Congestion-dependent pricing and forward contracts for complementary segments of a communication network

Miklós Reiter and Richard Steinberg

LSE Research Online Documents on Economics from London School of Economics and Political Science, LSE Library

Abstract: Congestion-dependent pricing is a form of traffic management that ensures the efficient allocation of bandwidth between users and applications. As the unpredictability of congestion prices creates revenue uncertainty for network providers and cost uncertainty for users, it has been suggested that forward contracts could be used to manage these risks. We develop a novel game-theoretic model of a multiprovider communication network with two complementary segments and investigate whether forward contracts would be adopted by service providers. Service on the upstream segment is provided by a single Internet service provider (ISP) and priced dynamically to maximize profit, while several smaller ISPs sell connectivity on the downstream network segment, with the advance possibility of entering into forward contracts with their users for some of their capacity. We show that the equilibrium forward contracting volumes are necessarily asymmetric, with one downstream provider entering into fewer forward contracts than the other competitors, thus ensuring a high subsequent downstream price level. In practice, network providers will choose the extent of forward contracting strategically based not only on their risk tolerance, but also on the market structure in the interprovider network and their peers' actions.

Keywords: communication system traffic; Internet; communication systems; contracts; economics; game theory; traffic control (communication) (search for similar items in EconPapers)
JEL-codes: L81 (search for similar items in EconPapers)
Date: 2012-04-18
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Published in IEEE/ACM Transactions on Networking, 18, April, 2012, 20(2), pp. 436-449. ISSN: 1063-6692

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