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Bachelor ThesisErasmus School of Economics

Exploiting Social Networks

A study on the business decisions behind advertising

Author: Francien A. Heckman

Student Number: 369000

Supervisor: Dr. Jurjen Kamphorst

July 2015 Rotterdam

F. Heckman | Bachelor Thesis | Economics & Business Economics | Exploiting Social Networks | July 2015

1 - Introduction

“Every man (thus) lives by exchanging” –Adam Smith

These well-known words are instrumental in ‘The Wealth of Nations’ (1904). Though these

words emulate a barter economy, the notion is relevant in today’s economy. Each individual will

evaluate what skills they possess and which one is most profitable, the gains of which can be traded in

order to fulfil all needs and wants. This paper will examine this exact phenomenon, with the network of

an individual being the subject of the exchange.

Through the rise of social media, it has become easier to expand networks. An example is the

app Instragram, where users can follow other users based on common interests or individuals who are

already part of their (offline) network. Some individuals gain mass amounts of followers. The current

account belonging to Instragram has more than 60 million followers (“Instagram: Most followed

accounts”, 2015). Firms have taken notice, and realised that one post on this specific Instragram

account will reach 60 million consumers. Additional to firms setting up their own social media

accounts, they are stimulating consumer-generated marketing (Papasolomou and Melanthiou, 2012).

This entails they reach out to popular users, or opinion leaders, and engage them to feature their

products on their social media sites. Individuals are thus exchanging their network for monetary or in-

kind incentives; they become Brand Ambassadors due to their large network.

This case is an example of Word of Mouth (henceforth WOM) advertising, a well-established

marketing strategy with an innovative use of the Brand Ambassador concept. I define WOM

advertising as the use of customers, hence Brand Ambassadors, to convince members of their network

to procure similar products.

The forms of marketing that lead to the highest rate of customer acquisition, is the subject of a

longstanding discussion. The two primary forms of customer acquisition are (i) marketing-induced and

(ii) WOM Advertising. I define marketing-induced customer acquisition as advertisement that does not

require a third party, so the information trail is straight from the firm to the consumer. These forms can

be distinguished based on time span and the necessary investments. Marketing-induced acquisition is

characterised by relatively large investments with quick returns, whilst WOM acquisition has relatively

a relatively low investment with slower returns (Villanueva, Yoo and Hanssens, 2006). Although

WOM is difficult to quantify, Day computed WOM is up to nine times as effective as traditional

advertising (1971). The process of WOM primarily depends on consumers conveying their positive

experiences with a product to their interpersonal network (Brooks, 1957). Due to the uncertainty

attached to the consumer’s satisfaction and probability of sharing this with their network, companies

are less able to account for the effects of this stream of potential income.

This paper will examine whether Ambassador advertisement is more effective than

conventional advertisement and under what conditions. The key difference between the two methods is

Tie Strength, the relation between the Ambassador and an individual in the network has value, whilst

this is not the case for start-up firms entering the market and potential consumers. Tie Strength will be

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the variable of interest in this paper that distinguishes between these methods. The research question

is:

To what extent does Tie Strength make Brand Ambassadors a profitable advertising decision for

firms?

WOM revolves around incentivizing previous customers to convey positive view of the

product to their network and thus recruit new customers. They can be incentivized to share their

satisfaction with the brand through a Brand Ambassador fee. This will be a monetary or in-kind

payment from the firm to the Brand Ambassador. Due to this one-on-one interaction between a Brand

Ambassador and their personal network, this form of advertising is less intrusive and the rate of success

therefore possibly larger. This link between the Ambassador and their network allows the network to

determine whether the information they receive is credible, and if it is, lead them to purchase the

product. This leads to the first hypothesis: The use of Brand Ambassadors increases the firm’s

credibility and revenue, if the Ambassador is credible.

If the firm’s credibility and revenue can increase when using Brand Ambassadors as a form of

advertisement, their profitability will increase ceteris paribus. However, if the Tie Strength affects the

reaction of the Ambassador to a fee offered by the firm, this can reveal some additional information to

the network. This leads to the second hypothesis:

The relationship with the Ambassador influences the network’s decision to buy.

The structure of this paper is as follows; I will begin with a literature review in order to grasp

a better understanding of the current view on WOM and how it differentiates itself from conventional

advertising. In this paper I will formalize the empirical research that has been conducted. Subsequently

the central model of this paper is introduced, after which a discussion will follow and finally I will

conclude.

