arbatska_05

Emory University
Department of Economics
Working Papers

Title: Referrals in Search Markets

Number: 05-21

Author: Maria Arbatskaya and Hideo Konishi

Issue Date: July 2005

Abstract: This paper compares equilibrium outcomes in search markets with and without referrals.
Although consumers would benefit from honest referrals, it is not at all clear
whether firms would unilaterally provide information about competing offers since such
information could encourage a consumer to purchase the product elsewhere. In a model
of a horizontally differentiated product and sequential consumer search, we show that
valuable referrals can arise as a part of equilibrium: firm will give referrals to consumers
whose ideal product is sufficiently far from the firm’s offering. The effect of
referrals on the equilibrium prices is examined, and it is found that prices are higher in
markets with referrals. Although consumers can be made worse off by the existence of
referrals, referrals lead to a Pareto improvement as long as search cost is not too low
relative to product heterogeneity. The effects of referral fees and third-party referrals
are examined, and policy implications are drawn.

Title:	Referrals in Search Markets
Number:	05-21
Author:	Maria Arbatskaya and Hideo Konishi
Issue Date:	July 2005
Abstract:	This paper compares equilibrium outcomes in search markets with and without referrals. Although consumers would benefit from honest referrals, it is not at all clear whether firms would unilaterally provide information about competing offers since such information could encourage a consumer to purchase the product elsewhere. In a model of a horizontally differentiated product and sequential consumer search, we show that valuable referrals can arise as a part of equilibrium: firm will give referrals to consumers whose ideal product is sufficiently far from the firm’s offering. The effect of referrals on the equilibrium prices is examined, and it is found that prices are higher in markets with referrals. Although consumers can be made worse off by the existence of referrals, referrals lead to a Pareto improvement as long as search cost is not too low relative to product heterogeneity. The effects of referral fees and third-party referrals are examined, and policy implications are drawn.

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