A cross-subsidy may be anti-competitive when a firm with market power prices services in less competitive markets higher so that it can have lower price for services it sells into competitive markets.
Not all cross-subsidies are anti-competitive. Traditionally, telephone operators have cross- subsidized high-cost (under-priced) services from low-cost (over-priced) services:
· Line rentals or handsets from call revenues
· Residential customers from business customers in line rentals
· Country customers from metropolitan customers
Cross-subsidy has been important in driving adoption of both fixed and mobile services. But this worked only when access and calls were joint in both supply and demand, as with fixed monopoly and mobiles. With the introduction of competition for calls, cross-subsidies are “cream-skimmed” (Figure 2.4).
Figure 2.4: Cross-subsidy and Competition
New entrants do not complain about the above cross-subsidies as they provide scope for profit in serving low-cost markets. Competition is very good at attacking cross-subsidy.
Incumbents complain about “cream-skimming” competition allowed by the cross-subsidies above. So, regulators assist incumbents with price rebalancing to meet competition, which generally increases line rentals so that call prices can fall. This is a politically sensitive process because raising access prices disadvantages the poorer users who make fewer calls; so some policy direction may be needed.
Anti-competitive pricing can be difficult to identify. Ideally, competition drives prices to marginal cost. But in network industries, the cost curve declines across the range of possible levels of output so prices must be set above marginal cost to recover all costs. Since the network supports many different services, it is difficult to say which services are cross-subsidising others.
The remedies for cross-subsidization are preventative in nature:
· Implement and enforce a price floor,
· Require accounting separation of the costs of the firm’s competitive and non-competitive products.
Figure 2.5: Remedies for Cross Subsidization
For a firm that at least breaks even across all of its products, any single product receives a subsidy if the revenue it generates fails to recover its total service long run incremental cost (TSLRIC). Thus, the effective price floor in a test of whether a product receives a subsidy is:
TSLRIC of the service / number of units produced
For a multiproduct firm, the rule for preventing cross-subsidization requires that, for a firm that at least breaks even, every product must satisfy this price floor test.
The objective of accounting separation in this context is to separate the costs of the firm’s competitive and non-competitive products. This can be achieved through price regulation (either direct regulation, or a price cap). Such regulation can prevent cross-subsidization by allocating competitive and non-competitive products to separate “baskets”, with separate controls or rules for the each basket.