Your Network or Mine? The Economics of Routing Rules

Networks, the Internet, and Cloud Computing, Networks and Infrastructure and Wireless

Article Snapshot

Author(s)

Benjamin E. Hermalin and Michael L. Katz

Source

RAND Journal of Economics, Vol. 37, No. 3, pp. 692-719, Autumn 2006

Summary

This paper looks at how firms and consumers decide which network to use when several are available.

Policy Relevance

Consumers’ and merchants’ decisions about which networks to join can make a network’s rules about how to route traffic more or less profitable.

Main Points

  • Firms that provide services such as debit cards, telecommunications, or advertiser-supported content sometimes provide networks for their users’ transactions.

  • When two users want to conclude a deal and both belong to more than one network, how is it decided which network is used? With credit cards the cardholder chooses which card to use and this determines the network.
    • If participants have only one network membership in common, this is the network they have to use (unless the networks agreed to interconnect beforehand).

  • Things get more interesting in cases like debit cards. When a consumer uses a PIN-validated debit card, most merchants have more than one PIN network available.
    • “Routing rules” control which network is chosen; for debit cards, it might be the card issuer, the merchant, or network membership that determines the route. 
    • If a merchant subscribes to networks with different routing rules, conflicts can arise.

  • “Network routing” requires the network be used when both parties are members.
    • Some think “network routing” leads to a network’s getting more traffic because any deals that can run over the network must be run over the network.
    • But network routing rules are less profitable because merchants hesitate to join, since they can join only one such network. Issuer routing and merchant routing tend to be more profitable.

  • With mobile phones, the rule is that if one party chooses the network, the other party must pay nothing. Calling-party-pays billing is not allowed when the called party is using a mobile phone and therefore chose the wireless carriers.

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