Strategic Commitments and the Principle of Reciprocity in Interconnection Pricing

Abstract

We discuss the effects of strategic commitments and of network size in the process of setting interconnection fees across competing networks. We also discuss the importance of the principles of reciprocity and imputation of interconnection charges on market equilibria. Reciprocity means that both networks charge the same for interconnection. Imputation means that a network charges its customers as much as it charges customers of the other network for the same service. Assuming that each consumer cannot subscribe to more than one network, we begin by analyzing a game of strategic symmetry where the two networks choose all prices simultaneously. Second, we allow a dominant network to set the interconnection fee before the opponent network can set its prices. This results in a price-squeeze on the rival network. Third, we show that the imposition of a reciprocity rule eliminates the strategic power of the first mover. Under reciprocity, one network sets the common interconnection fee at cost, and the equilibrium prices for final services are lower than in the two previous games without reciprocity. Moreover, prices under reciprocity obey the principle of imputation. In the long run, consumers subscribe to one of the two networks. Typically, there is a multiplicity of equilibria, including corner equilibria, where all consumers subscribe to the same network. However, under reciprocity, there are no corner equilibria.

Keywords: Two-way networks, interconnection, reciprocity, parity, two-sided bottlenecks

JEL Classification: L1, D4