Competitive Pricing Strategies in Social Networks

Abstract

We study pricing strategies of competing firms that sell heterogeneous products to consumers in a social network. Goods are substitutes and there are network externalities between neighboring consumers. We show that there exists a unique subgame-perfect equilibrium where, in the first stage, firms choose prices while, in the second stage, individuals consume differentiated goods. In equilibrium, firms price discriminate based on the network positions and charge lower prices to more central consumers. We also show that, under some conditions, firms' equilibrium profits decrease when either the network becomes denser or network effects increase. In contrast, consumers always benefit from being more connected to each other because this increases their utilities and, at the same time, this lowers the prices due to intensified competition between firms. We determine the optimal network structure both for firms and consumers, and compare uniform pricing and discriminatory pricing from the perspectives of firms and consumers.

Keywords: social networks, pricing, competition, differentiated products, welfare, network design

JEL Classification: L14, L13, D43, D85