Peer Influence in Network Markets : An Empirical and Theoretical Analysis

Network externalities spur the growth of networks and the adoption of network goods in two ways. First, they make it more attractive to join a network the larger its installed base. Second, they create incentives for network members to actively recruit new members. Despite indications that the latter "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 address this gap. Using a game-theoretical model, we show that 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, personal networks and large, global, anonymous networks thus arises endogenously from our model. We use survey data from users of the Internet services, Skype and eBay, to illustrate and support our theoretical results. As predicted by the model, we find that the peer effect matters strongly for the network of Skype users which effectively consists of numerous small sub-networks but not for that of eBay users. Since many network goods give rise to small, local networks, our findings bear relevance to the economics of network goods and related social networks in general