2 – Literature review

WOM

The current literature concerning WOM consists of three streams (Iuliana-Raluca, 2012):

1. Consumers spreading WOM

2. Information-seeking behaviour of potential customers and reliance on WOM

3. Effectiveness of WOM

In this section all three streams will be discussed. The focus will be on the effectiveness of WOM as

this is the subject of this paper.

Consumers spreading WOM

Consumers will spread WOM based on experiences they have had with the product/service provided by

the firm. This can be positive or negative based on the experience. Arndt has shown that positive WOM

is less effective in changing individuals’ perceptions relative to negative WOM (1967). There are

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several factors that motivate consumers to share their opinion with their network. The central factors

are the perception of value and quality (Hartline and Jones, 1996). These are strongly positively

correlated with consumers spreading positive WOM.

Referral marketing can also play a large role in consumers spreading (positive) WOM. Referral

marketing is defined customers referring their network to the firm for a product/service and in return

possibly receiving a monetary incentive. Schumann et al. have shown that this method has a positive

effect on consumer’s perception of quality and that this is also relevant in existing service relationships

(2010).

Information-seeking behaviour of potential customers and reliance on WOM

Research has shown that individuals seek WOM as an information source when they are exposed to

more risk (Schumann et al, 2010). This is more the case with services than products (Schumann et al,

2010). Individuals who are gathering information tend to seek out opinion leaders. Studies have shown

that each network has several opinion leaders, which other members of the network look towards for

advice (Brooks, 1957). The characteristics of an opinion leader are their specialization in the area of

interest and their specialization by social and economic strata (Brooks, 1957). Taking these two factors

as search criteria could therefore lead firms to individuals that would make valuable Brand

Ambassadors, and thus the chance of acquiring customers higher. Brooks has shown evidence of the

effects of opinion leaders, such as a study done on air conditioners in Philadelphia found that certain

streets had a much higher concentration of air conditioners. These opinion leaders spread WOM

concerning the air conditioners. The households were connected by the friendships of wives and their

children, thus showing the channel of WOM (1957).

Effectiveness of WOM

Much research on the comparison between WOM marketing and traditional forms of marketing is

available. Several studies support the enhanced effectiveness of WOM compared to traditional forms of

marketing. Day concluded that WOM is nine times as effective as traditional advertising in converting

negative or neutral perceptions into positives perceptions, thus making sales more likely (1971). Even

though the factor of effectiveness varies in different studies, the consensus is that WOM is more

effective in conveying positive perceptions to individuals. However WOM advertising is still a

relatively new phenomenon and conventional advertising has proved effective in the past. Some firms

may want to refrain from changing their advertising strategy due to uncertainty. The workings of

WOM marketing are constantly adjusting to the technological changes occurring around us. Although

many recent studies focus on digital WOM, a considerable amount of studies on offline forms of WOM

is available. Arndt has also shown that negative WOM is more ‘effective’ compared to positive WOM

(1967). This paper will however focus on positive WOM and turning negative or neutral perceptions

into positive ones.

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Tie Strength

Researchers have determined several variables that seem to be the driving force behind the

effectiveness of WOM. One widely discussed variable is Tie Strength. Marsden and Campbell found

that the best measure of Tie Strength is closeness, as other measures can overestimate certain Tie

Strengths and that Tie Strength is dependent on both time spent together and the depth of the

relationship (1984). Similarly, Granovetter has defined Tie Strength as “a combination of the amount

of time, the emotional intensity, the intimacy (mutual confiding), and the reciprocal services which

characterize the tie” (1973). In his paper, Granovetter distinguished between two networks each

individual may have, a network consistent of strong ties and one consistent of weak ties. The strong ties

make up a denser network, but weak ties turn out to be essential in spreading information. The

networks of strong ties, though more dense, are disjointed and only connected to each other by weak

ties. Brown and Reinigen found empirical evidence that weak ties are more likely to be activated for

referral than strong ties (1987). They traced the information flow for three different piano teachers who

solely relied on WOM to acquire customers. However, this research also showed that if both strong and

weak ties are available for information, strong ties are more likely to be used.

Having said this, it is not only important that the tie between two individuals exists, but also

that the information received through this tie is reliable and thus that the tie is to a credible source.

