‘On-net’ discounts – reduced rates for calling other subscribers on the same network – have been a feature of mobile phone tariffs and packages for many years. Historically, they have also attracted the attention of authorities regulating wholesale mobile termination rates, which affect the margins available on mobile traffic originating from other networks, and of researchers looking to understand the competition implications of on-net/off-net retail price differentials.
Comments by regulators that the recent EC recommendation on the lowering of European termination rates should all but eliminate any competition concerns around on-net pricing, may however be overly optimistic. Even small on-net/off-net differentials can have competition effects. Savvy mobile customers are not just better today at identifying attractive packages, they are also beginning to coordinate their behaviour across various social groups, making decisions to switch en masse. Some providers are facilitating such behaviour, for example by offering subscribers free pre-paid SIMs to hand out to their friends and family.
Recent dynamic modelling supports the view that even small price differentials can lead to substantial and enduring asymmetries. At the same time, customer coordination can raise switching costs, and customer perceptions about the strength of the larger players – shared widely through social networks and reinforced by operators’ own marketing – serves to create a level of inertia that may dampen network competition. Once lost, smaller networks may not be able to entice customers back, and the asymmetric market structures that result from mass migration to the networks of first movers may endure.
Tariff-mediated network effects
‘On-net’ discounts are reduced rates offered to subscribers – pre-paid and post-paid – for calling others on the same network. These may take the form of lower rates for calls to other subscribers on that network, or say a number of ‘free’ on-net minutes as part of a wider package. Such on-net discounts have been a feature of mobile phone tariffs and packages for many years.
Regulators setting wholesale mobile termination rates (MTRs) have historically shown a keen interest in on-net discounts, both because on-net prices might provide some guidance on the ‘true’ underlying cost of handling calls, and because MTRs have an immediate impact on the margins that are sustainable on mobile traffic that goes ‘off-net’ and hence on one operator’s ability to offer rates for calling another network that are competitive with the latter’s on-net rates.
The differentials between on-net and off-net prices have also been the subject of investigation by numerous academics; some concerned about resulting ‘tariff- mediated network effects’ and the ability of larger networks to tip markets in their favour, others highlighting the pro-competitive effects of such offers insofar as they may foster a level of inter-network competition.
Universal interconnection obligations deal with the direct network effects that have historically been analysed by economists, but leave in place the scope for tariff-mediated network effects.1
Whilst a subscriber to a particular network can reach all telephone customers regardless of whether they are connected directly to that same network, in the presence of on-net discounts, customers on the same network can be reached more cheaply. A subscriber may, therefore, have an interest in choosing the same network as most of the people that he/she calls on a regular basis.
An example of possible calling club effects
Assume there are two competing networks, Network 1 and Network 2. Assume further that there is a group of users who regularly call each other, labelled A, B, C and D. For the sake of simplicity, assume that each of these users makes one call per day of one minute duration to the other, so A makes and receives three calls (to and from B, C and D respectively), the same holds for B and so on. Assume that, initially, A and B are customers of Network 1, and C and D are customers of Network 2, with each network charging 20 pence per minute (ppm) for both on-net and off-net calls. This means that each user pays 60 pence per day for making calls, of which one is on-net and two are off-net.
If Network 2 now lowers the price of on-net calls to 10 ppm, say, this means that the cost of calling falls for C and D from 60 pence per day to 50 pence per day (as one of the calls made by each of these two customers is on-net), whilst the cost for A and B remains unchanged. By switching to Network 2, A can reduce her daily calling cost to 40 pence, as this would mean that two of her calls would be on-net. Making the switch would also reduce the daily calling cost for C and D to 40 pence, as one of the calls that was previously off-net would become an on-net call. This means that C and D have a strong incentive to persuade A to switch to Network 2.
If A has switched, the cost savings become even greater for B. By moving to Network 2 as well, B could reduce his calling costs from 60 pence per day to 30 pence, as all calls would then be on-net. A, C and D would as a result enjoy a similar reduction in their calling costs.
Note that the decision to switch networks becomes more attractive if the network that offers the on-net discount has a larger number of customers overall. This means that calls outside the closed user group are more likely to be on-net, removing any potential downside from switching. The larger network might, as a result, be able to increase its off-net charge and keep attracting customers.
This means that once a member of a tightly-knit customer group is attracted by an on-net offer from a provider, other members of that group may have a strong incentive to move to that network as well. One by one, customers may make the decision that enough of their contacts are on the new network to make switching an attractive proposition, as more of their calls would be on-net rather than off-net. The logic here is straightforward: low on-net charges with correspondingly high off-net charges make a larger network more attractive to a customer expecting more of his/her contacts to be on that larger network, and for every customer that goes on to join the larger network the attractiveness of the network increases further still. After a while, the larger network may begin to benefit from a ‘snowball’ or ‘runaway’ effect with the network getting much larger, much faster. In other words, the market may ‘tip’ in favour of the larger network.
