Peers and trend-setters have a powerful say in what products we decide to buy, particularly on online social media platforms. Naturally, this means that firms must consider the influence of network connections on purchase behaviors when designing pricing strategies. In doing so, they must consider when consumers decide to buy a new product—some consumers dive straight in, while some wait for others’ product feedback. These issues were explored in important new work by HKUST’s Yingju Chen and colleagues.

Social networks play an increasingly important role in consumers’ purchase decisions, and many firms have learned how to exploit social influence to increase sales through “freebies” and discounts. For example, the booking platform Hotelied offers discounts on hotel bookings to people with many followers on Facebook, Twitter, and Instagram who are willing to post hotel photos. However, prior attempts to define optimal pricing strategies have failed to take consumer strategies into account. “These studies often focus on the static one-period differential pricing problem,” explain the researchers, “which assumes that all consumers make purchase decisions at the same time.”

Consumer strategies can differ vastly when it comes to buying new products. While “first-period” consumers buy immediately, “second-period” consumers wait for product information and technical support from first-period consumers before buying. Second-period consumers thus obtain benefits from the presence of previous consumers, a phenomenon known as “positive network externality.” “How do different social network structures influence consumers’ strategic purchase decisions,” asked the researchers, “and how can firms utilise detailed social network structure information to design the optimal differential pricing strategy?”

Using refined theoretical models, the researchers characterised the impact of social network connections on strategic consumer decisions. They tested several model conditions to define how social network structure information can be used to optimise firms’ pricing strategies. In doing so, they also calculated the hypothetical profit loss of firms that overlook consumer network structures when developing pricing strategies.

Below a certain network externality threshold, the researchers found that an increasing-price strategy from period 1 to period 2 was best. Under these circumstances, a lower price should be applied in the first period to attract early adopters, followed by “a higher second-period price to extract extra profit from the network externality effect,” the researchers explain. However, when the network externality effect is strong, it may be better to adopt a decreasing-price strategy that “postpones some consumers’ purchases to the second period.”

The researchers also found that when network externality intensity was low, it was more effective to sell a product through numerous small interconnected community networks. However, when network externality intensity is high, a product should be sold through a few large networks of superstar fans. This clearly shows that different network structures lead to substantially different pricing policies.

This is the first study to model the optimal pricing strategy for a new product when consumers strategically choose their purchase timing. Crucially, the results show that firms should take network connections into account when developing pricing strategies. Failing to do so can deprive a seller of more than 50% of the optimal profit. “The profit loss caused by ignoring consumer network structures can be significant,” conclude the researchers.