Modern Economy, 2011, 2, 901-909
doi:10.4236/me.2011.25101 Published Online November 2011 (http://www.SciRP.org/journal/me)
901
An Economic Evaluation of New Optional Calling Plans in
Telephone Service
Sung Ho Seol1, Moon-Soo Kim2*
1Electronics & Telecommunications Research Institute (ETRI),
Daejeon, Korea
2Department of Industrial & Management Engineering, Hankuk University of Foreign Studies,
Yongin-si, Korea
Received August 31, 2011; revised October 12, 2011; accepted October 26, 2011
Abstract
With the growth of competition in the telecommunication market, optional calling plans were introduced in
1980s, have expanded dramatically in 1990s and now have become widespread rate systems in many coun-
tries. In this respect, the Korean telephone market also provided various rates. Compared to other countries,
however, a special optional calling plan has activated in Korean market. It is a unique calling plan where
rates are based on previous calls made. That plan provides high market performance, yet it arouses criticism
in the industry. There are questions raised by professionals in the industry if that plan based on previous call
made is fair to consumers and is it more effective than other type of calling plan. Considering this circum-
stance, we theoretically analyzed and compare between rate system based on previous call made and differ-
ent rate system including unlimited flat-rate and BOT, by mainly the perspective of efficiency. The results
show that rate system based on past calling patterns will be economically more efficient compared to other
types. Therefore, it is necessary not to prohibit this rate system, rather selectively regulating or other flexible
means of regulation is desirable, nevertheless it has some week point.
Keywords: Optional Calling Plans, Telephone Service, Pricing Scheme, Social Welfare, Regulation, Korea
1. Introduction
The first OCP (optional calling plan) introduced in June
1984 by AT & T in the name of the “Reach-out Amer-
ica,” became popular and a marketing success [1]. Once
into the 1990s, with the accelerating competition in the
telephone market, optional calling plans which allow
consumers to freely choose a rate structure had expanded
dramatically and were offered in many countries although
it drives up congestion costs to consumers due to a large
variety of rate structures. US provider Verizon provides
several different pricing options for its long-distance
services (flat rate pricing for local calls), including a flat
tariff, two-part tariff and per-minute charge. Optional
plans, applying to bundles including local and long-dis-
tance calls, and internet access service, are also gaining
popularity in the US and another example, UK provider
BT offers a two-part tariff, partial flat pricing and flat
rate plan. It has also discontinued its standard rate plan, a
per-minute pricing plan, in favor of more flexible pricing
plans [2]. Development of attractive OCPs has emerged
as one of the key factors to succeed in the telephone
business, especially under market situation which is get-
ting much faster in substitution mobile traffics for fixed
telephone ones and rapidly decreasing calling demand of
fixed telephone.
In past, there were so many researches to examine
economic welfare on telephone pricing scheme including
optional plan and calling patterns such as Alleman [3],
Mictchell [4], Wilkinson [5], Park, Wetzel & Mitchell
[6], Park, Mitchell, Wetzel & Alleman [7] and Train,
McFadden & Ben-Akiva [8], etc. Those studies have
emphasized the theoretical analysis of various tariffs in
telecommunications industry, especially; Train et al. [8]
indicated the necessity that evaluation on the welfare
implications of numerous voluntary calling options is an
important direction for future research. Several studies
analyzing efficiency of optional calling plans in tele-
phone service are as follows. Martins-Filho and Mayo [9]
evaluated welfare effects of the geographic patterns of

