Who Should Pay for Two-Way Interconnection?

• Authors: Angel Luis López and Sjaak Hurkens.
• BSE Working Paper: 111356 | September 15
• Keywords: Networks , rational expectations , Regulation , access pricing , Interconnection , Telecommunications
• JEL codes: D43, L13, L51, L96
• Networks
• rational expectations
• Regulation
• access pricing
• Interconnection
• Telecommunications

European and the US mobile communication services markets have developed in rather different ways. There are striking differences in termination regulation and retail pricing models and one may wonder why this occurred and whether either of the markets outperforms the other in terms of efficiency and/or profitability. We address these issues by analyzing a symmetric oligopoly model in which firms are able, but not obliged, to charge subscribers for receiving and placing calls, may discriminate between on- and off-net calls and may request a monthly subscription fee. We show that a continuum of equilibria exist for any reciprocal termination rate, some of which resemble the European business model (with zero charges for reception) while others resemble the US business model (with equal prices for placing and receiving calls). We show that under neither of these business models full efficiency can be achieved. Comparing the European business model with termination regulated at cost to the US business model with voluntary Bill and Keep arrangements we show that the European scenario is more efficient when call externality is modest, and more profitable when either call externality is modest and call demand elasticity high or call externality high and call demand elasticity low. Our predictions are consistent both with observed network operators’ opposition to lowering termination rates in Europe and with voluntary agreements to Bill and Keep arrangements in the US.