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.
We incorporate word of mouth (WoM) in a classic Maskin-Riley contracting problem, allowing for referral rewards to senders of WoM. Current customers’ incentives to engage in WoM can affect the contracting problem of a firm in the presence of positive externalities of users. We fully characterize the optimal contract scheme and provide comparative statics. In particular, we show that offering a free contract is optimal only if the fraction of premium users in the population is small. The reason is that by offering a free product, the firm can incentivize senders to talk by increasing expected externalities that they receive and this is effective only if there are many free users. This result is consistent with the observation that companies that successfully offer freemium contracts oftentimes have a high percentage of free users.
We incorporate word of mouth (WoM) in a classic Maskin-Riley contracting problem, allowing for referral rewards to senders of WoM. Current customers’ incentives to engage in WoM can affect the contracting problem of a firm in the presence of positive externalities of users. We fully characterize the optimal contract scheme and provide other comparative statics. In particular, we show that offering a free contract is optimal only if the fraction of premium users in the population is small. The reason is that by offering a free product, the firm can incentivize senders to talk by increasing expected externalities that they receive and this can (partly) substitute for paying referral rewards only if there are few premium customers. This result is consistent with the observation that companies that successfully offer freemium contracts oftentimes have a high percentage of free users.
We incorporate word of mouth (WoM) in a classic Maskin-Riley contracting problem, allowing for referral rewards to senders of WoM. Current customers’ incentives to engage in WoM can affect the contracting problem of a firm in the presence of positive externalities of users. We fully characterize the optimal contract scheme and provide other comparative statics. In particular, we show that offering a free contract is optimal only if the fraction of premium users in the population is small. The reason is that by offering a free product, the firm can incentivize senders to talk by increasing expected externalities that they receive and this can (partly) substitute for paying referral rewards only if there are few premium customers. This result is consistent with the observation that companies that successfully offer freemium contracts oftentimes have a high percentage of free users.