The (In)efficiency of the retail-minus rule

Abstract The Retail-Minus Rule (RMR) specifies that the rate for a mandated wholesale service is set by subtracting from the vertically integrated provider's (VIP's) retail price the costs it avoids by selling the wholesale service rather than the retail service. While the RMR offers regulators an expedient method for setting wholesale prices, we show that it is efficient only under restrictive conditions. The proper test for a price squeeze inquires whether the VIP's retail price is greater than or equal to the sum of the direct cost and the opportunity cost of supplying the retail service. The RMR passes this test only when the competing retail services are perfect substitutes.