The network origins of entry

Abstract

We develop a model of the process of entry under social learning via word-of-mouth (WOM). An incumbent’s product is known to the consumers, while the success of a potential entrant hinges on generating consumer awareness of the entrant’s product through WOM. We model WOM as a percolation process on a random graph. We show that whether an entrant can gain a non-negligible level of awareness depends on the social network structure via two sufficient statistics, which are functions of the first three factorial moments of the degree distribution. We categorize the different pricing equilibria into the classical blockaded, deterred, and accommodated entry taxonomy. Under deterred entry, our model produces a model of limit pricing by an incumbent to prevent an entrant gaining a non-negligible level of awareness. By focusing on multinomial logit demand and on a mixed-Poisson degree distribution, we show that increasing the network density shifts the pricing equilibrium from blockaded to deterred and, finally, to accommodated entry. Using numerical simulations, we also show that the aggregate consumer surplus may be non-monotonic with respect to network density. Finally, if the incumbent has knowledge about the consumer’s number of friends and can charge personalized prices, we find that it is optimal for the incumbent to charge lower prices to more-connected consumers