Hotelling-Bertrand duopoly competition under firm-specific network effects

Abstract

Social pressure plays a crucial role in consumer choices; the impact of network/social effects has also been largely recognised in the context of market competition. In this paper, we consider a duopoly where competing firms are differentiated solely by the level of social (or network) externality they induce on consumers’ perceived utility. We fully characterise Nash equilibria in locations, prices and market shares. Under a scenario of weak social externality, firms opt for maximum differentiation, and the firm with the highest social recognition enjoys a relative advantage in terms of profit. This outcome is not the only possible; we formally prove that large values of social recognition may lead to “adverse coordination among consumers” and move the strongest firm out of the market with positive probability. This scenario is related to a Pareto-inefficient trap of no differentiation.