Pricing and Diffusion of Durables with Network Externalities

This paper considers the optimal pricing and diffusion of a durable good that exhibits positive network externalities, when consumers are heterogeneous with respect to their expectations about future network sizes. We consider the existence of naive consumers, as well as of sophisticated consumers who have fulfilled expectations about future network sizes. At the time of purchase, naive consumers presume that the current network size will continue over future periods. We find that the firm charges the sequential-diffusion pricing that makes sophisticated consumers function as early adopters, unless consumers quickly become bored with using the goods and/or unless the firm heavily discounts its future profits. In addition, we show that naive consumers may enjoy a greater surplus than do sophisticated consumers, implying that the firm benefits when more consumers are sophisticated. We also compare the profitability of three possible pricing strategies with different commitment powers: fixed, responsive, and pre-announced pricing.