Contracting with Word-of-Mouth Management

Authors

Yuichiro Kamada
Aniko Öry (Oery)

Document Type

Discussion Paper

Publication Date

7-1-2016

CFDP Number

2048R

CFDP Revision Date

2017-11-01

CFDP Pages

39

Abstract

We incorporate word of mouth (WoM) in a classic Maskin-Riley contracting problem, allowing for referral rewards to senders of WoM. Current customers’ incentives to engage in WoM can affect the contracting problem of a firm in the presence of positive externalities of users. We fully characterize the optimal contract scheme and provide comparative statics. In particular, we show that offering a free contract is optimal only if the fraction of premium users in the population is small. The reason is that by offering a free product, the firm can incentivize senders to talk by increasing expected externalities that they receive and this is effective only if there are many free users. This result is consistent with the observation that companies that successfully offer freemium contracts oftentimes have a high percentage of free users.

Comments

Supplement Materials, 10 pp

Recommended Citation

Kamada, Yuichiro and Öry (Oery), Aniko, "Contracting with Word-of-Mouth Management" (2016). Cowles Foundation Discussion Papers. 2504.
https://elischolar.library.yale.edu/cowles-discussion-paper-series/2504