Incremental-cost test

Economic theories have been preoccupied with the topic of competitive transformation in network industries for several years now. The issue of cross- subsidization, and the associated requirement that the price of a service be oriented towards the costs it brings about, especially play an important role in this context.

The companies affected by this are usually multi-product enterprises offering a multifarious range of products and services. It is especially this diversification which is responsible for significant difficulties in identifying cross-subsidization because the costs accrue to a considerable degree for several services together and for this reason pose problems in properly assigning costs to their causes.

The issue of cross-subsidization in this context typically comes up in the question of whether the profit generated with one service in the reserved market is used to finance another service in competitive markets. To identify such a cross-subsidization, an analysis based on average costs assigned to each service is simply not appropriate at all.

The most appropriate analysis according to economic fundamentals is the incremental-cost test. The definition of the incremental-cost test is as follows: The revenues collected from any service (or group of services) must be at least as large as the additional (or incremental) cost of adding that service (or group of services) to the enterprise's other offerings.

This economic model has been experienced and accepted in the US for price policy issues of multi-product-firms.

EE&MC is very familiar with the methodical basics of the incremental-cost test and has used this concept for evidence of "fair" prices and as an argument against the complaint of cross subsidization.