© Frontier Economics Ltd, London. Mobile termination: what is the right charge? Presentation of paper by G. Houpis and T. Valletti to the ITS conference, Berlin George Houpis 6 September 2004

Outline of presentation Why is mobile termination an issue? Setting optimal fixed-to-mobile termination charges: a simple model The regulatory approach so far Conclusions

Mobile termination: why is it an issue? For operators: Fixed-to-mobile (F2M) termination revenues typically account for c. 30% of revenues For regulators: Termination bottleneck under Calling Party Pays: Inefficiently low fixed to mobile calls Inefficiently high number of mobile subscribers/mobile outgoing calls In UK: more than 60% reduction in F2M termination rates (up to 2006), since regulation introduced (1998) Increasing trend to intervene to regulate directly fixed-to-mobile termination charges

Setting optimal fixed-to-mobile termination charges: the literature Standard F2M results * in simple model: Unregulated F2M Profit max (Pmax) charge > Cost = Welfare maximising (Wmax) Additional assumptions in the literature modify, but do not alter this main result: In the presence of network externalities: F2M Pmax > F2M Wmax > Cost In the presence of fixed and common costs: similar result Inclusion of mobile-to-mobile calls Literature “asymmetry”: 2-way v 1-way access * For example Armstrong’s chapter 8 in Handbook of Telecommunications Economics, 2002

Setting optimal fixed-to-mobile termination charges: the model Used developments in mobile-to-mobile literature, to understand impact on fixed-to-mobile Key issues: Competition between mobile operators (model as “Cournot”) Realistic assumption of regulator having only one instrument: “3 rd best” Model assumptions: Consumer’s demand can differ with two options: All consumers make the same number of calls once they subscribe (marginal call consumption = average) Consumers differ in the number of calls they make, once they subscribe (marginal call consumption < average) Take into account network externalities Remaining assumptions are standard: no fixed/common costs, no call externalities, CPP

Model results If: The mobile market is not “perfectly” competitive (PC); and The regulator can only set the fixed to mobile termination charge The results are: Unregulated F2M Pmax > F2M Wmax 3 rd best > F2M Wmax PC > cost The welfare maximising termination charge is higher if marginal consumption is lower than average consumption In a model simulation with 2 mobile competitors, the optimal (3 rd best) fixed to mobile termination charge is 20% higher than if the market is “perfectly competitive”

The regulatory approach so far Trend to stipulate ex ante regulation based on cost oriented F2M termination charges Although “cost orientation” allows flexible interpretation, in practice benchmark used or recommended is network Long- Run Incremental Cost (or variant). Some allowance for network externalities. Limited/no allowance for: Degree of competition Limited set of regulatory instruments Customer differentiation/heterogeneity Non-network costs & Ramsey recovery of fixed and common costs Welfare implications of getting it wrong could be substantial – for example setting termination charges at cost in our model simulation with 2 mobile competitors, could imply a welfare reduction of more than 20% relative to maximum that can be achieved Addressed by our model

Possible reasons for current regulatory approach 1.The fixed network legacy; No competition when access prices established “low” wholesale access prices to “bottleneck” facilities, generally seen as promoting competition for developed countries, limited externalities in fixed networks with incumbent USO Non-discrimination between approach to fixed and mobile 2.Regulatory needs ahead of theory/evidence genuine complexities in the modelling of interconnection between networks data/research to estimate required parameters

Conclusions Direct regulation of F2M termination charges under CPP growing and likely to continue Should aim to get the levels right – potential welfare effects of getting it wrong can be substantial Our results suggest that factors that will affect optimal termination charges include: Degree and type of retail competition Type of customer heterogeneity; and Significance of network externalities … and these are factors that should be assessed in practice.

Frontier Economics Limited in Europe is a member of the Frontier Economics network, which consists of separate companies based in Europe (London & Cologne) and Australia (Melbourne & Sydney). The companies are independently owned, and legal commitments entered into by any one company do not impose any obligations on other companies in the network. All views expressed in this document are the views of Frontier Economics Limited. George Houpis Frontier Economics Limited 71 High Holborn London WC1V 6DA United Kingdom switch: +44 (0) direct: +44 (0) fax: +44 (0) Contact details