Social Media Marketing, Quality Signaling, and the Goldilocks Principle

Embraced by a rapidly increasing number of companies, social media marketing has become an integral part of companies’ business strategies. However, not all the firms plan on a big spend on social media marketing. Our stylized model investigates the strategic effects of social media marketing spending (SMM spending) with the presence of exogenous quality revelation through sources over which firms have no direct control. Unlike traditional advertising, social media marketing has two roles: awareness enhancement and information revelation . Consumers are heterogeneous in their awareness of the product (e.g., whether they know the existence of the product). Our analysis yields three main findings. First, our results show the existence of a separating equilibrium and a partial-pooling equilibrium where the high-/low-quality firms pool together and spend less on social media marketing than the mid-quality firm. Intuitively, the high-quality firm gets enough quality transparency from background user-generated discussions, and the cost of maintaining a social presence outweighs the benefits. The low-quality firm avoids social media marketing because quality transparency is broadly detrimental, whereas the midtier firm is just right to benefit from social media discussions they encourage. Second, we also find that in the partial-pooling equilibrium, as the fraction of aware consumers increases, the mid-quality firm spends less on social media marketing, whereas its optimal spending on social media marketing first decreases, and then increases with the precision of the external information signal. Third, by comparing these two equilibria, we show that if the partial-pooling equilibrium survives the intuitive criterion, it Pareto-dominates the separating equilibrium.