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

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.