Consumer coordination and optimal pricing under network externalities

In the adoption decisions of network goods, coordination problems lead to multiple equilibria. While consumer coordination significantly impacts the firm’s pricing strategies, the precise relationship between coordination behavior and optimal pricing has received little attention. This paper analyzes optimal pricing strategies for network goods under different forms of coordination by strategic consumers in a two-period model. We introduce two novel coordination criteria: risk dominance and threshold coordination. Risk dominance coordination accounts for the risk of a coordination failure, and threshold coordination reflects consumer heterogeneity in the valuation of the good. We show that under the risk dominance criterion, the firm sets a lower price in period 1 when the risk of a coordination failure is high, but sets a higher price in period 1 when the risk is low and the proportion of early adopters is large. Under threshold coordination, the firm sets a lower price in period 1 when consumers hold pessimistic beliefs about the network size and sets a higher price in period 1 when beliefs are optimistic. Our findings highlight the critical implications of consumer coordination for firms’ pricing strategies.