Promoting network competition by regulating termination charges

Abstract

This paper contributes to the policy debate about the optimal termination charge when penetration rates are explicitly taken into account. Although lowering termination charges towards cost leads to more efficient usage, its impact on consumer surplus is ambiguous since it induces an increase in fixed subscription fee through the so-called waterbed effect. We show that a reduction in termination charge below cost has two opposing effects on consumer surplus: it softens competition but also helps to internalize network externalities. Hence, it can decrease or increase penetration, depending on whether or not the first effect dominates the second. We show that the first effect dominates the second when networks are weak substitutes or the penetration rate is high.