Originating in the work of Armstrong (1998) and Laffont, Rey, and Tirole (LRT, 1998a,b), theories about competition in the Telecommunications industry have been placed within the framework of horizontal product differentiation models. The literature is summarized in a recent survey article by Armstrong (2003).
One of the recent and controversially debated issues within this literature is that of the ’correct’ termination charge for the Telecommunications industry, which results from the need of different networks to interconnect when consumers make ’off-net’ calls. Clearly this debate had no precedent at the time when there was only a (state owned) monopoly incumbent in the industry. One branch of the theoretical literature is concerned with the possibility to sustain collusive outcomes using the termination charge which allows networks to increase each others’ perceived costs (see LRT, 1998a,b). This scope for collusion is pervasive with linear tariffs as a high access charge makes efforts to expand market share by price cutting very costly. Introducing a fixed charge (non-linear tariffs) into the analysis implies that the collusive effect vanishes by allowing networks to engage in fixed charge competition without incurring access deficits.
Assuming both non-linear tariffs and network based price discrimination, a paper by Gans & King (2001) investigates the optimal choice of reciprocal access charges and finds that such optimal charges will be below cost so that call termination is in fact subsidized. A model that looks at the character of equilibrium with non-linear tariffs, network based price discrimination, and competitively chosen non-reciprocal access charges has been absent so far but is considered a most valuable area for research (Armstrong, 2003, p.373).
Important and yet unresolved practical questions that a theoretical model of the industry should set out to answer are positive such as: ”Why are access charges commonly perceived as being substantially above cost in a ’laissezaire’ regime, given that the existing theory of reciprocal access charges predicts that charges below cost are jointly optimal?”, and normative such as ”Should one allow inflated access charges as a hidden way to cross subsidize new networks and to encourage further entry into the Telecommunications industry or at least to prevent exit (see UK Competition Commission, 2003, p.90)?”.
In the present paper we model the outcome of a duopoly in the Telecommunications industry with non-linear, two-part tariffs and network based price discrimination using the basic framework of theoretical economics literature. In contrast to the previous literature we assume that networks choose access charges competitively and we show that optimally chosen non-reciprocal access charges will not preclude the existence of equilibrium in the model. We are also able to show that in equilibrium non-reciprocal access charges will exceed the true cost of termination.
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