Contracting with Word-of-Mouth Management

Authors

Yuichiro Kamada
Aniko Öry (Oery)

Document Type

Discussion Paper

Publication Date

7-1-2016

CFDP Number

2048R2

CFDP Revision Date

2018-08-01

CFDP Pages

44

Abstract

We propose a model for word of mouth (WoM) management where a firm has two tools at hand: referral rewards and offering a free contract. Current customers’ incentives to engage in WoM can affect the contracting problem of a rm in the presence of positive externalities of users. Formally, we consider a classic Maskin-Riley contracting problem for the receiver of WoM where the firm can pay the sender’s referral rewards and a sender experiences positive externalities if the receiver adopts. A free contract can incentivize WoM because the higher adoption probability increases the expected externalities that the sender receives. We characterize the optimal incentive scheme and show when the two tools serve as substitutes and complements to each other depending on whether the market is niche and whether the product is social. We show that offering a free contract is optimal only if the fraction of premium users in the population is small, which is consistent with the observation that companies that successfully offer freemium contracts oftentimes have a high percentage of free users.

Comments

Supplement Materials, 31 pp

Recommended Citation

Kamada, Yuichiro and Öry (Oery), Aniko, "Contracting with Word-of-Mouth Management" (2016). Cowles Foundation Discussion Papers. 2505.
https://elischolar.library.yale.edu/cowles-discussion-paper-series/2505