Economic theory of intercarrier compensation: twosided markets Tommaso Valletti Imperial College Lon

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Economic theory of intercarrier compensation
two-sided marketsTommaso VallettiImperial
College London and CEPR

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Two-sided markets and interconnection

• Why subscribe to a network? Ability to exchange
  messages between parties.
• Consumption involves both a sender and a
  receiver.
• Networks are platforms that bring together
  senders and receivers.
• Users typically subscribe to different networks.

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Two-sided markets and interconnection

• There are externalities (network call).
• Prices play a role in internalising
  externalities.
• Crucial role of interconnection intercarrier
  compensation rules affect efficiency and market
  structure.
• Two roles (at least) source of revenue affect
  the structure of traffic-sensitive retail prices.

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Who should pay for interconnection?

• Interconnection is costly. Cost causation.
• Does the sender cause costs by making a call? If
  so then the terminating network should recover
  from the sender (directly or indirectly).
• Does the receiver cause costs by accepting a
  call? Then the other way around!
• Originating network buys termination (access),
  or terminating network buys origination?
• Mere conventions. Outgoing and incoming services
  are complementary.

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Literature on two-way access pricing

• Earlier literature (Armstrong,
  Laffont-Rey-Tirole)
• Access charges affect retail pricing and users
  consumption decisions.
• collusive nature of access charges YES with
  simple (e.g., linear) pricing structures, NO with
  more sophisticated (e.g., two parts).
• Overall, not a big a concern for policy makers
  compared to one-way interconnection
  (foreclosure).
• Allow for reciprocal negotiations if possible
  (applies to M2M, not F2M).
• One crucial missing bit utility only from making
  calls, no interaction sender/receiver (no call
  externality).
• Only sender causes cost access charge
  recovered by terminating operator cost of
  termination (LRIC).

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More recent studies with receivers benefits

• De Graba
• Jeon-Laffont-Tirole
• Hermalin-Katz
• Cambini-Valletti

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Efficient pricing structures

• When sender benefits are a fixed proportion of
  total benefits from exchange efficient network
  utilisation attained when total cost allocated to
  sending and receiving parties in proportion to
  benefits received (DeGraba).
• Outgoing and incoming prices sum to marginal
  cost.
• With CPP, sender is king. Outgoing price should
  typically be below total cost to generate more
  calls.

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Unregulated (competitive) pricing

• Possible problem, connectivity breakdown using
  off-net discriminatory pricing (J-L-T)
• If users care a lot about receiving calls -gt set
  very high off-net price (punishe the rival
  relatively more).
• If users care a lot about sending calls -gt set
  very high reception charge (under RPP) which
  destroys the rivals ability to make outgoing
  calls.
• But, this problem much reduced in the presence of
  call propagation (call-back, Cambini-Valletti).
• Empirical evidence (1 call sent -gt at least ½
  calls received).

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Role of access charges

• When access below cost break-down problem much
  reduced (off-net price pushed down).
• Firms themselves have an interest not to induce
  break-down (e.g., by choosing low access
  charges) with b-d competition for customers is
  toughest!
• (Hold if no tipping effects.)
• If traffic is unbalanced targeted entry
  (Hermalin-Katz). Positive access charges induce
  entrants to target mostly users who receive calls
  but do not originate many -gt target fewer end
  users -gt soften competition.

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Bill keep

• Usage. Access charges affect efficiency via
  usage-sensitive retail prices. BK optimal when
  senders and receivers equally benefit.
• Connectivity breakdown. Reduced risk.
• Investments. BK increases investment! (Think
  about opposite, i.e., a gt LRIC. If network jumps
  ahead of a rival -gt traffic imbalances -gt access
  deficit! -gt No incentive to invest).
• Targeted entry. BK prevents strategic behaviour.
  Possible divergence between total welfare and
  consumer surplus. If entry needed to bring prices
  down -gt may accept even inefficient entrants -gt
  attracted only if can make targeted offers.

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Mobile networks
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RPP vs CPP

• RPP vs CPP.
• Empty debate if we do not say how access charges
  are set.
• RPP already doable in Europe (intl roaming). At
  present, F2M termination well above cost -gt no
  reason to charge own customers for receiving
  calls.
• BK might induce RPP without mandating it.

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RPP vs CPP
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Mobile-to-mobile vs fixed-to-mobile

• M2M vs F2M
• Very different economics
• Strategic interaction for M2M/(largely) no
  interaction for F2M
• Possible bargaining for M2M/no bargaining for F2M
  (asymmetric treatment of termination on fixed)
• Allow for differential treatment of the two sets
  of access charges (undone if no discrimination
  requirement).
• M2M BK should emerge!

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On-net/off-net price discrimination

• Typical complaint on-net prices of the large
  network are lower than its termination charge.
• Pon price on net, Poff price off net
• co origination cost, ct termination cost
• a (reciprocal) access charge (termination).
• A prohibition to have a higher margin off net
  (prevent predation)
• (1) (Pon co ct) (Poff co a)
• A prohibition to discriminate over incoming calls
  (prevent foreclosure)
• (Pon co ct) (a ct)

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On-net/off-net price discrimination

• co and ct are not easy to observe -gt set them to
  zero (a conservative assumption)
• (1bis) a Poff Pon,
• (2bis) a Pon.
• Typical complaint could mean principally that
  either on-net prices are below cost, or that the
  termination charge is far above cost.
• Important role played by access charges.

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• Danke schön! - Thank you!
• t.valletti_at_imperial.ac.uk
• http//www.imperial.ac.uk/people/t.valletti