A Retail Benchmarking Approach to Efficient Two-Way Access Pricing:Termination-Based Price Discrimination with Elastic Subscription Demand

We study how access pricing affects network competition when consumers'subscription demand is elastic and networks compete with non-linearprices and can use termination-based price discrimination. In the caseof a fixed per minute termination charge, our model generalizes theresults of Gans and King (2001), Dessein (2003) and Calzada and Valletti(2008). We show that a reduction of the termination charge below costhas two opposing effects: it softens competition and it helps tointernalize network externalities. The former reduces consumer surpluswhile the latter increases it. Firms always prefer termination chargebelow cost, either to soften competition or to internalize the networkeffect. The regulator will favor termination below cost only when thisboosts market penetration. Next, we consider the retail benchmarkingapproach (Jeon and Hurkens, 2008) that determines termination charges asa function of retail prices and show that this approach allows theregulator to increase subscription without distorting call volumes.Furthermore, we show that an informed regulator can even implement thefirst-best outcome by using this approach.