Dynamic Referrals in Peer-to-Peer Media Distribution

Abstract:     
Peer-to-Peer (P2P) networks, a decentralized content distribution format in which users distribute media to each other, is fast gaining popularity for delivery of digital media such as music and videos. Product diffusion in P2P is unique because free riders ý users who download content from others in the network without redistributing it to others ý can create a supply constraint that results in the incomplete fulfillment of generated demand. P2P firms offer distribution referrals, i.e. payments to users who distribute content to others, to provide users with incentives to distribute content. In this paper, we study a P2P firm's optimal referral strategy. Starting with a simple model for media diffusion in P2P networks, we apply optimal control theory to determine a dynamic referral strategy. The diffusion model uniquely captures the role of the referral in addressing the supply constraint in P2P diffusion. We find that the referral strategy is governed by two main effects. Early in the diffusion, the referral strategy is dominated by a scarcity effect, namely that there exist very few users distributing the file in the work. Because the availability of users willing to distribute the file increases with time, the referral is nonincreasing with time during this phase. If the product is sufficiently diffused in the network, referral policy is dominated by a saturation effect later in the diffusion. In this Stage, the referral is non-decreasing with time in order to encourage sales which usually slow down late in the diffusion. In networks with significant free-riding, the optimal trajectory involves a very high referral at the beginning, followed by a decreasing trajectory. If the product is sufficiently diffused, the referral may start to increase in the final few periods due to the saturation effect mentioned above. Finally, we observe that firm profits under this dynamic strategy can be considerably higher than under a myopic referral policy. Our research represents a first step towards understanding marketing and operational issues in this emerging distribution format for entertainment goods and other digital media.

Keywords: Peer to peer, P2P, product diffusion, dynamic referral, Internet marketing, networks and marketing

JEL Classifications: M31

Working Paper Series