Peer influence in network markets: An empirical and theoretical analysis

Abstract

Network externalities spur the growth of networks and the adoption of network goods in two ways. First, they make it attractive to join a network with a large installed base. Second, they make it attractive for network members to actively recruit new members. Despite indications that this "peer effect" can be more important for network growth than the installed-base effect, it has so far been largely ignored in the literature. We aim at closing this gap, using both survey data and a game-theoretical model. Comparing respondents' adoption of two distinct networks goods, we find that the peer effect matters strongly for small, but not for large networks. Results from model analysis support this finding. Under conservative assumptions, the increase in network size due to the peer effect is by an additive constant - which, for small networks, can amount to a large relative increase. The difference between small, local, and personal networks and large, global, anonymous networks thus arises endogenously from our model. In the duopoly case, we find that introducing the peer effect favors winner-take-all outcomes. We use the examples of the Internet services, Skype and eBay, for our empirical analysis and as illustration of our theoretical findings. Since many network goods give rise to small, local networks, our findings are highly relevant for the management of network goods and the social networks they can give rise to.