Moreover, as customers begin to switch, the larger network may begin to benefit from cost efficiencies, say for example due to scale advantages. This could in turn allow it to offer deeper discounts still, until such times of course as the discounts are no longer necessary to retain customers and the size of the network is sufficiently attractive on its own to ensure customers do not switch to an alternative network.
Tariff-mediated network externalities can have substantial effects in the market place. For example, one recent study by Cabral (2011) suggests that asymmetries in mobile market shares brought about by on-net discounting may endure, and that markets may then spend a long time in an extreme equilibrium with a single dominating player before destabilising effects return it to a more symmetric point.2 Many of the theoretical models look at customers who call each other with a given probability and who choose their provider individually.
However, the literature has also begun to look at decisions made by customers as part of a social network, i.e. decisions that such groups of customers might make in a coordinated manner. For example, Birke and Swann (2010) have estimated the importance of tariff-mediated network effects and the impact of a consumer’s social network on their choice of mobile provider.3 The authors examined data from surveys of students in several European and Asian countries, and found that the respondents strongly coordinated their choice of mobile phone providers, but only if the provider induced the network effects in the first place.
Whether such co-ordinated behaviour amongst close-knit calling circles increases or decreases the effect of tariff-mediated network externalities is far from obvious. Vagstad and Gabrielsen (2004) point out that ‘calling clubs’ ought to reduce TMNEs, because consumers care about the identity and location of their favoured calling partners rather than necessarily the size of the network as a whole, and because they are able to coordinate – one user’s decision is no longer ‘external’ to another’s.4 Yet the assumption that consumers fall into self-contained calling clubs is itself not realistic, and this is set to be an active line of future enquiry.
By contrast, if coordination is costly (e.g. because the group will need to spend time and effort jointly researching and discussing the pros and cons of the different offers) and the cost increases with the size of the group, then once switched to join other friends on a network, it may be more difficult for a competing network operator to attract the now larger group. Once won over, certain coordinated calling circles might be even harder to win back without smaller networks offering significant discounts.
It is not just closed groups and tight-knit calling circles that might be prone to such coordination. Customers may also draw in others from a wider net of relations and contacts. For example, if a group that had switched was a group of students, they might also pass on the details of the offer to their parents, who in turn may co-ordinate with their own calling circles. An earlier study by Birke and Swann (2006) explored such network effects in a consumer’s choice of operator and found that even in the absence of any price differential between on-net and off-net prices, a disproportionate number of calls may be on-net and that individuals’ choices of network operator is influenced heavily by the choice of others within the same household.5 In other words, coordinating with family members is an important feature of customer switching behaviour.
The literature has also begun to consider the effects that may arise as a result of customer beliefs about the strength of certain market players or the speed with which different networks are expected to grow. Dube and Chintagunta (2010) find that strengthening indirect network effects can lead to a strong, economically significant increase in market concentration, highlighting the important role of customer beliefs.6 The authors consider that consumers will tend to pick the firm that they expect to have the larger network, irrespective of the actual behaviour of the firm, or for that matter, its size. Baraldi (2008) suggests that a start-up network would have to make significant investments in terms of subsidies in order simply to create the expectation that its network might be sufficiently large before it could realise any critical mass.7
All of this suggests that it is prudent for regulators to keep a watchful eye on actual market developments even as MTRs are reduced.
Belgium: In May 2009, the Belgian competition authority imposed the largest fine in the history of Belgian competition law (€ 66.3 million), on the mobile branch of the fixed incumbent Proximus. The operator was found to have abused its dominant position for mobile telephone services in 2004 and 2005 by a strategy of margin squeeze between its corporate on-net retail tariffs and the mobile termination tariffs charged to competing operators, in particular excluding rivals from the business market.8
Columbia: In 2009, the Communications Regulatory Commission (CRC) adopted a resolution regulating the differentials between prices of off-net and on-net calls charged by the dominant operator Comcel.9 In accordance with the determination, the differential between on-net prices offered by Comcel and the average price of off-net calls could not be greater than the mobile termination rate. At the time, the CRC noted that its regulations were a temporary measure to be lifted once network effects identified had been curbed and more balanced traffic patterns between mobile networks were achieved. The CRC is holding a further public consultation on a series of potential scenarios for the regulation of the retail mobile market.10
Kenya: In 2010, the Communications Commission of Kenya (CCK) made a decision to implement a price rule requiring dominant providers in the retail mobile market to adopt a price cap for off-net call prices to the level of their on-net prices.11 The price rule was introduced as the CCK took the view that the retail voice market was not effectively competitive as large operators were using large on-net to off-net pricing differentials and product differentiation of voice services to sustain a ‘club effect’ and curtail competition in the market.
