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
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
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
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
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
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
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
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
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?
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 (?)
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
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
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
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
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
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
Simulation: call externality pii: on-net. pij: off-net. Gamma=0: no call externality. Termination at cost, thus pii=pij at left border.
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!
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
Simulation: predation Nash equilibrium at the right border. Predation lowers profits of firm 2.
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