Some Economics of Call Termination

1

• Some Economics of Call Termination
• Carlo Cambini
• Politecnico di Torino
• carlo.cambini_at_polito.it

Encore Workshop The Hague, 22 April 2008
2
Motivation call termination, a market failure

• Each Network Operator (NO) has monopoly power
  over the termination of calls on its network ? NO
  can set termination charges at the monopoly level
  without fearing competition from rivals.
• Evidence Competition Commission (2002),
  termination charges in mobile markets were 30 to
  40 in excess of a fair charge.
• New European Regulatory Framework (2002) ?
  investigation over fixed and mobile termination
  markets. Recent EU release confirms these markets
  into the new list.

3
Market power over access to a customer

• Calling party pays (CPP). Suppose A wants to call
  B. Bs network has market power over the price it
  charges A to terminate calls to B.
• This price is not taken into account by B when it
  chooses network.
• Externality potential source of problems.
• Issue for all carriers, independently from market
  share termination is a bottleneck to reach a
  particular customer.

4
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) due to the
  waterbed effect.
• 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).
• Only sender causes cost access charge
  recovered by terminating operator cost of
  termination (LRIC).

5
Regulation and the waterbed effect

• Intervention to cut termination rates -gt can it
  cause other prices to go up? The waterbed!
• Only anecdotal evidence
• Ofcom in UK (2006, 2007) it exists but is
  incomplete
• CC in New Zealand (2005) first did not believe
  it exists, then convinced it exists but not sure
  about practical relevance.

6
Empirical evidence

• Genakos and Valletti (2007)
• Strong evidence of a waterbed effect. Strong
  but not full (elasticity 0.33).
• This has antitrust implications market for
  subscription and outgoing interlinked with market
  for incoming calls.
• Implications in terms of remedies (welfare
  maximising regulated termination rates) if
  elastic subscription network externalities.

7
The economics of terminationthe two-sideness
of interconnection

• Why subscribe to a network? Ability to exchange
  messages between parties.
• But It takes two to tango !! (Hermalin and
  Katz, 2005).....Consumption involves both a
  sender and a receiver.
• Networks are platforms that bring together
  senders and receivers.
• Users typically subscribe to different networks.

8
The economics of terminationthe two-sideness
of 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 that
  positively affects the structure of
  traffic-sensitive retail prices.

9
How to solve the termination problem? CPP vs RPP

• RPP is a less intrusive remedy that could solve
  the problem of monopoly over termination as
  receivers, by being charged, would become
  sensitive to termination charges and prices would
  go down.
• Difficult instrument to implement
• Potential draw backs for both operators and
  customers (!?)

10
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. Problem of market definition
  ....

11
Bill and Keep Cambini and Valletti (JIE, 2008)

• Endogenous negotiations with call propagation
• Taylor (2004) a call in one direction
  stimulates something like one-half to two-thirds
  of a call in return ? call propagation effect
• This results is also confirmed in Andersson,
  Foros and Steen (2005) for mobile services.
• CPP vs. RPP empty debate if we do not say how
  termination is set.
• RPP already doable in Europe (intl roaming) and
  in many MNOs retail offers (with a negative
  price ..).

12
Bill Keep Cambini and Valletti (JIE, 2008)

• Relationship between termination and reception
  charges
• If termination is based on LRIC, receiver
  charges may not be introduced.
• If termination follows a BK system, more likely
  to be introduced.
• Termination may be offered at a zero cost (BK).
  This is efficient when receivers care about being
  called
• At present, F2M/M2M termination well above cost
  -gt no reason to charge own customers for
  receiving calls.
• Our results in line with US experience.

13
Dynamic efficiency of BK

• Network investments (Cambini and Valletti, EL
  2003 Valletti and Cambini, RAND 2005)
  Investment decisions are strategic subsitutes.
• Termination charges do matter for investments
  Firms tend to under-invest in quality if they can
  negotiate reciprocal termination charges above
  cost.
• Intuition when termination charges are above
  cost, an increase in own quality creates an
  access deficit that makes an operator reluctant
  to invest.
• Below-cost termination good both for investments
  and for efficiency. BK is not too bad after all??

14
CPP vs RPP the US experience

• Relatively lower penetration rate but much higher
  utilization. Lower revenues per minutes but
  higher ARPU.
• In US, introduction of innovative packages. In
  particular, bucket plans ? fixed fee applying
  both to incoming and outgoing calls.
• Pricing issues while in CPP countries mobile
  termination rates is on average equal to 0,16,
  call termination rates in the US are less than
  0,005 with obvious effect in terms of retail
  pricing (FCC, 2003).

15
An international comparison Minutes of use (Mou)
16
An international comparison Revenue per minute
(US cents)
17
An international comparison Average Revenue per
Units (US )
18
CPP vs RPP the US experience

• Marcus (2004)
• Call termination has a strong tendency toward
  symmetry in the rates charged for reciprocal
  compensation
• ILEC-CLEC and ILEC-mobile reciprocal compensation
  rates are generally symmetric, and set at a rate
  that reflects the marginal cost of the ILEC
• ILEC-ILEC, CLEC-CLEC, CLEC-mobile, and
  mobile-mobile reciprocal compensation rates are
  determined through voluntary negotiations, and in
  many cases are set to zero (bill-and-keep), in
  particular for ILEC-ILEC and mobile-mobile
  interconnection.
• Mobile operators formally also charge their
  customers for receiving calls (RPP). Anyway, flat
  contracts mitigate this effect.

19
Drawbacks of BK

• No disruptive effects on telecoms operators, like
  the US experience shows.
• What about traffic asymmetries? It seems to hurt
  more networks who have a net inflow of calls and
  so who terminate more calls .
• True if we apply BK to the present traffic
  level, but since wholesale charges change, also
  retail prices will change modifying the potential
  traffic imbalances .
• BK takes time to be implemented and refined
  but in the long run it could be a good solution!!

20
BK applied to the whole industry

• Must find a long-term structural solution.
• Two brave ways forward
• Remove regulation of M2F, and impose reciprocity
  -gt leave two truly bargaining parties to find the
  rate -gt should lead to BK!
• Impose BK across the board (not RPP), let then
  operators choose their own pricing structures
  (including RPP).
• Implementation in the medium run MRT should
  progressively tend to costs in the long run, MRT
  and FTR should converge to similar values.
• Then, BK could endogenously be a solution .

21
Thank you!