Luxembourg: As part of its latest market review, the EC notes that the incumbent mobile operator offers free on-net calls as a part of its bundled offer and that alternative operators have criticised this product, since they are not able to replicate it given that they have to pay interconnection fees to the incumbent. The EC notes that this case has yet to be resolved.12
Portugal: It has been noted that low churn in the Portuguese mobile market has been attributed to such factors as the difference between on-net and off-net tariffs. In its 2005 review of the wholesale mobile termination market, the regulator ANACOM recognised potential competitive distortions associated with on-net off-net price differentiation in the Portuguese mobile market.13 ANACOM found this pricing practice was resulting in a high percentage of on-net calls. The regulator also noted that price differentials adopted by the two larger operators TMN and Vodafone, in combination with high MTRs, could foreclose competition from smaller operators in the market, which in its view, were placed at a competitive disadvantage in acquiring and retaining subscribers.
Slovenia: In 2009, Si.mobile the second largest operator in the market lodged a margin squeeze complaint in respect of Mobitel’s “Džabest” product, a post-paid package which offers a large amount of on-net minutes.14 In a supplementary complaint made in February 2010, Si.mobil argued that Mobitel’s conduct amounted to predatory pricing. While this case is still being investigated, the third largest operator in the market Tusmobil has also filed a complaint against Mobitel, on the grounds that the same package is priced anti-competitively and that the difference between the price of on-net and off-net calls are such that Tusmobil cannot attract any new customers.15
Turkey: In 2007 the regulator (ICTA) determined it necessary to impose a price cap on off-net calls, after a complaint filed by the operators Avea and Vodafone against the dominant operator Turkcell alleging the practice of setting high on-net/ off-net price differentials and pricing on-net calls below the regulated MTR.16 The ICTA imposed a price cap on off-net calls; and an ‘internal non-discrimination obligation’ on the dominant operator Turkcell.17 The off-net price cap was made applicable to all operators in the market while Turkcell was exclusively to abide by the internal non-discrimination obligation. The internal non-discrimination rule adopted by the ICTA prohibits Turkcell from setting average on-net tariffs below the lowest MTRs applicable to other operators.
Many of the packages offered by mobile operators appear to incentivise customers to coordinate their behaviour: cheaper on-net minutes, deeper discounts for calls to subsets of friends or family members on the same network, free SIMs to pass on to a handful of close friends or family members, and so on. They are aimed not just at post-paid customers, but also at the much larger group of pre-paid customers. In fact, one of the drivers of strategies to increase customer coordination may be that it is easy to take up pre-paid offerings coupled with the fact that customers likely to be in tight-knit groups are also more likely to be pre-paid customers (e.g. students or youth groups).
Whilst trying to induce such customers to switch en masse may bear the outward semblance of vigorous competition, discount structures of this nature can pave the way for larger networks to grow rapidly, and once asymmetries become large enough to reap real long-term rewards to the detriment of smaller competitors. The dynamic models of competition discussed above suggest that the increased coordination across customer groups could lead to swift market share gains for first movers, as tightly-knit calling clubs research alternatives, take advantage of offers in a coordinated manner, and draw in other members of their circle (who in turn bring with them further subscribers). The models also suggest that once tipped in favour of a larger provider’s network, asymmetric market structures may persist as groups that have switched en masse to join groups of friends on a network may be more difficult to win back. It may also be difficult for new entrants to gain traction when faced with a much larger established network. Faced with increased switching costs and the need to create an expectation of substantial growth, simply matching a larger network’s on-net retail tariffs would be likely to prove insufficient to attract customers to a smaller competitor. With wholesale call termination rates – even low ones – limiting the scope for off-net discounts, smaller rivals might struggle to offer compelling alternatives. The more asymmetric the market, the greater the difficulty faced by smaller networks. In other words, the customer coordination discussed above can lead to a dampening of inter-network competition and can lead to an equilibrium that revolves around extreme asymmetry, with the larger network dominating.
Given the risk to competition in the medium to long term, aggressive pricing practices adopted by larger operators might well raise legitimate competition concerns. This is especially likely where retail on-net calls (which comprise both call origination and call termination) are priced at a discount compared to wholesale call termination and the benefit of being on a larger network with a reputation for matching competitors’ offers is the main marketing message.
