Calling Circles and Network Competition (Microeconomics)
Investigação | 02 junho 2014 Calling Circles and Network Competition (Microeconomics)

The impact of calling patterns and their implications for network competition and market outcomes.
Researcher: Steffen Hoernig

The literature on competition between telecommunications networks makes a standard assumption of uniform calling patterns, where each subscriber is assumed to call each other subscriber with equal likelihood both on the same network and across networks. However, in reality users tend to concentrate their contacts in small groups, the “calling circles”. A recent paper by Steffen Hoernig (Nova SBE), Roman Inderst (Goethe-Universität, Frankfurt) and Tommaso Valletti (Imperial College, London) analyzes the impact of these non-uniform calling patterns and their implications for network competition and market outcomes. 

Calling Circles – users call “similar” users  
Modern communication networks allow users to easily establish a large number of links, both on the same network and across networks. Still, most users' contacts are often limited to a small fraction of all other users. Of these, frequent contact is only made with an even smaller set of people. These tend to be similar users, such as friends and family, or people with close social links, such as neighbors, students at school or university, or business user groups. This affinity is reinforced as networks' brand positioning often appeals to a particular age group, social stratum or professional class.

Standard assumptions contradicted
These observations contradict a standard assumption that is frequently made in the literature on competition between telecommunications networks: the assumption of uniform calling patterns, where each subscriber is assumed to call each other subscriber with equal likelihood. As calls between networks (off-net calls) involve the payment of access charges (also called termination rates), the assumption of a uniform calling pattern has consequences on how access charges impact on the market outcome. When networks competing in multi-part tariffs can set access charges jointly, a standard finding is that these would be set below cost, which in turn leads to higher prices for on-net than for off-net calls.

Calling Circles affect network competition and outcomes
In this article the authors address the above evidence by introducing non-uniform calling patterns in a tractable model of network competition. The authors suppose that it is more likely that subscribers with similar preferences are called than those further away in preference space They analyze how such concentrated calling patterns, with the resulting higher fraction of on-net calls, affect the equilibrium outcome.

Key findings: a different view on call prices and jointly set access charges
When calling patterns are uniform, economic theory predicts that under multi-part tariffs call prices should be set equal to (perceived) marginal costs. Instead, with non-uniform calling patterns, the authors find that networks optimally deviate from such marginal-cost pricing in order to price discriminate:
• On-net prices are set above, and off-net prices below, perceived marginal costs in order to extract rents related to consumers' concentrated calling behavior.

This research also identifies important implications for networks' choice of jointly profit-maximizing access charges. Under a uniform calling pattern, networks would agree on access charges below cost. However, when the calling pattern is concentrated, the proportion of on- and off-net calls of the marginal subscriber is less closely tied to market shares.
• This diminishes the role of tariff-mediated network effects, whereas profits from off-net calls gain in importance.
• Indeed, the researchers find that if calling patterns are sufficiently concentrated then networks will agree on access charge above cost.

This article is based on the paper “Calling Circles: Network Competition with Non-Uniform Calling Patterns” authored by Steffen Hoernig, Roman Inderst and Tommaso Valletti; published in the RAND Journal of Economics.

Know more about Steffen Hoernig, Associate Professor at Nova SBE.

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