Mergers in Network Industries

When an individual network value function exhibits declining marginal returns to network size, a small network derives more value from interconnection than a large network. If this value difference extends to pricing, small networks may pay larger networks for interconnection. To receive more advantageous terms from larger networks, small networks may join together to form coalitions that lower the per-member fee for interconnection. A merger disadvantages the non-merging networks by increasing the loss in network size from failing to contract. However, mergers need not generate a loss in welfare from within this model, since the model focuses on an installed base of consumers with unit consumption. In contrast, when the individual network value function exhibits increasing marginal returns to network size, a large network derives more value from interconnection than a small network. If this value difference extends to pricing, large networks may actually pay smaller networks for the privilege of interconnection. A merger would lead the merging networks to pay even more for interconnection.