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

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

On/Off-net Pricing on Asymmetric Telecommunications Networks

Steffen HoernigFEUNL, Lisbon; CEPR, London

ICP-Anacom, 08/05/2007

Overview

1. Interconnection2. Uniform tariffs versus destination-based

price discrimination3. Above-cost termination charges4. Call externalities5. Predation attempts



Interconnected Networks

• Telecommunications networks were not always interconnected– Result was AT&T monopoly (until 1980’s)

• 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 B’s 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 network’s 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 network’s 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

Questions!

Documents

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