Cheap Talk and Bogus Network Externalities in the Emerging Technology Market

  • Authors:

  • Xiaotong Li

  • Affiliations:

  • College of Administrative Science, The University of Alabama in Huntsville, Huntsville, Alabama 35899

  • Venue:
  • Marketing Science
  • Year:
  • 2005

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Abstract

Many emerging technologies exhibit path-dependent demands driven by positive network feedback. Such network effects profoundly impact marketing strategists' thinking in today's network economy. However, the significant network externalities expected by many people often fail to materialize in the emerging technology market. We analyze this phenomenon in the context of a technology distribution channel. By studying cheap-talk strategies under information asymmetry, we show that incentive-compatible contracts are essential for achieving credible information transmission. In our model, the better-informed technology vendor has an incentive to inflate the retailer's ex ante belief of network externalities when a wholesale price contract is adopted. When properly termed revenue-sharing contracts are implemented, there are information-efficient cheap-talk equilibria where truthful information transmission is mutually beneficial. When the vendor's information is imperfect, even revenue-sharing contracts cannot guarantee credible information transmission if there is significant prior belief disparity between the vendor and the retailer. This study demonstrates how information-inefficient equilibria (e.g., information blockage) arise because of the conflict of interest or the conflict of opinion among channel members. It also explores the role of cheap talk in facilitating channel coordination.