Dynamic Pricing in Social Networks: The Word-of-Mouth Effect

Abstract

We study the problem of optimal dynamic pricing for a monopolist selling a product to consumers in a social network. The only means of spread of information about the product is via Word of Mouth communication; consumers' knowledge of the product is only through friends who have already made a purchase. By analyzing the structure of the underlying endogenous process, we show that the optimal dynamic pricing policy for durable products drops the price to zero infinitely often, giving away the immediate profit in full to expand the informed network in order to exploit it in future. We provide evidence for this behavior from smartphone applications, where price histories indicate frequent free-offerings for many apps. Moreover, we show that despite infinitely often drops of the price to zero, the optimal price trajectory does not get trapped near zero. When externalities are present, we show that a strong enough network externality can push the price drops to a nonzero level, but similar price fluctuations to this new price floor still remain. When the product is nondurable, we show that the fluctuations disappear after a finite time.

How online word‐of‐mouth impacts receivers

“…Sellers can change the impact of WOM via influencer marketing, where they offer price discounts or other benefits to senders to create positive WOM and thus increase demand (Ajorlou, Jadbabaie, & Kakhbod, ; Chae, Stephen, Bart, & Yao, ; Kuksov & Xie, ; Libai et al, ). The effect of paid WOM on receivers is mixed because the possibility of paid WOM can lead receivers to become suspicious of senders’ motivations (e.g., Packard et al, ; Tuk, Verlegh, Smidts, & Wigboldus, ; Verlegh, Ryu, Tuk, & Feick, ).…”

Contracting with Word-of-Mouth Management

“…9 A recent working paper by Ajorlou et al (2015) builds a social-network model that highlights this effect. 10 Lee et al (2015) empirically analyze the trade-off between growth and monetization under the use of freemium strategies.…”

A monopoly pricing model for diffusion maximization based on heterogeneous nodes and negative network externalities (Case study: A novel product)

“…Akhlaghpour et al (2010) investigated positive externalities in network pricing models and proposed two iterative pricing models for optimization of expected revenue in the presence of myopic consumers. Ajorlou et al (2015) modified the IE-strategy slightly to make the price valid only at the exploitation step and employed this strategy to demonstrate a non-negative and non-uniform expected revenue for the concave graph model. They proposed the 1/2-approximation model for achieving an optimal design for the two stage fixed price marketing strategy.…”

“…Therewith, Ajorlou et al (2015) studied the optimum dynamic pricing for a monopoly vendor in social networks and demonstrated variability in the validity of results in the presence of strategic customers, various internal and external network influences, and customer indifference to price. They also examined how the amount and duration of discounts would affect final profitability.…”