Keeping an eye on price differentials
Against this background, the view that on-net/off-net price differentials on competition are less important today than they were historically, and that they will disappear with tighter controls of MTRs, is potentially wrong. For example, in its recent statement on MTRs, the UK regulator Ofcom suggests that the lowering of MTRs (to pure LRIC without any mark-up for common costs) will serve to eliminate differentials altogether and with them competition concerns8 – a view that is consistent with that expressed by the EC in its recommendation on the treatment of fixed and mobile termination rates.9 Whilst it is true that lowering MTRs to LRIC will help reduce (though not eliminate) the scope for on-net/off-net pricing differentials, MTRs in a number of countries are not at LRIC at present and the strategic incentives of operators to offer on-net discounts are far from moderated. The changing nature of customer behaviour within mobile markets suggests that even small price differentials can have non-trivial competition effects, and that competition and regulatory authorities might wish to view discounting practices with caution. Indeed, a handful of recent cases (see the box on the right) suggest that concerns around on-net/off-net differentials despite lower MTRs are bubbling up worldwide.
Interestingly, competition authorities have considered some of these cases, whilst telecommunications regulators have assessed others. This is likely to be a reflection of the difficulty in identifying the appropriate authority for complaints. Regulators seem to be of the view that once MTRs are at LRIC, their job with respect to the promotion of competition is done, and that competitors would have to turn to competition authorities to pick up any complaint under the auspices of competition law – say as a margin squeeze, predation or price discrimination case. However, competition law requires a finding of significant market power (SMP), which may not exist at the time of a complaint being made, say if the market is moving towards a tipping point but has yet to tip. Yet, if a complainant were to wait until such time as the rival held a position of SMP, it may well be too late to reverse any resulting market asymmetry.
One option may be for regulatory or competition authorities to consider such issues as part of a market investigation or study, where structural features of a market are assessed to determine whether or not they may restrict or distort competition. However, even here it is unclear how such issues may be addressed before a market has tipped, given that the concern relates more to hysteresis in consumer switching patterns than to clear structural features of the market.
There is no easy answer, but national authorities may wish to provide operators with some level of guidance as to the appropriate legal framework under which such complaints might best be brought, the supporting evidence that may be required and the cost tests that would likely be adopted in the assessment of the alleged abuse.
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- Direct network effects arise where a customer’s valuation for a product increases directly as a result of other consumers buying into that same product – the extreme case being captured in the well-known adage that there is no point in being the only person with a fax machine. [↩]
- See “Dynamic Price Competition With Network Effects”; L. Cabral, 2011, Review of Economic Studies (2011) 78, 83–111. [↩]
- See Birke, D and G. Swann (2010) “Network effects, network structure and consumer interaction in mobile telecommunications in Europe and Asia”, Journal of Economic Behaviour & Organization, 153-167. [↩]
- See Vagstad, S and T.S. Gabrielsen (2004) “Why is on-net traffic cheaper than off-net traffic? Access markup as a collusive device and barrier to entry”, Econometric Society Australasian Meeting, 2004. [↩]
- See Birke, D and G. Swann (2006) “Network Effects and Choice of Mobile Operator”, Journal of Evolutionary Economics, 16 (1-2), 65-84. [↩]
- See Dube, J-P and P. Chintagunta (2010) “Tipping and Market Concentration with Indirect Market Effects”, Marketing science 2010, 216-249. [↩]
- See Baraldi B, (2008) “Network Externalities and Critical Mass in the Mobile Telephone Network: a Panel Data Estimation”, unpublished. [↩]
- Press Release of The Belgian Competition Council 26 May 2009 [↩]
- CRC Resolution 2066 of 2009. [↩]
- CRC, Consulta Publica – Escenarios Regulatorios para el Mercado “Voz Saliente Movil”, (2010). [↩]
- CCK, Kenya, Interconnection Determination No. 2 of 2010. [↩]
- “Commission staff working document: Progress report on the single European electronic communications market (15th report)”; European Commission, 2010. [↩]
- ANACOM, Decisão – Mercados grossistas de terminação de chamadas vocais em redes móveis Individuais, 2005. [↩]
- European Commission, Case COMP/39.707 Si.mobil / Mobitel. [↩]
- Slovenian Press Agency “Mobile Operator Tusmobil Claims EUR 83M in damages from Telekom”. [↩]
- Atiyas, Izak (2010),. “Regulation and competition in the Turkish telecommunications industry: an update.” In: Çetin, Tamer, Oguz & Fuat, The Political Economy of Regulation in Turkey. [↩]
- Turkcell, U.S. SEC Form 20-F (27/05/10). [↩]