Margin Squeeze in Fixed-Network Telephony Markets -- Competitive or Anticompetitive?

This paper looks at the effects of different forms of wholesale and retail regulation on retail competition in fixed network telephony markets. We explicitly model two asymmetries between the incumbent operator and a group of homogenous entrants: (i) while the incumbent has zero marginal costs, the entrant has the wholesale access charge as (positive) marginal costs; (ii) while the incumbent sets a two-part tariff at the retail level (fixed fee and calls price), the entrant can only set a linear price for calls. We model the product of the incumbent as horizontally differentiated from the products of the entrants, who are homogenous and do not have any market power. Competition from other infrastructures such as mobile telephony or cable is modelled as an "outside opportunity" for consumers. We find that entrants without market power might be subject to a margin squeeze if the wholesale access price is set at average costs and competitive pressure from other infrastructures increases. We argue that wholesale price regulation at average costs is not optimal in such a situation and discuss other forms of cost-based regulation, retail-minus and deregulation as potential alternatives.