S. H. SEOL ET AL.
902
telephone pricing like adoption of extended area service
in the 4 major metropolitan areas in Tennessee US which
noticeably enhanced consumer surplus. More in recent,
Miravete [10] suggested that a menu of optional two-part
tariffs dominates any other pricing strategy from analyz-
ing the expected welfare associated with standard
nonlinear pricing and optional tariffs by using informa-
tion directly linked to the type of individual consumers.
And Masuda and Whang [11] developed the optimal
menu of FUT (fixed-up-to) plans which is almost same
to BOT-type plan in our paper and showed it delivers as
good performance as any nonlinear pricing scheme. Oth-
erwise, Jensen [12] showed some examples from tele-
communications industry where firms offer two part tar-
iffs with free call minutes to low demand segments.
KT, the dominant telephone service provider in Korea,
has planned a new OCP, ARPU (Average Revenue Per
User)-based pricing, to activate the call effectively to
decreasing the volume of call traffic and its revenue due
to the substitution between fixed and mobile call as well
as Internet telephony. But the Korean regulator has been
anxious about decreasing the consumers’ surplus consid-
ering that the new OCP can be operated like a price-dis-
crimination by the dominant provider. This study ana-
lyzes economic effects of the ARPU-based pricing in
terms of provider- and consumer-side with the existing
OCPs including a linear pricing and examines regulatory
implication for Korean telephone service industry.
The rest of this study is organized as follows. Section
2 examines the background of introduction of ARPU-
based pricing system and economic research method for
the new OCP in Korean telephone industry. Section 3
describes a simple economic model used in this study
and presents the range of optional calling plans consid-
ered and under the model analyzes a theoretical explora-
tion of the economic effects of each of the optional call-
ing plans and their comparative analysis. In Section 4,
we discuss the validation of the potential benefits of the
ARPU-based pricing system in terms of the social wel-
fare, price discrimination and predatory pricing-related
issues. Finally, in Section 5, we present policy implica-
tions derived from our findings and directions for future
research.
2. A New Optional Calling Plan
Unlike in the advanced countries, in Korea, over 70% of
fixed-line telephone users are subscribed to standard rate
plan such as a simple two-part tariff. This has much to do
with the meager choice of available optional calling
plans; there is only one optional pricing model in use in
Korea. The standard rate-centered pricing policies among
Korean telephone service providers, as they fail to ad-
dress diverse needs of consumers, are responsible, at
least in part, for the current stagnancy of the fixed-line
market and are contributing to the acceleration of the
phenomenon of substitution of fixed-line services by
mobile services. As shown Figure 1, while the mobile
call volume has been continuously increased in originat-
ing call from mobile network as well as terminating call
on one, the total volume of fixed-telephone call has been
decreased since 1996, in particular, it shows steep de-
creasing in fixed to fixed call.
In order to activate fixed telephone call demand, KT
looked into offering an ARPU-based optional calling
plan, whereby the rate is determined according to the
average past usage. At first, this was not approved by the
Korean Ministry of Information and Communication
(MIC)1, which recommended that it be replaced by a
BOT (Block of Time)-type plan or an unlimited flat rate
plan, finding price discrimination under the former to be
more than others.
The purpose of new optional calling plans adoption is
increasing consumer surplus nonetheless enduring a de-
gree of price discrimination in the pricing. Thus, the
regulatory stance toward optional calling plans must be
based on an economic analysis determining which of the
optional pricing models (ARPU-based pricing, BOT or
unlimited flat rate model) are more likely to enhance
consumer surplus, all the while enduring the discrimina-
tory effect against users which their use entails. KISDI
[14] analyzed different types of pricing combinations, to
determine the optimal price range, related consumer sur-
plus and social welfare under the scenario that the tele-
phone market is a monopoly market, assuming that het-
erogeneous consumers exist in this market and that the
goal of the monopoly supplier is to maximize the profit.
They concluded the OCP was more efficient than the
existing linear pricing and two-part tariff. And Yeom
[15], assuming a situation where a monopoly supplier
Figure 1. The trend of Fixed and mobile call traffic in Ko-
rea [13].
1It was renamed KCC (Korea Communications Commission) in 2008.

