Strategic Dynamic Pricing with Network Effects

TL;DR

This paper analyzes a monopolist's optimal dynamic pricing strategy in a networked environment, revealing that prices should be non-decreasing and influenced by network structure and customer valuation thresholds.

Contribution

It provides an explicit asymptotic characterization of optimal prices considering network effects and introduces a threshold-based customer behavior model in a dynamic setting.

Findings

Optimal prices are non-decreasing over time.

Increasing network imbalance boosts monopolist revenue.

Price discrimination based on network centrality encourages early purchases.

Abstract

We study the optimal pricing strategy of a monopolist selling homogeneous goods to customers over multiple periods. The customers choose their time of purchase to maximize their payoff that depends on their valuation of the product, the purchase price, and the utility they derive from past purchases of others, termed the network effect. We first show that the optimal price sequence is non-decreasing. Therefore, by postponing purchase to future rounds, customers trade-off a higher utility from the network effects with a higher price. We then show that a customer's equilibrium strategy can be characterized by a threshold rule in which at each round a customer purchases the product if and only if her valuation exceeds a certain threshold. This implies that customers face an inference problem regarding the valuations of others, i.e., observing that a customer has not yet purchased the product, signals that her valuation is below a threshold. We consider a block model of network interactions, where there are blocks of buyers subject to the same network effect. A natural benchmark, this model allows us to provide an explicit characterization of the optimal price sequence asymptotically as the number of agents goes to infinity, which notably is linearly increasing in time with a slope that depends on the network effect through a scalar given by the sum of entries of the inverse of the network weight matrix. Our characterization shows that increasing the "imbalance" in the network defined as the difference between the in and out degree of the nodes increases the revenue of the monopolist. We further study the effects of price discrimination and show that in earlier periods monopolist offers lower prices to blocks with higher Bonacich centrality to encourage them to purchase, which in turn further incentivizes other customers to buy in subsequent periods.