Strategic Pricing and Entry under Universal Service and Cross-Market Price Constraints

Recent changes in telecommunications markets raise the issue of how price restrictions across markets impact strategic entry and pricing decisions. The Telecommunications Act of 1996 opens all telecommunications markets to competition and contains a provision for universal service, requiring that advanced services be made available to rural customers at rates comparable to those for urban customers. We develop a simple multi-market model which features an oligopolistic urban market, entry auctions for rural service, and a price restriction across markets, and analyze strategic pricing and entry choices. We show how these price restrictions induce a firm operating in both markets to become a "softer" competitor, thus placing the firm at a strategic disadvantage relative to urban markets competitors. However, once we account for entry incentives and recognize that firms may bid strategically for rural markets, we find that the downstream strategic disadvantage becomes advantageous, leading to higher prices and profits in both markets. We also identify when these price restrictions put outside firms, even relatively inefficient ones, at a strategic advantage in entry auctions.