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Optimal Consumer Network Structure Formation under Network Effects: Seeds Controllability and Visibility

Understanding the process of software adoption is of paramount importance to software start-ups. We study a monopolistic seller’s optimal consumer network structure formation (seeding, segmentation, sequencing, and pricing strategies) under network effects. We demonstrate the importance of adoption sequencing as well as controllability over the seeding process to seller’s profit, consumer surplus, and social welfare. Under multi-pricing, full information, and full control over the seeding process, with both multiplicative and additive forms of network effects, we show that all segments contain only paying customers except the first one, which contains both seeded and paying customers; and segments are opened in order of the customer valuation. Further, the seller’s optimal strategy is socially optimal. Under single-pricing and limited seeding control, worst case seeding (where all seeds go to the high-valuation customers) leads to higher social welfare and consumer surplus than uniform seeding, as the former covers a larger portion of the market while charging a lower price. In the case of random seeding with limited control, we identify an optimal strategy and conditions under which the optimal price is not affected by the randomness of seeding.

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File URL: http://www.netinst.org/Dou_Niculescu_11_07.pdf
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Paper provided by NET Institute in its series Working Papers with number 11-07.

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Length: 37 pages
Date of creation: Sep 2011
Date of revision: Oct 2011
Handle: RePEc:net:wpaper:1107
Contact details of provider: Web page: http://www.NETinst.org/

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  1. Donald Lehmann & Mercedes Esteban-Bravo, 2006. "When giving some away makes sense to jump-start the diffusion process," Marketing Letters, Springer, vol. 17(4), pages 243-254, December.
  2. Cheng, Hsing Kenneth & Tang, Qian Candy, 2010. "Free trial or no free trial: Optimal software product design with network effects," European Journal of Operational Research, Elsevier, vol. 205(2), pages 437-447, September.
  3. Economides, Nicholas, 1996. "The economics of networks," International Journal of Industrial Organization, Elsevier, vol. 14(6), pages 673-699, October.
  4. Frank M. Bass, 1969. "A New Product Growth for Model Consumer Durables," Management Science, INFORMS, vol. 15(5), pages 215-227, January.
  5. Andrea Galeotti & Sanjeev Goyal, 2009. "Influencing the influencers: a theory of strategic diffusion," RAND Journal of Economics, RAND Corporation, vol. 40(3), pages 509-532.
  6. Kapil Bawa & Robert Shoemaker, 2004. "The Effects of Free Sample Promotions on Incremental Brand Sales," Marketing Science, INFORMS, vol. 23(3), pages 345-363, November.
  7. Michael L. Katz & Carl Shapiro, 1994. "Systems Competition and Network Effects," Journal of Economic Perspectives, American Economic Association, vol. 8(2), pages 93-115, Spring.
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