Mobile Network Interconnection and Investments

European mobile communication markets are two-stage markets which are composed of the infrastructure (the network and its components) and the service markets (telephony, mobile internet, SMS). In contrast to most other network-based markets there are multiple fully integrated providers which keep their own network and offer services on their network. Following continuously conducted market inspections of the European Commission, the revenue share of pure service providers is (still) below 10 percent in each of the member states. I concentrate on fully vertically integrated mobile network providers and analyze the effect of investments on wholesale charges for call termination, termination charges, and the amount of off-net traffic, that is the exchanged calling minutes between the investor’s and the competitors’ networks. If one network provider invests into its network to reduce the costs of service provision (or to increase service quality) it directly influences its offer and its prices. Lower costs enable the investor to reduce its service prices which should increase the traffic volume, what means the amount of calling in terms of the number of calls and duration. A competitor has to pay a network provider for terminating calls from its networks to the other network. If the provider of the terminating network invests it is able to reduce the termination rate which the other provider has to pay. As termination rates are costs for the other provider, the investment also affects the incoming traffic from competitive networks. The European Commission asks national regulatory authorities to regulate termination rates based on the so-called long-run incremental cost (LRIC) approach which encourages infrastructure investments. The investment incentive of this regulation scheme has been multiply proven in the literature. I show in a theoretical model that investments increase the amount of incoming traffic both to the investor’s and to the competitors’ networks. Moreover, the cost-reduction reduces the investor’s termination rates. The cost-reduction also lowers the investor’s termination rates but increases (in the absence of regulation), reduces (with LRIC regulation) or keeps the competitors’ termination rates constant (with standard cost-based or price-cap regulation). Employing data for the European mobile markets I analyze the theoretical results in a simultaneous estimation approach. While both the effects on off-net traffic and the effect on own termination rates are confirmed, I find a negative effect of investments on competitors’ termination rates which cannot be deduced from regulation. Moreover, considering the change in profits from call termination it exists a positive effect on the investor’s short-run profits but nearly no effect on competitors’ short-run profits though I find a change in termination rates and in incoming traffic to competitors. The empirical findings question the usually assumed importance of regulation for investment incentives. Moreover, investments and, in particular, the resulting change in off-net traffic volumes seem to be driven by interactions among the network providers.

Veith, Tobias (2009), Mobile Network Interconnection and Investments, ZEW Discussion Paper No. 09-071, Mannheim.