903 S. H. SEOL ET AL.
with a constant marginal cost and a single pricing system
adds an optional calling plan, calculated the price range
and costs which can increase both provider profit and
consumer surplus. Meanwhile, Byun [16] explored opti-
mal designs for a BOT rate system, allowing a monopoly
supplier to maximize profits in a market where consum-
ers are heterogeneous. And in real world, a similar plan
to ARPU-based pricing, so-called Tailored Flat Pricing
(TFP) plan for only three months in 2002 by KT ap-
peared a marketing success that the churning number of
existing subscribers to TFP was more than 6.2 million as
of end of May 2009 and took the No. 1 ranking among
fixed telephony plans except for standard pricing plan as
well as increased about 31% in call amount compared
with previous call amount under the standard pricing
plan [17].
This study is to examine the validity of introducing a
new ARPU-based rate system in telephone service mar-
ket of Korea. This analysis, assuming that an optional
calling plan is added to an existing per-minute charge
system, looks for the call pricing scheme most beneficial
for consumers by comparing ARPU-based pricing with
other types. We considered a wider variety of pricing
structures, including APPU-based and BOT-style models,
to derive policy implications for this latest issue.
3. A Simple Model and Comparative
Analysis
3.1. A Simple Model and Analytical Method
A theoretical analysis conducts in this study rests on a
number of assumptions. First of all, we assume that the
price decided by a monopoly supplier covers the entire
cost of providing services, and that the marginal cost is 0.
Further, fixed-line telephone services provided by the
monopoly supplier, whilst serving a large number of cus-
tomers, are assume to yield different benefits to different
consumers. To capture the diversity of consumption pat-
tern, consumers are classified into different types, and
different types of consumers are assigned the t, i.e., be-
cause consumer is heterogeneous, instead of aggregated
demand function which used in many cases of economic
analysis, individual demand function is used in this
model. For all t, a uniform distribution is assumed. In
other words, the probability density function of t is f(t) =
1 for t  [0, 1]. The demand curve for an individual cus-
tomer with the above characteristics assumes to be
p = t – qt. Although there are many types for individual
demand function used in economic analysis, an individ-
ual demand function in this paper is supposed to be lin-
ear for simplicity and has equal slope not to cross be-
tween demand curves, then all consumer’s characteristics
are described by his maximum value t. Further, we as-
sume that the operator’s behavior is driven by maximiz-
ing profits, and that the regulatory body is only con-
cerned by the type of optional calling plans which the
operator offers, and does not interfere with the price it-
self. This is because the new OCP can’t be designed to
be unduly high or low if existing standard rate plan (as a
based plan) is assumed to be unchanged, and each con-
sumer is rational. Thus potential problems for regulator
to consider are closely connected with structure or type of
OCP. Then the possible maximum of social welfare sum-
med the producer profits and consumer surplus will be
12
0
11
d
26
tt
.
We consider a simplified scenario that the fixed-line
telephone service market being studied practices only a
standard pricing like per-minute charge system, and that
the operator is looking into introducing one of the four
pricing models: unlimited flat fee, ARPU-based unlim-
ited flat fee, BOT-style plan and ARPU-based plan with
free calling times. Although there are some kinds of OCP
in real world, as far as we know in telephone service
market of Korea, they all do not have so many subscrib-
ers except for TFP, which belongs to the type of ARPU-
based flat fee plan, and new potential customer can’t
subscribe to the TFP due to subscription restriction as
mentioned. Therefore, the model simplifies the actual
situation as if only standard pricing plan existed before
new OCP adopted with the view of new consumer. Un-
der the assumption of demand function and market con-
ditions, after analyzing the economic effect of per-min-
ute charging system, that of four-possible OCPs with the
per-minute charging system is sequentially analyzed and
carried out comparison of economic effects among 5
pricing schemes.
3.1.1. Per-Mi nute Charging System Alo ne
Assume that the current standard tariffs are the rates de-
termined through the service provider’s optimization
behavior. If the provider charges its fixed-line telephone
services at the rate “p”, only those consumers for whom t
> p will purchase them. In this case, the objective func-
tion of this provider will be expressed as follows.
 
