Contracting with Word-of-Mouth Management

Yuichiro Kamada () and Aniko Öry
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Yuichiro Kamada: Haas School of Business, University of California Berkeley

No 2048R2, Cowles Foundation Discussion Papers from Cowles Foundation for Research in Economics, Yale University

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.

Keywords: Word-of-mouth; referral rewards; freemium; contract theory (search for similar items in EconPapers)
JEL-codes: D82 L21 M3 (search for similar items in EconPapers)
Pages: 77 pages
Date: 2016-07, Revised 2018-08
Note: Includes Supplemental Material
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Related works:
Working Paper: Contracting with Word-of-Mouth Management (2017)
Working Paper: Contracting with Word-of-Mouth Management (2016)
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