In the ICT sector, it is common for firms to supply a number of services. Network operators generally sell services in both competitive and non-competitive markets.
A firm with market power in one area may charge a high price for non-competitive services and use the proceeds to subsidize low prices for competitive services.
If the firm breaks even overall, a given service receives a subsidy if it does not generate sufficient revenue to cover its total service long run incremental cost (TSLRIC).
For example take an incumbent firm with market power in the provision of long distance calls. The incumbent could use its market power to charge high prices to long distance customers, and use the excess revenue to support low prices for internet access and undercut competing internet access providers.
By cross-subsidizing competitive services, a telecommunications firm can:
- Ensure that it covers its overall costs, including fixed costs, and
- Strengthen the firm's competitive position where it matters most, namely in the supply of its more competitive products.
Cross-subsidization will only maximize the firm’s profitability if the resulting gain in market share in the competitive market outweighs the loss in revenue from the reduced price. This is because the firm could still increase prices for the non-competitive service, even if it did not subsidize the competitive service. So its next best option would be to increase the non-competitive price and keep the resulting revenue.
RELATED INFORMATION
Remedies for Cross-Subsidization