A theory of consumer referral

In this paper, we consider the network as an alternative communication channel to undirected advertising in the market. The main distinctive feature of the network-embedded transaction is the interdependency of buyers' purchasing behavior. Since most transactions in a network are made sequentially, earlier consumers are more valuable to a seller. We characterize the optimal behavior of a seller and consumers in a network. A seller's strategy of paying referral fees can be understood as a way to price discriminate between more valuable consumers and less valuable ones. Numerical simulations demonstrate that social networks may be either over-utilized (if the referral cost is high) or under-utilized (if the referral cost is low).