In the U.S., consumers are charged for both sending and receiving calls. In Ireland, they are only charged for making mobile calls. What might explain this difference?
There are considerably fewer mobile phones per capita in the U.S. as opposed to Europe. There is also greater income inequality. These may be the proximate causes, or the former could just be an effect of the pricing mechanism.
Traditionally, the difference is explained by ‘termination rates’ – the charges that mobile phone networks levy on each other for connecting an incoming call from another network’s customer to one of their own. Unfortunately, this is only a symptom and not the cause.
Firms basically have the option of charging their own customers for receiving calls from other operators, or charging the rival operator for connecting the call. In Europe, they typically choose the latter.
Obviously, that cost is borne by the consumer making the call. Between large networks, the net transfer of funds is probably very low. However, smaller networks may find the variability in the ratio of calls made to other networks relative to calls received from other networks a barrier to entry.
For larger firms, it will be more predictable and thus easier to bare. If European markets are less competitive and exhibit greater concentration of power in the hands of a few powerful firms, that might explain why they favour their system of pricing. It makes it more life more difficult for small firms.
The side-effect of not being charged for receiving calls may however benefit consumers. It allows individuals greater control and freedom over their spending, as friends with different incomes or spending capacity essentially pool the joint expenditure on their mutual conversations.
In each case, the call will be made by the ‘spender’ party who is most willing to bear the cost – although in the long run, it may often be reciprocal. ‘Cheapskates’ that don’t wish to spend money on calls can spend less on texting or just receiving calls.
The catch is that ‘spenders’ making calls are charged much more, as they are less sensitive to price. The market is more efficient though as the firms can practice price discrimination, tailoring prices to their customers and selling more phones at lower cost. This theory explains why mobile phone penetration is so much higher in Europe.
But if this is more efficient, why does the receiver pay in the U.S.? It might be explained by greater income inequality. Remember that there were just under 850 mobile phones per 1000 persons in the United States in 2007, as opposed to over 1200 in Ireland.
The European system is predicated on profits are made on cheapskates because the marginal cost is so low. It might no longer work though if there aren’t enough spenders to go around, and there are too many cheapskates.
In order for that same arrangement to work, prices would need to be so high that spenders were eventually chilled to the prospect of making calls. They’ve reached their limit, so we can no longer involve and make money off the cheapskates through price discrimination. If we allow cheapskates to receive calls for free and send cheap texts, they’ll just mooch off the system.
They need to be stopped, so hence charges need to be introduced. But also it makes sense to charge spenders for both making and receiving calls, since they constitute more of the market and are our primary concern.
The decision to make the call is always borne by the caller, but now the cost is suffered by both sender and receiver. That makes it more likely that people will make more calls, and spend more on their mobile phone than they otherwise would.
Think of making phone-calls as having the option whenever you wanted of a cheap meal with friends in your favourite restaurant, where the bill is split in equal slices. If you had such an arrangement, you’d probably want to go there a lot more than if you were charged the full bill. Unfortunately, your friends would feel the same way about their favourite restaurant, and drag you along as well at your expense. Everyone spends more.
The result is that American firms are maximising profits in the best way that they can – which means lower mobile phone penetration, higher usage amongst users, and charges for receiving calls. Meanwhile, European spenders and cheapskates are able to find a mutually beneficial arrangement – critically reliant on income demographics.
© The Free Marketeer 2009