net discrimination: LRT98b, Hoernig05

11 1.Interconnection 2.Uniform tariffs versus destination-based price discrimination 3.Above-cost termination charges 4.Call externalities 5.Predation attempts

12 Principal Types of Tariffs Linear versus two-part tariffs –linear: constant price per minute –TPT: fixed fee plus constant price per minute –co-exist in menus –common variant: minimum consumption Uniform tariffs versus destination-based price discrimination –Uniform: same price to all networks –PD: on-net price different from off-net price

13 Uniform tariffs Quite rare in Portugal Since 2005: UZO, rede4, Vodafone Direct –uniform tariffs with 12 or 16 c/min Main advantage: simplicity –valued more by consumers who make few calls

14 Destination-based price discrimination Most common model On-net price lower than uniform price, and off-net price higher than uniform price Questions: –simply one more pricing instrument? –undue advantage for larger networks? –instrument of predation? –> good or bad for competition?

15 Drivers of On/Off-Net Differentials Termination charges –higher cost of off-net calls –Attention: need to distinguish clearly between F2M and M2M interconnection Strategic motives –Create tariff-mediated network externalities –Exploit call externalities –Predation (?)

16 1.Interconnection 2.Uniform tariffs versus destination-based price discrimination 3.Above-cost termination charges 4.Call externalities 5.Predation attempts

17 Termination: Fixed-Mobile Above-cost termination on mobile network is a subsidy paid by users of fixed network –Was considered justified when mobile penetration was still low: competition should increase number of users –Source of revenue for mobile operators Higher fixed-mobile termination charges during entry phase help new mobile entrants

18 Termination: Mobile-Mobile Reciprocal termination charges –Can be instrument of collusion (focus of economic literature on the subject) Individual (non-cooperative) setting of termination charges –(Double marginalization problem) –Instrument of foreclosure of rivals –Lead to adverse tariff-mediated network effects since rivals off-net prices increase accordingly especially for small networks

19 Termination charge at cost Result from academic literature: –On-net price = off-net price if termination price equal to cost –Implies that on/off-net differentials are simply cost-driven Only true if there are no call externalities –Only takes callers utility and decisions into account, but –People care about being called

20 1.Interconnection 2.Uniform tariffs versus destination-based price discrimination 3.Above-cost termination charges 4.Call externalities 5.Predation attempts

21 Call Externalities Utility of receiving calls! –Has long been neglected in the literature –Now at a focus of investigation Additional effects: –Possibility of hurting rivals consumers through higher off-net prices => fewer calls Therefore choice of higher off-net prices! –Significant on/off-net differentials even with termination prices at cost

22 Equilibrium Prices Model in paper: –in LRT tradition, adds call externality –focus on retail prices –assumes one large and one small network In Nash equilibrium, both for linear and two- part tariffs, –both networks charge more for off-net calls –larger network charges more and has higher on/off-net differential

23 Effect of Call Externality Stronger call externality leads to –insignificant changes in market share –lower on-net prices –(mostly) higher off-net prices –lower profits Competition for clients intensifies Conclusion: on/off-net differential is instrument of normal network competition

24 Simulation: call externality pii: on-net. pij: off-net. Gamma=0: no call externality. Termination at cost, thus pii=pij at left border.

25 1.Interconnection 2.Uniform tariffs versus destination-based price discrimination 3.Above-cost termination charges 4.Call externalities 5.Predation attempts

26 Predation Hypothesis Hypothesis: firm A tries to limit firm Bs profits –Short-term loss but long-term gain for firm A Question: What would on/off-net prices be in a predation strategy? –Clearly, lower on-net price –Lower off-net price to attract consumers? Or higher off- net price to harm other networks clients? –We can expect much larger on/off-net differential –Quantitative, not qualitative, question!

27 Predation Equilibrium If the large network predates in the above sense, then –Large network has high on/off-net differential –If termination price is above (below) cost then large network increases (decreases) off-net price in order to limit small networks termination revenue –Small network responds by lowering prices while maintaining differential –Large network profits suffer strongly

28 Simulation: predation Nash equilibrium at the right border. Predation lowers profits of firm 2.

29 Conclusions On/off-net differentials appear as a result of competition between networks, in the presence of –above-cost termination charges –strategic effects due to call externalities Even with a balanced calling pattern, small networks will tend to face permanent access deficits On/off-net differentials will be larger than in Nash equilibrium if there is anti-competitive intent –but making the distinction empirically is hard

30 Questions!


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