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

In this paper, we examine how cross-market price restrictions impact strategic entry and pricing decisions. A motivating example is the 1996 Act in the United States which opens 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 multi-market model which features an oligopolistic urban market, entry auctions for rural service, and a price restriction across markets. Price restrictions induce a firm operating in both markets to become a ‘softer’ competitor, thus placing the firm at a strategic disadvantage. 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.