Facility based competition in telecommunications

In this paper we study network competition when costs differ among interconnected networks. Such cost differences are observed in the mobile sector as well as in fixed networks. In the paper we find that cost based regulation will not result in first best market shares. The low cost firm will be too small in equilibrium. This is partly due to tariff mediated network externalities. This result is in contrast to the standard result in the literature on network competition where one assumes symmetric cost structure. In the present paper, the regulator can induce a first best market equilibrium by combining cost based regulation of termination rates with a tax based on the number of subscribers. If such a tax is not an available instrument, the regulator can improve welfare by granting a termination margin to the low cost firm as compared to cost based regulation.