Your network or mine? The economics of routing rules

• Published in: The Rand journal of economics Vol. 37; no. 3; pp. 692 - 719
• Main Authors: Hermalin, Benjamin E., Katz, Michael L.
• Format: Journal Article
• Language: English
• Published: Oxford, UK Blackwell Publishing Ltd 01.09.2006; The RAND Corporation; RAND Corporation; Rand, Journal of Economics; Rand Corporation
• Series: RAND Journal of Economics
• Subjects: Analysis; Communications networks; Competition; Computer networks; Debit cards; Debits; Economic analysis; Economic competition; Equilibrium (Economics); Equilibrium models; Formal authority; Game theory; Games; Information networks; Market equilibrium; Market theory; Merchants; Nash equilibrium; Network analysis; Price systems; Pricing; Routing; Service industries; Symposium of Two-Sided Markets; Trade; Transaction costs; United States
• ISSN: 0741-6261; 1756-2171
• DOI: 10.1111/j.1756-2171.2006.tb00038.x

In many markets, including payment cards and telecommunications, service providers operate networks that support customer transactions with each other. When the two sides of a transaction belong to more than one network in common, the question arises as to which network will carry the transaction. We show that the answer depends on a combination of who has the formal authority to choose and the parties' network subscription decisions. Our central finding is that granting formal authority to one side of the market can increase the extent to which transactions run over the network preferred by the other side of the market. We also characterize competing networks' equilibrium choices of routing rules and prices.