Strategic Interaction under Asymmetric Regulation - Adoption, Usage, and Global Impact of Broadband Technologies - page 32

the marginal benefit of the telephony component
was zero, not the marginal price of the call (How-
ell, 2008a). The four countries with widespread
'unmetered' voice telephony pricing' (i.e. 'free
local calling') - New Zealand, Australia, Canada
and the United States - exhibited some of the
earliest and highest rates of connection and usage
of dial-up internet access in the OECD, leading to
an endorsement of such pricing policies in order
to increase internet usage (OECD, 2000). Such
endorsement has likely been a significant factor
in the commonly-observed practice of offering
'unmetered' or 'flat-rate' broadband tariffs.

revenue-sharing acts as an inducement for the
otherwise hard-to-identify relevant customers
to 'self-select' by subscribing to the network in
the first place. Such inducements are also likely
associated with contract terms that discourage
signing with a rival 'locking customers in' for an
extended period of time 16 .
In 1996, Telecom and Clear negotiated a five-
year ICA. The agreement required Telecom to
pay 2c per minute for all calls originating on the
Telecom network and terminating on the Clear
network. The Clear payment varied from 1c to
2c per minute over time, on the assumption that
Clear's network size would increase. Discounts on
both sides were offered for off-peak calling. The
Telecom-Clear ICA became the prototype upon
which Telstra, Saturn, Compass and others sub-
sequently negotiated ICAs with Telecom (Karel,
2003). Whereas call origination and duration was
likely approximately symmetric when the ICA
was signed (as traffic was exclusively voice), the
emergence of the internet dramatically changed
calling patterns. Firstly, traffic generated on the
PSTN grew exponentially (Figure 2), induced by
'free local calling' as new internet users dialed
up to their internet service providers (ISPs). Sec-
ondly, as the vast majority of internet users were
Telecom fixed line customers, the vast majority
of this traffic originated on Telecom's network.
Thirdly, internet calls were very much longer in
duration than average voice calls.
Together, these factors created a classic ICA
arbitrage opportunity for Telecom's competitors.
As long as they could sign on the majority of ISPs
as customers, there would be a net flow of ICA
cash from Telecom to its competitors. Competitors
moved rapidly to sign on ISPs, offering substan-
tial cash payments as an inducement (Karel, 2003).
These payments were further shared by ISPs with
their customers, via reduced-cost or even free ISP
accounts. The heavier the internet use of an ISP
customer, the more valuable they were to Tele-
com's rivals, so there was intense competition
amongst non-Telecom ISPs to sign on the heavi-

'Free Local Calling' and
Interconnection Contract Arbitrage

To compensate for the costs of carrying the call to
its destination, classic interconnection contracts
(ICAs) typically require the owner of the network
on which a call originates to make a payment to the
owner of the network on which the call terminates
(Laffont & Tirole, 2002). Interconnection can be
billed by call or by call duration. The most com-
mon billing is by call duration. The rate will vary
depending upon the relative size of the networks.
Such ICA agreements have proved reasonably ac-
ceptable to both parties as long as the calls made
on each network are of the same length.
However, if the call origin or duration pat-
terns are asymmetric, the network operators
can engage in strategic selection of customers
in order to arbitrage upon the gains and losses
from interconnection revenues (classic 'adverse
selection' or 'cream-skimming'). Networks have
an incentive to sign on those customers who, on
average, receive longer calls from customers of
other networks than they make to customers of
other networks (e.g. call centres), as these calling
patterns generate net positive ICA cash flows to
the receiving network. Indeed, it is strategically
advantageous for a network operator receiving net
positive ICA revenues to share some of the gains
with the customers generating the revenues. The