Price Discrimination

Price Discrimination in the Mobile Phone Market

Mobile phones are nowadays a part of our lives, the majority of us use them on a daily basis. Some people use them less frequently, when they are away from their homes, while for some they have already replaced the old landline phone. Young people use the SMS and MMS services quite often, while more senior people limit themselves to just making calls . Some prefer the pay-as-you-go; others have monthly contracts for a flat fee. There are a variety of ways we can use mobile phones, and this comes, of course, at different prices. This essay focuses on how mobile phone operators discriminate among consumers and charge by charging them different prices. The essay is divided into two parts: the first part is focused on the three types of price discrimination, while the second analyses why price discrimination is possible.

Types of Price Discrimination

Price discrimination is the ability of a firm to charge different prices to different consumers. By charging consumers the price they are willing to pay, a firm can increase its profits at the expense of consumers’ surplus (see Figure 1.) This, of course, happens when that firm has market power to discriminate-when the market is oligopolistic or the firm is a monopoly (there is little price discrimination in the market for washing powder, for example).

There are three degrees of price discrimination: the first degree means charging each consumer as much as she wants to pay, therefore extracting all the consumer surplus (see Figure 1). This is difficult to put in practice, as one cannot know the willingness to pay of each consumer. The alternative is to offer as many products as possible, letting the consumer reveal her willingness to pay. E.g. various combinations of handsets and price plans, bundles of text or picture messages, phone insurance, etc.

The second degree price discrimination means charging a different unit price depending on the quantity purchased (non-linear pricing). This attempts at capturing the surplus of the �marginal’ consumer, by charging a lower price. For example the peak/off-peak discrimination: charge less when the demand is more elastic, i.e. at off-peak times. In both cases, even if the average tariff is lower than the standard tariff, it is still profitable because it is above the marginal cost. Mobile phone operators have large sunk costs, like setting up the network, but once these costs are paid, the marginal cost is close to zero. If the network has spare capacity- for example during off-peak times- then the marginal cost is virtually zero. Another way is to offer individuals a choice between a monthly contract and a pay-as-you-go one. The first comprises a high fixed cost and a low marginal cost, while for the second the opposite is true: no fixed costs, but high marginal costs.

The third degree price discrimination means charging different prices on different segments of the market. One possibility is to segment the market into individual and institutional consumers: different deals are offered to firms, as opposed to individual users. Another example is offering “student deals”: students are consumers without an income, so they are less willing to pay the standard price. That’s why the mobile phones operators rolled out student deals, based on a lower average tariff.

The Causes of Price Discrimination

As mentioned earlier, price discrimination occurs where the firms have the market power to discriminate. This is the case in oligopolistic markets, like to market for mobile phones. So why, in the first place, isn’t there a competitive market for GSM operators? There are three reasons for this: first, licensing. The government offers GSM licenses for auction, thus limiting the number of operators. Second, consumers face high switching costs. These costs are imposed upon by the GSM operators themselves: standard contract for at least 12 months, high cross-network charges (“interconnection fee”), phones being locked on a particular network. For this reason you’ll never see a dual-sim phone produces by a major phone maker. Their biggest clients are the GSM operators themselves, and they do not want you to be able to change networks easily. Third, there are high entry costs related o setting up the physical mobile network.

Looking at the competition among GSM operators, Vadafone Romania, we notice that they seldomly compete in prices. Instead, they compete in offering a better handset or othe related services. To understand why they don’t compete in prices, we need to look at the Bertrand model of oligopolistic