Empirical Evidence on the Relationship between Mobile Termination Rates and Firms' Profits

• DOI: http://doi.org/10.1111/sjoe.12125
• Published date: 01 January 2016
• Date: 01 January 2016

Scand. J. of Economics 118(1), 129–149, 2016

DOI: 10.1111/sjoe.12125

Empirical Evidence on the Relationship

between Mobile Termination Rates and

Firms’ Profits∗

Kjetil Andersson

University of Agder, NO-4630 Kristiansand, Norway

kjetil.andersson@uia.no

Øystein Foros

NHH Norwegian School of Economics, NO-5045 Bergen, Norway

oystein.foros@nhh.no

Bjørn Hansen

Telenor, NO-1331 Fornebu, Norway

bjorn.hansen@telenor.com

Abstract

The theoretical literature on mobile termination rates (MTRs) is inconclusive on how the

level of MTRs affects overall consumer charges and firms’ profits. We show that when fir ms

offer bundles with fixed included usage – a tariff structure that has become more common

in recent years – an identical change in all MTRs does not affect firms’ retail prices or

profits. We use a panel dataset from saturated European markets to estimate the effect of

MTRs on mobile operators’ profits. As predicted by the theoretical model, we cannot reject

the fact that firms’ prof its are unaffected by an identical change in all MTRs.

Keywords: Competition; mobile communication markets; regulation

JEL classification:C23; L21; L51; L96

I. Introduction

When a telephony subscriber calls a subscriber on another mobile network,

the originating network operator pays a fee per minute to the terminating

mobile operator; this is called the mobile termination rate (MTR). Since

the mid-1990s, the levels of MTRs have been a topic for disputes, both

between market players and between market players and policy makers.1

∗There is a previous version of this paper (Andersson and Hansen, 2009). We are grateful

for helpful comments from Kjell Arne Brekke, Espen R. Moen, and seminar participants at

the Norwegian School of Management, NTNU, and the ZEW 2008 Conference on ICT.

1Armstrong and Wright (2009) note that the UK governmental reports on termination rates

aggregate to several thousand pages. Reductions in MTRs have also encountered many

CThe editors of The Scandinavian Journal of Economics 2015.

130 Relationship between MTRs and firms’ profits

The European Commission wants to reduce the level of MTRs, the conjec-

ture being that firms have incentives to agree on high MTRs as a collusive

device.2

Theory predicts that a firm always has an incentive to unilaterally in-

crease its own termination rate. This arises from the competitive bottle-

neck problem. When consumers subscribe to only one mobile operator

(single-homing consumers), the operators have exclusive monopoly power

in providing termination (i.e., allowing subscribers on other networks to

call its customers). The competitive bottleneck problem is a general prob-

lem in two-sided markets where consumers are single-homing (Armstrong,

2006). For fixed-to-mobile calls, where fixed-line operators face restrictive

one-sided regulation of termination rates, mobile operators thus have an

incentive to raise termination rates (e.g., Armstrong and Wright, 2009).3

In contrast, for mobile-to-mobile calls, termination rates are often set

reciprocally. The theoretical literature is then inconclusive on how MTR

levels affect overall consumer charges and fir ms’ profits. The outcome

depends on the type of retail tariffs.4In the case of linear retail pricing with

no discrimination, based on whether the receiver of a call subscribes to the

same network as the caller (on-net calls) or a rival’s network (off-net calls),

Armstrong (1998) and Laffont et al. (1998a) show that firms might use

high MTRs as an instrument to soften competition by raising each other’s

marginal cost. However, linear tariffs (no other charges than per minute)

are rarely observed, and Laffont et al. (1998a) demonstrate that the profit

raising effect from increasing MTRs disappears when networks compete in

two-part tariffs. Any increase in termination revenues from higher MTRs

is passed on to consumers in the form of reduced subscription fees – a

so-called waterbed effect.5Gans and King (2001) show that if two-part

tariffs are combined with network-based discrimination (the call prices

reports from market players. See, for example, Frontier Economics (2008), a report prepared

for Deutsche Telekom, Orange, Telecom Italia, Telefonica, and Vodafone.

2Recently, there has been a change in the Commission’s approach. Previously, the level

of regulated MTRs was based on a principle of coverage of common and fixed costs

(e.g., Armstrong and Wright, 2009). The current approach is that MTRs should reflect the

incremental costs of providing termination services (European Commission, 2009).

3By the same token, in media markets, for example, a newspaper has exclusive market power

in delivering single-homing readers as eyeballs to advertisers (see Anderson and Coate, 2005,

for an influential contribution).

4Armstrong (2002) provides a comprehensive review of the early literature. Hoernig (2014)

and Armstrong and Wright (2009) synthesize and summarize the subsequent literature.

5Dessein (2003) and Hahn (2004) extend this basic model to allow for customer hetero-

geneity. They find that the profit neutrality result still holds when the networks compete in

menus of non-linear tariffs (as long as all customer groups participate in equilibrium).

CThe editors of The Scandinavian Journal of Economics 2015.