Strategic Commitments and the Principle of Reciprocity in Interconnection Pricing

Abstract

We examine the effects of strategic commitments and network size on equilibrium interconnection fees set by competing local telecommunications networks. Our goal is to analyze how the regulatory rules of symmetric reciprocity and parity applied to interconnection charges affect the outcome of network competition. Symmetric reciprocity means that both networks charge the same price for termination, whereas parity holds when a network charges its customers as much as it charges customers of the other network for the same service. Assuming that each consumer does not subscribe to more than one network and given subscription decisions, we begin by analyzing a game of strategic symmetry where the two networks choose prices simultaneously. Second, we allow a dominant network to set its interconnection fees before the rival network can set its prices. This results in a price-squeeze on the rival network. Third, we show that the imposition of a rule of symmetric reciprocity on termination fees eliminates the strategic power of the first mover. When this rule is imposed, at equilibrium one network chooses to set the common interconnection fee at cost, and prices for final services are lower than in the two previously-analyzed games without symmetric reciprocity. Moreover, prices under symmetric reciprocity obey the parity principle. In the long run, consumers subscribe to one of the two networks. Typically, there is a multiplicity of equilibria in the subscription game, including corner equilibria, where all consumers subscribe to the same network, resulting in monopoly. However, when the rule of symmetric reciprocity is imposed, corner equilibria are eliminated. Thus, the rule symmetric reciprocity reduces the strategic asymmetry in local telecommunications networks and increases welfare.