Revenue Volatility under Uncertain Network Effects

41 Pages Posted: 15 Apr 2020

See all articles by Opher Baron

Opher Baron

University of Toronto - Operations Management

Ming Hu

University of Toronto - Rotman School of Management

Azarakhsh Malekian

University of Toronto - Rotman School of Management; Massachusetts Institute of Technology (MIT) - Electrical Engineering and Computer Science

Date Written: March 25, 2020

Abstract

We study revenue volatility of a monopolist selling a divisible good to consumers in the presence of local network externalities among consumers. Each consumer's utility depends on her consumption level as well as the consumption levels of her neighbors in a network through network externalities. In the eye of the seller, there exist uncertainties in the network externalities, which may be the result of unanticipated shocks, or lack of exact knowledge of the externalities. But the seller has to commit to prices ex ante. We quantify the magnitude of revenue volatility under the optimal pricing in the presence of those random externalities. We consider both a given uncertainty set (from a robust optimization perspective) and a known uncertainty distribution (from a stochastic optimization perspective) and carry out the analysis separately. For a given uncertainty set, we show that the worst case of revenue fluctuation is determined by the largest eigenvalue of the matrix that represents the underlying network. Our results indicate that in networks with a smaller largest eigenvalue, the monopolist has a less volatile revenue. For the known uncertainty, we model the random noise in the form of a Wigner matrix and investigate large networks such as social networks. For such networks, we establish that the expected revenue is the sum of the revenue associated with the underlying expected network externalities and a term that depends on the noise variance and the weighted sum of all walks of different lengths in the expected network. We demonstrate that, in a less connected network the revenue is less volatile to uncertainties, and perhaps counter-intuitively, the expected revenue increases with the level of uncertainty in the network. We show that a seller in the two settings favors the opposite type of network. In particular, if the underlying network is such that all the edge weights equal 1 (resp., the sum of all the edge weights is fixed), the seller in the robust optimization setting prefers more (resp., less) asymmetry in the underlying network, while the seller in the stochastic optimization setting prefers less (resp., more) asymmetry in the underlying network.

Keywords: pricing, network effect, uncertainty

Suggested Citation

Baron, Opher and Hu, Ming and Malekian, Azarakhsh, Revenue Volatility under Uncertain Network Effects (March 25, 2020). Available at SSRN: https://ssrn.com/abstract=3561270 or http://dx.doi.org/10.2139/ssrn.3561270

Opher Baron

University of Toronto - Operations Management ( email )

105 St. George st
Toronto, ON M5S 3E6
Canada

Ming Hu

University of Toronto - Rotman School of Management ( email )

105 St. George st
Toronto, ON M5S 3E6
Canada
416-946-5207 (Phone)

HOME PAGE: http://ming.hu

Azarakhsh Malekian (Contact Author)

University of Toronto - Rotman School of Management ( email )

105 St. George Street
Toronto, Ontario M5S 3E6 M5S1S4
Canada

Massachusetts Institute of Technology (MIT) - Electrical Engineering and Computer Science ( email )

77 Massachusetts Avenue
Cambridge, MA 02139-4307
United States

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