1
max πd
p
pptp
t (A-1)
Then, the first derivative condition for maximizing
profit would be (A-2) whereby the profit function, dif-
ferentiated with respect to p, equals 0, given below:
2
dπ31
2
d2 2
pp
p0

 (A-2)

S. H. SEOL ET AL.
904
The optimum per-minute rate, calculated using (A-2),
is p* = 1/3, and the provider profit, * = 2/27 = 0.0741.
Meanwhile, the consumer surplus (CS) is
2
1
1/3
11
d 0.0494
23
tt





at p* = 1/3.
3.1.2. Unlimited Flat Fee Plan
In this case, p* = 1/3, the existing metered rate, calcu-
lated using (A-2), remains in place, even after the new
unlimited flat fee system is introduced, as an optional
plan. Let us assume t1 marginal consumers who are un-
sure whether or not they should go for a per-minute
charge plan and t2 borderline consumer hesitating be-
tween a per-minute charge plan and a flat fee plan. Then
the function of profit for the provider must satisfy the
incentive compatible constraint, requiring that utility
gained by t2-type consumers through the flat fee plan be
equal to that gained through the per-minute charge plan.

2
12
1
11 2
max πd
t
tt
pt ptFt  

d 
(B-1)
s.t.

2
21 2
22
1
22
tp
tF  
(incentive compatible constraint equation for type t2)
1
1
3
p (existing standard tariff pricing maintained)
t1 and t2, solved using the first derivative condition for
the maximization of provider profit, yield t1
* = 1/3 and
t2
* = 5/6. If one substitutes these values into the incentive
compatible constraint equation, this yields an optimum
flat rate price (F2
*) of 2/9. Further, by substituting this
value of optimum price and consumer type t1
* into (B-1),
we obtain the provider profit of 17/216=0.0787. In this
case, the consumer surplus is
2
5/61 2
1/3 5/6
11 12
dd 0.0540
23 29
tt tt
 
 
 
 

indicating a clear increase in user welfare over the situa-
tion in which no other price option existed except per-
minute charge.
3.1.3. A RPU-Based Flat Fee Plan
Now suppose that the optional calling plan added is an
ARPU-based flat fee plan, instead of a simple flat fee
plan. An ARPU-based flat fee plan allows consumer “t”
to make unlimited calls for a fixed fee corresponding to
his or her average spending call under the per-minute
charging plan (ARPUt) plus
 ARPUt, as illustrated in the
graph in Figure 2. “A” in the graph in Figure 2 is the
Figure 2. Change in consumer surplus when switching to
ARPU-based flat fee plan.
additional payment incurred by the customer switching
to this plan, and B, the gain in utility realized by the
same customer. The change in net utility, therefore, is
equal to B – A. Hence, a rational consumer would not
switch to the new pricing model, unless B – A > 0.
Let us refer to marginal consumers who are wondering
whether they subscribe or not as t1, and the other border-
line category of consumers hesitating between the ARPU-
based optional plan and the per-minute charge subscrip-
tion as t2. Especially, in this case heavy consumers re-
main to the per minute charge plan, middle-ranged con-
sumers go to the ARPU-based flat fee plan and lighter
users do not subscribe. The objective function of the
provider, then, is (C-1), given below:
 
2
12
1
11 11
max π1dd
t
tt
pt ptpt pt  

(C-1)
s.t.

2
1
12 12
p
pt p
  (area A = area B in Figure 2,
incentive compatible constraint for type t2)
1
1
3
p

(existing standard tariff pricing maintained)
We can now determine the first derivative condition
for maximizing the provider profit. The first partial de-
rivative of objective function by t2 is positive for all t2.
That means the boundary condition, t2 = 1 and the opti-
mum

*, which can induce many consumers including
heavy consumers, is 1/4 = 0.25. In this case, the provider
profit is 5/54 = 0.0926, and the consumer surplus,
2
1
1/3
11 1
1d11/162 0.0679
2433
ttt


 




.
3.1.4. A BOT-Type Plan
We will now suppose that the new optional calling plan
added is a BOT-type plan. A BOT-type plan has a three-
tier pricing system, consisting of (F2, h2, p), as shown in
Figure 3. Here, F2 is a fixed fee, h2 is the maximum min-