Levin and Cross have completed empirical research that has revealed that individuals rely on strong

ties for information, as these are perceived as trustworthy (2004). After controlling for perceived

trustworthiness, they found that weak ties lead to more receipt of useful information (quite similar to

Granovetter’s insights on the strength of weak ties). However, the weak ties have to be trusted to

permit this information transfer to be able to occur (Levin & Cross, 2004).

Though there is a considerable amount of studies on WOM, few have focused on the process

of turning customers into Brand Ambassadors for the firm and thereby gaining access to their network.

Most of the research is empirical, whereas this paper is theoretical. There are some papers that

implicitly discuss Brand Ambassadors, but this paper discusses and interprets Ambassadorship as a

viable advertising method for firms rather than explaining a phenomenon. The next section will focus

on research conducted on Brand Ambassadors.

The Role of Brand Ambassadors

Instead of marketing towards one large target audience, WOM advertising divides this large

audience into smaller networks that are in direct contact with one Brand Ambassador. This form of

advertising is therefore tailored towards individuals and their needs. Their relation to their interpersonal

network characterizes these Brand Ambassadors.

One of the earliest successful implementations of Brand Ambassadors was by Tupperware.

Their strategy consisted of hosting parties, where individuals would invite their network and introduce

them in an informal atmosphere to the product. Duffy suggests that this strategy is a crossover between

WOM and direct selling, incentivizing individuals with a pay-for-performance commission (2005).

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Firms aim to receive the maximum amount of exposure for the minimum amount of cost. For

this reason a selection can occur for Brand Ambassadors. When the selection occurs firms will look at

the amount of potential customers that are placed within the network of a Brand Ambassador.

Thorough firms will subsequently look at the size of the networks related to those potential customers

etc. Using this method a lifetime value can be calculated for each Brand Ambassador, consisting of the

one-time purchases of each person in the network. This lifetime value is what firms will want to

maximize. Hogan, Lemon and Libai introduce this method (2004).

Even though this approach can be beneficial for the firm employing it, Hogan, Lemon and

Libai ignore the large market research costs attached. In order to isolate useful Brand Ambassadors,

their network and the network of all subsequent potential customers have to be examined. This will not

only have monetary costs, the information needed to evaluate will most likely not be free, but also take

time which in turn raises opportunity costs. Due to these research costs it becomes probable that

conventional advertising becomes equally or more interesting. The model introduced in this paper

distinguishes itself by allowing the firm to take these costs into account.

3 – Theoretical Framework

This paper will introduce a model that aims to estimate the effectiveness of WOM in

comparison to conventional marketing. In order to contrast these two methods, a theoretical model

concerning the choice of a start up will be examined.1 This start-up has the choice between a

conventional advertising campaign, and a WOM campaign using Brand Ambassadors. The methods are

compared by means of profit, and the firm objective is to maximize profit. Two extensions will be

introduced; in these extensions alterations are made to the WOM strategy, but the conventional strategy

remains the same throughout the model. The first extension will introduce severance of ties upon bad

advice, with the Tie Strength being the same for the entire network. The second extension will

introduce two separate networks, one close and one distant (as is custom in research concerning

WOM). For this extension, the Tie Strength of the close network is larger than the distant network. In

the model only positive WOM is allowed, the Ambassador is aware when the product is not a good

purchase and the network will drive disutility from the purchase.

Several assumptions are made in order to make the cases comparable, which is important as

comparative statistics are used:

- The good sold is a durable good and each individual will either purchase one unit or zero. The

model is a one period model, such that no repeat purchases are relevant.

- The marginal cost, c, is equal for W=H and W=L.

- For each case the same target market is assumed; only the method of advertising differs.

- Firms have to opt for one or the other form of advertising due to their budget constraint.

1 A start-up is used as there is no status quo (no costs yet related to previous campaign), additionally an existing firm can have build up a reputation and have some credibility concerning the worth of the product.

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- Before an individual can purchase the product, he/she will have to gain knowledge of the product

first, either through conventional advertising or WOM.

- The Ambassador’s marginal cost is equal to zero.

- The firm is able to set the Ambassador fee.

- The conventional advertising cost, A, is significantly higher than the fixed costs for Ambassador

advertising, F.

- Individuals cannot see what other consumers are approached by the Ambassador.

