When does tiered wholesale pricing create an incentive to reduce retail prices?

ABSTRACT

Wholesale ‘ladder pricing’ involves setting the wholesale price retailers face as a nonlinear (generally increasing) function of price chosen by retailers. This form of wholesale pricing occurred recently in UK Telecoms, and the issue became extensively debated in the law courts. A major concern in deciding the merits of the case lay with the question of whether or not the introduction of tiered wholesale pricing created incentives for retailers to actually reduce their prices. This paper examines the incentive for the case where the wholesale tariff is a non-linear continuous differentiable function. It is shown that so long as the tariff is strictly increasing, convex, and positive only for retail prices greater than the maximum retailer marginal cost, then there is indeed an incentive to reduce price, whatever the actual gradient of the tariff schedule.

KEYWORDS:

• Tiered pricing
• ladder pricing
• revenue sharing
• wholesale pricing

JEL CLASSIFICATION:

• C61
• D42
• L42

Disclosure statement

No potential conflict of interest was reported by the author.

Notes

¹ Mobile phone users often have a contract which may include ‘free minutes’, but NGN numbers often lie outside the package, and have to be paid for on a pence per minute basis.

² Dobbs (2013) gives a useful review of the issues involved.

³ This is a total cost function, so would contain many other variables; however, other than the volume of NGN calls, everything else is constant in the ensuing analysis, so the only variable of interest is the volume of NGN calls. Note also that any pre-existing uniform wholesale charge can be included in this cost function; the wholesalers introduced an incremental wholesale tiered price over and above any pre-existing charge.

⁴ To see this, take an exact first-order Taylor series expansion around the point K. Thus, we have where lies between K and p and is a function of p as p varies. Hence, define where since and this has to hold for all p – note as , the right-hand side converges on unity, and is everywhere an increasing function; hence, its value must lie everywhere below unity.