905 S. H. SEOL ET AL.
Figure 3. Pricing structure in a BOT-type plan.
utes of call at no additional charge over the fixed fee, and
“p”, the rate per minute charged on calls over and above
the maximum minutes of call.
Let us call t1 marginal consumers who are wondering
whether they should go for a per-minute charge subscrip-
tion, and t2 borderline subscribers who straddle between
the per-minute charge and the BOT-type calling plan.
The provider’s objective function, in this case, will be
written as (D-1) below. The reason why the profit func-
tion in (D-1) has three terms is because those customers,
belonging to the [t2, 1] group subscribed to the BOT-type
calling plan, who meet the condition, t > h2 + p, are
charged an additional cost of p(t – p – h2) for their over
usages above h2. Each customer who belongs to the sub-
group [t2, h2 + p] pays only F2 for her call usage. For
example, borderline customer’s individual demand for
price p is t – p = (h2 + p) – p = h2. That means borderline
customer fully uses amount of maximum minutes of call
without additional charge by customer rationality. How-
ever, each customer who belongs to other sub-group [h2
+ p, 1] pays F2 as a fixed fee plus p(t – p – h2) as an ad-
ditional charge which is proportionate to over usage
above h2.
 
2
122
11
11 22
max πdd
t
tthp
pt ptFtpt pht

 
d
(D-1)
s.t.

2
21
2
22
1
22
tp
tF   (incentive compatible
constraint equation for subscriber type t2)
1
1
3
p (existing standard tariff pricing maintained)
The incentive compatible constraint equation requires
that utility gained by t2 consumer through BOT-style
plan be equal to that gained through per-minute charging
plan.
If we denote optimal free calling times to maximize
objective function as h2
*, then optimal BOT scheme is
expressed as (F(h2
*), h2 *, p(h2 *)). To maximize global
objective function, firstly F must satisfy to incentive
compatible constraint equation and p must be such a
price to maximize local objective function, which is
revenue through additional charge2. After substituting
two first derivative conditions into objective function of
(D-1), total differential by the h2 gives optimal solution
h2
* = 2/3. Hence, the optimal BOT pricing system would
have (F2
* = 16/81, h2 * = 2/3 and p* = 1/9)3. Thus, the
provider’s profit,
7/9 1
1/3 7/9
11 1617
dd 0.07956
33 8199
tt tt
 
 
 
 
 ,
and the consumer surplus,
2
7/9
1/3
22
2
1
7/9
11
CS d
23
161 2 17
d0.05487.
281232 9
tt
tttt






 







3.1.5. ARPU-Based Plan with Free Calling Times
An ARPU-based plan with free calling times is similar to
BOT-type plans, insofar as a fixed fee covers a set num-
ber of free minutes, and users pay an overage charge for
minutes beyond the free minutes. It is similar also to the
ARPU-based flat fee system, discussed earlier, in that the
fixed fee is set to an amount roughly equivalent to a
user’s monthly payment under the per-minute charging
system.
Concretely, the fixed fee paid by a customer switching
to an ARPU-based plan with free calling times corre-
sponds to (1 +
 ′)ARPUt, and this fee allows him or her
to talk for a total duration corresponding to (1 +
 ) of the
habitual call time. Minutes beyond this are charged “p”
per minute.
Let us assume t1 marginal consumers who are unsure
whether or not they should subscribe and t2 borderline
consumer hesitating between an ARPU-based plan with
free calling times and a per-minute charge plan. Then the
objective function of the provider, where the increase of
first term is larger than the sum of decreases of second
and of third term due to the marginal increase of t2, is (E-
1) given below:

  


2
1
1
1
2
11
1
1
1
11
maxπ1d
1d
d
t
t
pp
t
t
pt pt
pt pt pt
pt pt




 
 







(E-1)
2First derivative conditions are respectively F(h2) = h2/3 – (h2  h2)/18
and p(h2) = (1 – h2)/3.
3This solution was checked numerically by computer simulation.