Purchasing probability

The purchasing probability, , is relevant for all cases and includes the reaction of the customer to the

advertisement. The purchasing probability can will take on a value such that 0 < 1. A share of the

target market, , will purchase the product once they know of its existence, these individuals have

E(W)>P. The remaining share of the target market, (1-), will purchase the product upon certainty that

W>P, if certainty is not reached E(W)<P and this share will not purchase the product. The value of is

such that P= ρH+(1−ρ ) L . It is important to state that the preferences are homogenous, and if W>P,

the entire target market will want to acquire the product. The expectations differ, however without a

signal only part of the target market will purchase the product. This signal has to be credible, however,

in order to convince the market of the worth of the product

The firm cannot be seen as a credible source, because there is a moral hazard problem. As the

firm’s objective is to maximize profit, it can potentially make certain claims about the product that

would appeal to customers, but are not true. This is especially relevant for durable products, since

repeat purchases are irrelevant and there are no economic consequences related to that certain

customer.2 The same holds true for Brand Ambassadors due to the monetary incentive they receive.

Thus the customer will have to decide in each case whether they find the source credible. For the firm,

this may depend on the advertising budget. The larger the budget, the more invested the firm is in their

product and believes that their product is capable of delivering satisfaction to the customer. For the

Brand Ambassadors, this may depend on Tie Strength. If the relationship between the Ambassador and

network is strong, the consequences of lying to the network can outweigh the monetary incentive given

by the firm.

Conventional Marketing

Using the advertising budget, A, the entire market is exposed to the product. Upon exposure each

individual has a purchasing probability equal to . The firm will expend as much resources till the

point where marginal revenue is equal to marginal cost. For the purposes of this model, A is given and

is the point where the firm maximizes profits using conventional advertising.

For the WOM Model, based on the fee, the Ambassador will either expose the entire network or none

of the network, λ=0or λ=1

2 However, negative WOM can be a consequence, though it is not examined in this paper.

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WOM – Base Model

A firm introduces a new product, which sells at price P and has marginal cost equal to c. The target

market has a mass of consumers equal to one, all of these consumers are part of

the network of the Brand Ambassador. The Ambassador is approached by the firm and offered a fee, a

percentage of the profit per product sold. In order to receive this fee, the consumer has to hear about the

product through the Ambassador and purchase the product. The consumer’s utility function is equal to:

W P , where W is the worth of the product and P is the price of the product. The worth of the product

can take on two values, high (H) and low (L). W=H>P and W=L<P. Based on the worth of the product,

the consumers utility can either be positive, they derive pleasure from the purchase, or negative, they

derive displeasure from the product. Both the Ambassador and the firm are aware of the worth of the

product; the consumer is, however, not aware before the purchase of the product. The Ambassador and

the network have homogenous preferences. So, if the Ambassador finds that the product’s worth is

lower than the price, so will the network. If the Ambassador does falsely recommend the product to

their network, W=L, the relationship with his/her network is not harmed. Because the Ambassador does

not face consequences if W=L, there is a chance that W=L. A proportion of the network, , will take

the advice of the Ambassador regardless of his/her intentions, E(W)>P. The remaining proportion, (1-

), will only purchase the product once they can determine that (W)>P, however E(W)<P and they will

not purchase without a signal. Training and maintenance costs of the Ambassador are equal to F, whilst

the fee is equal to .

Extension 1 - Credibility

This extension is similar to the foundation model, but it differs in one aspect. The Ambassador knows

the value of the product, when recommending the product to his or her network the Ambassador claims

the product’s worth is higher than the price. If the product’s worth is lower than the price, individuals

in the network will not purchase the product and the referral is therefore moot. However, the

Ambassador can be incentivized to lie to his or her network and in doing so the individuals that have

purchased the product will sever ties with the Ambassador. The Ambassador is willing to lie if the

compensation is adequate. This compensation has to be equal or higher than the monetary value the

Ambassador attaches to each relationship, this value is equal to D. In this extension, the Ambassador

values the close and distant networks equally, therefore DD=DCL. Due to this equality, the Ambassador

does not discriminate between individuals, and if the compensation is adequate both networks will be

approached. The network can observe the value of the fee and the value of the relationship (value of

D). Both the Ambassador and the network value their relationship equally, though severing ties will

only harm the Ambassador. The network will need to know the value of their relationship in order to

correctly recognize signals concerning the worth of the product.

