Mobile Termination, Network Externalities, and Consumer Expectations

Abstract

We re-examine the literature on mobile termination in the presence of network externalities. Externalities arise when firms discriminate between on-and off-net calls or when subscription demand is elastic. This literature predicts that profit decreases and consumer surplus increases in termination charge in a neighborhood of termination cost. This creates a puzzle since in reality we see regulators worldwide pushing termination rates down while being opposed by network operators. We show that this puzzle is resolved when consumers' expectations are assumed passive but required to be fulfilled in equilibrium (as defined by Katz and Shapiro, AER 1985), instead of being rationally responsive to non-equilibrium prices, as assumed until now.

The welfare effects of mobile termination rate regulation in asymmetric oligopolies: The case of Spain

“…While the …xed fee decreases as the termination charge increases, …rms keep part of termination rents instead of passing them on to their customers; this explains why pro…t is decreasing in termination charge. As it is shown in Hurkens and López (2010), the partial waterbed e¤ect result is due to the assumption of passive consumer expectations. Nonetheless, we also observe in our asymmetric oligopoly model that lowering MTR does not always lead to increases in the …xed fee.…”

“…Moreover, these papers conclude that the need to regulate termination charges is reduced since the socially optimal termination charge would also be above cost. In contrast, Hurkens and López (2010) …nd that total welfare is maximized with termination charges at or below cost.…”

“…We will relax the assumption of rationally responsive expectations and replace it by one of ful…lled equilibrium expectations (as in Hurkens and López [2010]): First consumers form expectations about network sizes, then …rms set prices, and …nally consumers make optimal subscription or purchasing decisions, given the expectations and the prices. 2 In equilibrium, realized and expected network sizes coincide.…”

“…This is somewhat puzzling given the opposition by the industry and the intentions of NRAs (who are supposed to protect consumers) to reduce MTRs. Hurkens and López (2010) recently established a new theoretical result, that in fact predicts the opposite: consumers bene…t and industry loses from reductions in MTR. This new theory emphasizes the role of network externalities, and in particular, the role of consumer expectations.…”

Evaluating a Decade of Mobile Termination Rate Regulation

“…(12)). Other models that would generate a similar prediction on bills include those of Hoernig et al (2014) who model calling circles, Hurkens and Lopez (2014) who consider customers' expectations, and Jullien et al (2013), who deal with heterogeneous mobile calling patterns. For surveys on the existing literature, see Armstrong (2002), Gans et al (2005), and Hoernig and Valletti (2012).…”