The Network Origins of Entry

Working Paper: CEPR ID: DP18145

Authors: Arthur Campbell; Philip Ushchev; Yves Zenou

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 creating consumers' 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 the ratios of different 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. When we focus on a multinomial-logit demand, we show that increasing the network density shifts the pricing equilibrium from blockaded to deterred, and finally to accommodated entry. 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 personalised prices, we find that it is optimal for the incumbent to charge lower prices to more connected consumers.

Keywords: word of mouth; social learning; random network; limit pricing; entry

JEL Codes: D43; D85; L13

Causal Claims

Cause	Effect
network density (D85)	awareness of entrant (L26)
network density (D85)	pricing equilibrium (D41)
pricing equilibrium (D41)	market entry outcomes (L19)
incumbent pricing strategy (L11)	awareness of entrant (L26)
number of friends of consumers (D16)	incumbent pricing strategy (L11)
social network structure (D85)	awareness of entrant (L26)
network density (D85)	consumer surplus (D46)