S. H. SEOL ET AL.
906
s.t.
 

2
221
2121
11
2
tp
tp ptp 


  2
(incentive compatible constraint for t2)
an ARPU-based flat fee plan, by keeping the free min-
utes to a moderate number, and instead, setting the over-
age rate to a reasonable range, for example, not exces-
sively low compared to the standard rate.
1
1
3
p (existing standard tariff pricing maintained) Consumer surplus, on the other hand, is smaller under
an ARPU-based plan with free calling times, designed to
maximize the provider’s profit, than under an ARPU-
based flat fee plan;
The optimal design for the provider to realize maxi-
mum profit should have many consumers up to the type t
= 1 become the subscriber of the ARPU-based plan with
free calling times. This would mean
 ′ = 1/4, if   1/2
and  ′ =  – 
2, if
 < 1/2. Subscribers to a ARPU-based
plan with free calling times may be distinguished into
sub-group [t1, t3] whose usage exceeds the set limit of
free calls, and sub-group [t3, 1] whose usage is most of-
ten within this limit. Further t3 the boundary subscribers
between these two sub-groups, must satisfy the equation
(1 +
 )(t3 – p1) = t3 – p; in other words, t3 = (1 +  )/3  –
p/
 . The function of provider profit, meeting these con-
ditions, would be as follows:

2
1
1/3
13 13
4
CSd 0.0576
81 812
tt t



 


.
3.2. Comparison of Economic Effects

  

1
3
1
1
11
1
2
2
max π1d
1d
21
1
2723
t
t
t
pt pt
pt pt pt
pp


 
  











(E-2)
The economic effects of each optional calling plans ex-
amined above are listed in the Table 1. Figures in the
Table 1 reveal that optional call plans, regardless of their
type, result in an increase in consumer surplus, over the
per-minute charge only pricing system, as long as there
are a sufficient number of subscribers to cover the cost of
offering the new plan. This result, consistent with the
basic arguments of Samuelson’s revealed preference
theory, points to the potentially beneficial effect of the
introduction of optional calling plans on the Korean
fixed-line telephone service market, a market where few
price options are available.
“p” and “
 ” satisfying the first derivative conditions of
(E-2) are respectively 1/9, 1/3. Substituting those into (E-
2) yields a maximum profit of 0.09876. What this sug-
gests is that the provider can realize greater profit
through an ARPU-based plan with free calling times than
Which of these plans, then, would be the best and
most beneficial for the Korean market? The results
shown in the Table 1 provide theoretical evidence that
both an ARPU-based flat fee plan and an ARPU-based
Table 1. Comparison of economic effects.
Per-minute
Charge
Per-minute Charge
+ Flat fee plan
Per-minute Charge +
ARPU-based flat fee plan
Per-minute Charge
+ BOT plan
Per-minute Charge + ARPU-
b
ased
plan with free calling times
Charge per minute 1/3 1/3 1/3 1/3 1/3
Fixed fee 2/9 125% of ARPU 16/81 122% of ARPU
Free minutes 2/3 150% of ARPU
Overage rate 1/9 1/9
Provider profit 0.0741 0.0787 0.0926 0.07956 0.09876
Consumer surplus 0.0494 0.0540 0.0679 0.05487 0.0576
Social welfare (SW) 0.1235 0.1327 0.1605 0.13443 0.15636
% of SW to maximum SW(1/6) 74.1% 79.6% 96.3% 80.7% 93.8%

