Reflections on on-net / off-net differential in developing markets

The differential between on-net and off-net prices on mobile telephony networks is an issue that is hotly debated between telecoms operators and regulators. Small operators contend that their competitors’ high off-net prices are anticompetitive forcing them to face aggressive on-net strategies to drive market (or sim) penetration at a cost of significantly increasing on-net versus off-net price differentials.

It is now widely recognized that new entrants in mobile markets face a barrier to entry due to the structure of prices charged by incumbent networks. In particular, on-net versus off-net price differentials create tariff-mediated network externalities which make larger networks more attractive to consumers than smaller networks. When on-net calls are priced below off-net calls, ceteris paribus, subscribers to large networks experience lower average call charges than subscribers to smaller networks, since more of their calls are made on-net. This makes larger networks more attractive and places smaller networks at a competitive disadvantage.

It’s therefore important to establish a determined strategy as a challenger since day one after commercial launch. Third, fourth or even fifth entrants should realize of the impact of diverse on-net and off-net strategies before launching them to the market. A problem for the smaller and challenger operator appears when someone knocks to your door asking for a wholesale agreement with the objective of launching a mobile virtual network operator. If this case occurs, the small operators should face the questions: is this interesting for me? and case it is: can I afford this?

This was, for example, the case of our client, a multi-operation african telecom provider, to whom we were supporting to define a successful MVNO business model and contract agreement between MNO and MVNO. Our client had a more-than-aggresive price per on-net minute and when defining the wholesale business plan, we saw that the numbers would hardly fly at a shareholders perspective because of the aggressiveness of the current retail on-net prices. How can you expect to close a win-win wholesale deal if your retail price can hardly offer a discount on top?

But this is not just a retail vs wholesale problem. Large price differentials for on-net and off-net calls are common in most developed and developing mobile markets. If networks don’t have (or have roughly equal) termination costs, economic efficiency requires equal on-net and off-net call charges.

Now, where do you establish the equilibrium in price differentials for on-net and off-net calls to react to incumbent and large operators? There is another case I’ve recently seen in Central America in a third mobile operator trying to compete against the incumbent through ultra-aggressive on-net and off-net promotions, incurring in more than a 45% premium discount in price calls. Our client thought that this positioning could fight against the incumbent while the incumbent’s pricing decisions were specifically designed for clear predatory activity against our client, i.e. trying to hold down its profits and reducing the “competitive punch” of the third entrant.

In our opinion our client’s pricing strategy has been a recurrent error as 1) they didn’t see the real objective of our competitor’s positioning and more importantly 2) our client’s strategy didn’t show the expected success (measured in billed traffic increase and/or customer acquisition) of such strategy in the last 12 months. In the meantime, our competitor has continued charging higher off-net prices even without anticompetitive intent.

Predatory behaviour will be surely accompanied by larger on-net/off-net differentials even if access charges are set at cost. the on-net vs. off-net differential is driven not only by the level of termination charges, but also by the utility of receiving calls (the call externality) and the relative size of networks. Net, net, the large networks charge significantly higher off-net prices, and set a higher on-net / off-net differential. This happens because the presence of the call externality gives incentives to the large network to limit off-net calls in order to make the smaller network less attractive. Thus even while a large differential may not be the main weapon for predation, it can indicate its presence.

Having written this, on-net vs off-net differential is a topic with lot of literature behind. After addressing this issue in niche markets in Africa and Latin America for several times, we are still passionate consultants about it. We have additional insights and tools to provide pragmatic and decision-oriented approaches to win the on-net vs. off-net disjunctive. Feel free to contact us for additional details.

Nice reading. Best regards.
 CVA