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Capturing network externalities: should a surcharge apply?

… in mobile markets with high penetration and coverage but with low mobile phone usage, higher estimates for network externality may result…

Want to know more about this topic? Contact our economic expert Suella email usHansen

The introduction of a network externality surcharge (NES) is a factor that can be included when determining termination charges, and is usually considered within the context of cost-based pricing regimes (Exhibit 1). However, the degree to which the effect of this component is felt would be a function of whether or not, and to what extent, it can be demonstrated that the introduction of such a subsidy would encourage more people to join the network.

Exhibit 1: Factors usually represented in network termination charges [Source: Network Strategies]
Factors usually represented in network termination charges [Source: Network Strategies]

It is generally appreciated that the greater the size of the network, the greater the benefit to all users and the greater the overall value of the network. Although the network externality concept and its effects on telecommunications networks and pricing are widely accepted, the development and implementation of models to capture those effects have been limited.

In 2003, a NES was implemented in the UK for mobile/cellular networks, based on the Rohlfs model. The UK approach to network externalities was also used in a study of mobile termination charges in Israel, in which the value of the network externality was found to be negligible. In contrast to the UK, Israel is characterised by an extremely high level of subscriber usage. As a result, a low estimate of network externality was anticipated given the high mobile penetration coupled with the high usage (Exhibit 2).

Exhibit 2: Selected characteristics of the mobile markets in various countries, including Australia, Israel and the United Kingdom (2006) [Source: ITU, regulators, Network Strategies estimates]

Country Number of mobile network providers Mobile penetration Coverage
(% of population)
Average monthly minutes of use per subscriber
Australia 4 97.0% 98.0% 83
Canada 5 57.6% 97.0% 350*
Finland 3 107.8% 99.0% 191
Hungary 3 98.9% 99.0% 98
Ireland 3 111.4% 99.0% 140
Israel

4

122.7% 99.7% 320*
Norway 2 108.6% 99.0% 142
Sweden 5 105.9% 99.0% 113
Switzerland 5 102.0% 100.0% 82
United Kingdom 5 116.4% 99.0% 101

* incoming + outgoing minutes

The introduction of an NES was also proposed in Australia in 2004. However, the regulator was of the view that although the concept in relation to telecommunications markets was intuitively valid, based on the highly mature state that existed in the mobile telecommunications market in Australia, the relative importance of “network externalities” would be low.

As reflected in Exhibit 2, Australia does enjoy high penetration, which suggests that the number of potential new mobile subscribers is very small, perhaps limited to the very young and very old, and so any existing non-subscriber population would likely be negligible. However, it could be argued that unlike the Israeli market, Australia ought to be concerned about the number and likely impact of marginal existing subscribers, based on the relatively low usage of mobile phones, which could be attributed to relatively high rates (Exhibit 3).

Exhibit 3: Affordability of mobile services in various countries, including Australia, Israel and the United Kingdom [Source: OECD, ITU, national regulators]
GDP per capita vs annual mobile revenue per subscriber

Low mobile traffic, particularly if due to high rates, tends to suggest that a lower utility is being derived from mobile phone ownership. As a result, there is a greater possibility that either a mobile phone will not be replaced at the end of its life, or if it is retained, minimal use will persist, such as to permit access in cases of emergency, to receive calls, or for safety reasons. In other words, it will not be seen by users as a viable replacement of the fixed line telephone, or as a cost-effective means for voice communications. Thus, in mobile markets with high penetration and coverage but with low mobile phone usage, higher estimates for network externality may result, which could support the introduction of a surcharge to keep those marginal subscribers on the network.

February 2008

 

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