Proportional Fee vs. Unit Fee: Competition, Welfare, and Incentives*

Abstract

This paper compares social welfare for a unit versus a proportional fee on competing networks. When demand is sub‐convex or isoelastic, proportional fee welfare dominates unit fee and the comparison is independent of network competition. When demand is super‐convex, however, unit fee welfare dominates proportional fee if network competition is sufficiently weak. Dominance of unit fee is more likely when network competition weakens or if merchants must single‐home. For competing networks, proportional fee is each network’s dominant strategy but often leads to a Prisoners’ Dilemma that hurts not only networks but also merchants.