907 S. H. SEOL ET AL.
plan with free calling times are superior to a flat fee plan
or a BOT-style plan. It should be of course remembered
that this conclusion assumes rational decision-making on
the part both of the provider and consumers.
An ARPU-based plan results in more substantial in-
creases in provider profit and consumer surplus than a
flat fee or BOT-style plan, very simply because it is more
attractive to consumers and will generate a stronger
market response. Let us suppose that there are five con-
sumers we will call A, B, C, D and E, as in Figure 4, and
that the average number of minutes spent on fixed-line
calls is in increasing order, it being the lowest for A and
the highest for E. The flat fee plan will only attract peo-
ple like E with a high level of usage. The concentration
may be somewhat less for a BOT-style plan, which could
attract D, in addition to E. In comparison, an ARPU-
based plan can interest most users except A, whose usage
is so low that he or she may not consider signing up even
for a per-minute charging plan. As the subscriber base
includes B, C, D and E, an ARPU-based plan will natu-
rally result in a larger increase in consumer surplus. In
other words, an ARPU-based pricing model will yield
greater effect as it is likely to be adopted by both heavy
and less heavy to moderate users of fixed-line calls.
4. Discussions for Pricing Regulation on
Telephone Market
In what preceded, we examined whether an ARPU-based
optional calling plan can contribute to the increase of
consumer surplus and whether the increase of consumer
surplus was greater in size than the corresponding in-
creases that may be expected from other alternatives,
such as a flat fee or BOT-style plan, using a simple eco-
nomic analysis model. In this section, we will attempt a
more global assessment of ARPU-based optional calling
plans, by examining consumer surplus from an empirical
perspective and considering issues such as potential price
discrimination of users and predatory pricing associated
with the practice of calling plans. We will begin by tak-
ing a close look at a concrete example of an optional
calling plan, the one by KT, which considered. For the
sake of convenience, we will refer to this plan as Y; as
can be seen in the Table 2 below, the actual values of
 ′,
Table 2. Product concept of calling plan Y.
Item Additional
Charge Free Minutes Discount for calling more than Free Minutes
 ′ of ARPU  ′ of ARPU
Calling Plan Y
 ″ of ARPU  ″ of ARPU
 %
 ″,  ′,  ″,  , being confidential business information,
were kept undisclosed.
As the calling plan Y is to be introduced in addition to
the existing standard pricing system, consumer-side util-
ity should remain at its previous level or exceed it, pro-
vided that the new option does not entail congestion
costs. The question, therefore, is whether the introduc-
tion of calling plan Y, detailed in the Tabl e 1, can result
in a meaningful increase in consumer surplus. The an-
swer, according to our analysis, is “Yes”. This is because
the increase in utility can be sizeable, as long as the
value of
 ′ or  ″, the number of free minutes under Y, is
large enough. Benefits for consumers will include no
longer having to think about incurring additional costs
when staying on the phone for extended periods [18], the
ability provided by the fixed fee, of hedging against fu-
ture uncertainties and risks associated with fluctuating
demand [19], and having the option of choosing a rate
scheme more advantageous to one’s usage pattern [1].
Based on these considerations, we calculated the dis-
tribution of surplus among economic players, assuming
that subscribers to Y will enjoy about a half of the addi-
tional utility brought about by an ARPU-based flat fee
plan, over and above that provided by a per-minute
charging system, which was measured through a con-
sumer survey. The distribution of surplus between con-
sumers and producers, according to this calculation, was
approximately 71% vs. 29%. This result suggests that the
profit realized by a monopoly supplier, through the in-
troduction of calling plan Y, was far from excessive, and
that the benefit for consumers being significantly more
important than the latter, the plan was in fact a win-win
product, for mutual gain of the provider and customers.
As has been mentioned earlier, Y is a calling plan,
whereby the price of a call is in part determined by the
past call volume of a user or the average telephone ser-
vice spending. This pricing practice may, therefore, be
liable to accusations of price discrimination. According
to Stigler [20]4, price discrimination is inevitable and
inherent in all optional calling plans. The question is not
whether or not price discrimination is practiced, but
rather whether it is practiced within an acceptable level.
Y being a calling plan using a non-linear pricing struc-
ture, price discrimination involved in it falls into the
category of second order price discrimination. It is,
however, undeniable that the degree of price discrimina-
tion involved in Y is more marked than ordinary non-
inear pricing-based call products. l
4Stigler [20] states that a firm price discriminates when the ratio o
f
p
rices is different from the ratio of marginal costs for two goods of-
fered by a firm. And Stole [21] has advanced a broader definition tha
t
p
rice discrimination exists when prices vary across customer segments
that cannot be entirely explained by variations in marginal cost.

