Limit Pricing through Price Discrimination: A Theoretical study among Telocommunication Companies in East Africa

Limit pricing, which Competition Authorities view as anti-competitive and illegal, is an interesting issue in industrial organization. This is a case where firms with market power charge a price that is lower than their operational cost in order to prevent the entry of new potential competitors or drive out their smaller competitors out of business. This research paper examines limit pricing theoretically among telecommunications companies in the East African Community. The Community has experienced a consistent drop in mobile network service prices since the year 2000 with the smaller mobile network operators blaming their dominant counterparts for initiating these price cuts. These dominant firms are former monopolists who price discriminate between their two tariffs, the pre-liberalization (former monopoly) and post-liberalization (competitive), with a majority of their mobile subscribers still registered under their expensive pre-liberalization tariffs that have high switching costs compared to the competitive tariffs. The paper analyses limit pricing within an oligopoly framework involving a price discriminating dominant incumbent, a fringe (smaller) competitor and a potential entrant in a sequential three-stage game of price competition under complete information. The theoretical results show that the dominant incumbent can profitably use its pre-liberalization tariff price to deter market entry and force its smaller competitors out of business. These results have public policy implications for the East African Competition Authority and other policy makers. These should consider regulating the pre-liberalization tariffs among dominant firms thereby reducing their influence on pricing in order to enhance fair competition among firms in the market.