Skimming the other's cream: Competitive effects of an asymmetric universal service obligation

Abstract

We consider a common situation in energy markets: an incumbent firm provides an 'essential' good under ubiquity and uniform pricing requirements, while competing in two-part tariffs with an entrant providing a non-essential substitute. We find that consumers' captivity to the essential good allows the incumbent to partly appropriate the surplus brought to the economy by the entrant. Surprisingly, the ubiquity requirement induces more aggressive pricing by the incumbent (below marginal cost) and reduced entry, despite "cream-skimming" by the entrant. Far from being a burden, universal service obligations might thus confer strategic advantages to incumbents. (c) 2006 Elsevier B.V All rights reserved.