Why is on-net traffic cheaper than off-net traffic? Access markup as a collusive device

Mobile telephony networks typically overcharge each other for the termination of incoming calls, leading to high prices for off-net traffic. The existing theory claims that this behavior reduces profits since high termination charges make firms set high marginal prices, thus leading to lower subscription fees and reduced profits. This paper bridges the gap between theory and reality by incorporating several assumptions in a model that reflects the reality of mobile telephony markets. One of the key assumptions is the fact that subscribers tend to place their calls to a limited number of people consisting mostly of friends and relatives. The existence of such calling clubs, combined with switching costs, supports high access fees at the equilibrium. We also discuss the implications of our analysis for EU regulation.