S. H. SEOL ET AL.
908
Figure 4. Subscr ibe r c a te gories by type of OCPs.
To determine whether price discrimination practiced
in calling plan Y is excessive and unfair, we resorted to
the four criteria proposed by Bonbright [22]; 1) Is the
price discrimination intended to generate needed revenue?
2) Do all parties stand to benefit from the practice? 3) Is
there sufficient proof that the practice contributes toward
covering long-run incremental cost increase? 4) What are
the effects of the practice on competitors? Our analysis
revealed that Y satisfied three of the four conditions,
except criterion (1). KT being not a government-owned
firm, criterion (1), in this case, was less relevant than the
others.
Of the four criteria formulated by Bonbright, criterion
(3) is the one most closely related to whether a pricing
method is predatory. Predatory pricing refers to selling
products or services at very low prices with the intent to
keep newcomers from entering the market or driving
competitors out of the market. A two-tier rule is com-
monly used to determine whether a pricing method is
predatory. The first tier is the range above the average
cost, and a price within this range clears a provider of the
suspicion of predatoriness. If the price is below the av-
erage cost, situated somewhere between the average
variable cost and the average cost, considered as the gray
zone, further inquiries are undertaken to establish whether
or not the pricing is predatory.
Prices under calling plan Y, detailed in the Table 2,
are clearly above the average cost—evidence that no
predatory pricing is involved in this plan. In order to ver-
ify whether prices under calling plan Y are above the
average cost, one needs to estimate the increase in call
volume among subscribers switching from a per-minute
charge plan to Y. We judged that the increase in call
volume would not exceed 30%, given that Y is a plan
having a pricing structure that is only partially flat fee-
based. We therefore concluded that the pricing method
under Y is not predatory.
5. Concluding Remarks
ARPU-based pricing is clearly a very original pricing
model, as the rate is decided on the basis of the past us-
age or average call spending of a customer. The obvious
disadvantage of this pricing method is that it involves a
greater degree of price discrimination than other non-
linear pricing-based calling plans such as BOT-type
plans. This disadvantage comes with the offsetting ad-
vantage that ARPU-based calling plans are more effec-
tive in achieving improvement both in providers’ profit
and consumer surplus than others of its kind, and are
more likely candidates to successfully stimulate the fixed-
line telephone service market.
This study examined whether ARPU-based optional
calling plans can be more efficient than other optional
calling plans, using both a theoretical and empirical ap-
proach. We found that an ARPU-based plan, similar to Y,
will bring about a sizeable increase in consumer surplus.
Furthermore, this study found no evidence warranting
the concern of price discrimination or predatory pricing:
the degree of price discrimination in the calling plan Y
was moderate, well within the acceptable range, and the
prices offered under the plan did not constitute predatory
pricing.
There are currently in Korea, ARPU-based optional
calling plans, similar to Y, offered by service provider
providers. Consumers are responding positively to these
products, and a substantial number of users are switching
to the new plans. Allowing these plans, we believe, has
been a judicious course of action on the part of the regu-
lator, having carefully weighed the pros and cons of
ARPU-based pricing, decried as irregular or odd pricing
practices and accused of price discrimination, on the one
hand, and praised for contributing to consumer surplus
and balanced industrial growth, on the other. A unilateral
stance against ARPU-based pricing must be avoided, and
related plans examined on a case-by-case basis, to de-
termine their potential benefits and ramifications, using
various criteria of judgment.
This study has the following limitations which need to
be addressed in future research: First, we used a simpli-
fied model which assumes a uniform distribution of
consumers. Hence, future research should verify whether
the increase in consumer surplus brought about by
ARPU-based calling plans will still be greater than that
by other plans, when using the gamma distribution or
other models more closely capturing the actual call vol-
ume distribution. Second, we treated BOT-type calling
plans as a single category, whereas, in reality, there are

909 S. H. SEOL ET AL.
many variants of this pricing model. Third, more impor-
tant thing, although subscribers to ARPU-based plan in
Korea showed a considerable increase in call amount
compared with previous one, practical reductions in call
traffic of fixed telephony service from longer term,
which result by demand uncertainty, will be more critical
issue from carrier as well as policy maker. This uncer-
tainty problem on amount of call traffic needs to consider
a factor of demand model. Future research should, there-
fore, make appropriate changes to the research model to
remedy this.
6. Acknowledgements
This work was supported by Hankuk University of For-
eign Studies (HUFS) Research Fund of 2011.
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