On 1 January, Reliance Jio rolled out a three-month “Happy New Year offer” as a follow-on to the “Welcome Offer” that started in October 2016. Customers rejoiced, incumbents complained, courts opined, and Jio offered smooth rationalizations. A few days later, Airtel rolled out a 12-month offer of free data, only for non-subscribers. Obviously, this is silly season in telecom services. Or is it?
We have alluded in this column to the Prisoners’ Dilemma, the phenomenon of the pursuit of self-interest leading to sub-optimal outcomes for all. This phenomenon manifests in many situations, including price competition in oligopolistic industries, where it leads to price wars of the kind we are seeing in telecom services.
Winner of the 2005 Nobel prize in economics, Robert Aumann, showed that if the parties in a Prisoners’ dilemma were engaged in an infinitely repeated interaction, then it was possible to observe cooperative behaviour, i.e. rational or even monopolistic pricing, in the case of oligopolies. However, cooperation requires the adoption of specific strategies by the oligopolists. In one of these, the tit-for-tat strategy, parties start off by cooperating, but retaliate in a similar fashion when they observe price-cutting behaviour. If they observe a return to cooperation, they revert to rational pricing. Provided that the players care about future payoffs, tit-for-tat strategies result in cooperation from the very beginning.
But cooperation is only one of the possible equilibria in the infinitely repeated Prisoners’ Dilemma. For instance, if one player chooses a low price in every iteration of the game no matter what the other does, then adopting a non-cooperative strategy makes sense for the other player. In the real world, for cooperation to emerge from all the different possibilities, an initial phase of signalling intentions is often required. In the telecom space today, we are seeing this tit-for-tat behaviour. This might signal to all parties that price wars will meet swift retribution and eventually result in the cooperative equilibrium after the industry consolidates.
Or it might not. A 1987 paper by Paul Klemperer attaches less significance to the repetition of interaction for the emergence of cooperation. Instead, it highlights the importance of switching costs, i.e. costs incurred by customers to switch service providers. The effort required to inform friends about a new phone number is an example of such a cost.
With high switching costs, successful undercutting might require prices to be so low that the undercutting firm makes more profits when it was sharing the market compared to when it has captured the whole market. Since the switching costs in telecom services are likely to be small (for example, phone numbers are portable across operators), cooperation may not be sustainable even after firms have successfully captured dominant market shares. Thus, in the long run, connectivity is likely to become a commodity and will not yield high profits even for dominant players.
This scenario of continued cut-throat competition in telecom services is all the more likely because, historically, on the Internet, value has accrued to those entities that become the fulcrum of successful vertically integrated networks. While the Internet developed through an open architecture where anyone could create a website and plug into the World Wide Web, its recent development has been in the form of “walled gardens” where interconnected devices, connectivity providers, content sites, and applications, all tailored to build out the Internet of Things, and available on the cloud, come together to provide a seamless end-to-end solution for the user. High switching costs and possibilities of super-normal profits are unlikely within the market for connectivity. However, they are a reality across the value networks created by the likes of Apple, Google, Facebook and Amazon.
In these interconnected value networks, the power lies not with the telecom service provider, but with the device manufacturer, the hosting service provider and the app developer. Google, for instance, has used its search engine, email service, office applications, social network, and e-commerce services to create a value proposition that customer cannot get enough of, and cannot get out of either. The recent $4.8 billion purchase of Yahoo! by Verizon indicates the direction that telecom companies are taking.
It is the diversion of attention from the sources of sustainable value that represents the most harmful aspect of the current price war. If the aim is to use a dominant position in the connectivity space to direct users to proprietary content and applications, then this will rightly run foul of net neutrality advocates who will object to the assumption of gatekeeping functions by connectivity providers.
Jio’s approach, and the response forced upon Airtel, are reminiscent of old-world hucksters out to make a quick buck. Or, in this case, lose a quick buck. It is only the creation or acquisition of ‘killer apps’ and compelling content that will allow telecom service providers to capture value. The present situation is a war of attrition that they would do well to get out of.
Meanwhile, as customers celebrate the free goodies, the regulator need not bother with Jio’s tactics or with its competitors’ howls of protest. The most pressing issue is how to deal with vertically integrated powerhouses like Google and Facebook that provide a compelling value proposition but also inhibit competition in various layers of the Internet market. Telecom operators and regulators need to realize that life, as Milan Kundera famously wrote, is elsewhere.
Rohit Prasad is a professor at MDI, Gurgaon, and author of Blood Red River. Game Sutra is a fortnightly column based on game theory.