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Optimal Mechanism Design with Referral

Author

Listed:
  • Hao Zhou

    (China Institute of Regulation Research, Zhejiang University of Finance and Economics, Hangzhou 310018, China)

  • Jun Zhang

    (Economics Discipline Group, School of Business, University of Technology Sydney, Sydney, New South Wales 2007, Australia)

Abstract

This paper establishes the optimal selling mechanism when a seller can incentivize an existing buyer to refer his privately known potential buyer to participate. We identify three optimal channels for providing referral incentives. First, if the existing buyer declares that no potential buyer exists, his virtual value is penalized. Second, if the existing buyer refers the potential buyer to the seller, his virtual value is boosted. Third, in some scenarios where this carrots-and-sticks-via-virtual-value approach is insufficient for creating proper referral incentives, the existing buyer is then given a constant referral bonus for referring the potential buyer. We also provide conditions under which the optimal mechanism can be implemented using simple mechanisms. Finally, we demonstrate that the conventional resale mechanism is suboptimal.

Suggested Citation

  • Hao Zhou & Jun Zhang, 2025. "Optimal Mechanism Design with Referral," Management Science, INFORMS, vol. 71(5), pages 3734-3748, May.
    • Handle: RePEc:inm:ormnsc:v:71:y:2025:i:5:p:3734-3748
    DOI: 10.1287/mnsc.2023.01540
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