Extension 2 – Close & Distant Network

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Given that the Ambassador has two networks, the value attached to these networks is different. The

close network is valued higher than the distant network. This is reflected in the displeasure associated

with severing a tie. So,

DCL DD 0 . The proportion of the network that has a close tie to the

Ambassador is equal to , the remaining proportion,

1 , is in the distant network. The consumer

revenue regardless of what network they are in is equal to L-P<0 if W=L and H-P>0 if W=H.

In order to isolate the effect of the different reaction’s the network will have, comparative statics will

be used.

4 Model3

Base model

The Ambassador’s revenue is equal to

P c . Therefore the Ambassador will accept any fee that

is marginally higher than zero, if this fee is larger than zero the reach, , will be equal to one (the entire

network). The firm’s revenue is equal to

1 P c F , (where =1 in this case). The firm will

opt for Ambassadors if

P c F A, for this to hold

0 a A F P c .

As the upper limit of is at all times larger than zero, and the fee has to be marginally higher than

zero, the firm will always opt for Ambassador advertising. The Ambassador requires relatively little in

return for access to his/her network, as there are no negative effects or consequences. The individuals

in the network will derive utility, and the Ambassador will have a positive return. Furthermore the firm

is able to make a higher profit in comparison to conventional advertising. All agents benefit from this

form of advertising.

This model allows the Ambassador to inform his/her network about the existence of the

product. Though both the network and Ambassador have homogenous preferences, a proportion of the

network does not buy the product. This is due to the Ambassador lacking credibility, as hidden

intentions can be present, and there are no negative consequences. Furthermore the Ambassador faces

an increase in profit if he or she takes on the Ambassadorship and lies to their network. The profit

increases from zero to

P c .

Product Worth Consumer Utility Ambassador

profit

Min. Ambassador

fee (Ambassador

limit)

Max. Ambassador

fee (firm limit)

W=L L-P<0 ρα ( P−c ) > 0 α < A −Fρ ( P−c )

W=H H-P>0 ρα ( P−c ) > 0 α < A −Fρ ( P−c )

Extension 1 - Credibility

3 Due to the large amount of terms introduced, all can be found in the Appendix 1 rather then the text

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The Ambassador’s revenue is equal to

P c D . The Ambassador will be incentivized to

approach their network if the revenue is higher than zero, if this is the case the entire network is

approached,

1. There are two cases that can be distinguished:

1. W=L. If the Ambassador lies, and recommends a product that is not worth the price, the ties

between the network and the Ambassador are severed. The Ambassador will need to be compensated

for this displeasure, thus in order to incentivize the Ambassador,

a DP c .

2. W=H. When the Ambassador tells the truth in recommending the product, the relationship

between the network and the Ambassador is kept intact. Therefore the displeasure the Ambassador

would have if ties were severed does not have to be compensated. From the Ambassador’s revenue

function it can be deduced that the Ambassador will accept any fee where

0 , even if the fee is

marginally higher than zero.

The firm’s revenue is equal to

1 P c F for both cases.

In the first case, the firm will opt for Ambassador advertising if

1 P c F P c A . This is the case if

A F P c . Substituting the minimum acceptable

fee for the Ambassador gives

D A F . Thus if D=0, as in 2.1, the firm will always opt for Ambassador

advertising.

In the second case several mechanisms are introduced here. The firm will offer the

Ambassador a fee equal to

0 a DP c . The Ambassador will accept this, as W=H and the relationship

will not be damaged. The network observes this and is able to conclude that W=H. As the value of the

product is now determined, and the Ambassador fee acts as a signal,

1. The firm will opt for

advertising if

1 P c F P c A . This results in an Ambassador value equal to

a A FP c .

The chance that the relationship will be damaged increases credibility. This increase in

credibility results in an increase in profit, a result that cannot be obtained using conventional

advertising as the firm’s credibility cannot be determined.

Product Worth Consumer Utility Ambassador profit Min. Ambassador

fee (Ambassador

limit)

Max. Ambassador

fee (firm limit)

W=L L-P<0 ρα ( P−c )−Dρ

a DP c

A F P c

W=H H-P>0 α (P−c ) >0

a A FP c

The results show that if the product worth is low, Ambassador advertising is less likely

compared to if the product is high, however it can still be more profitable than conventional

advertising. For the low product worth both the minimum fee is higher, and the maximum fee is lower

compared to the high product worth. This smaller range makes Ambassador advertising less likely, and

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it can be the case that

D A F , in which case Ambassador advertising is not an option (or will result in

a loss).

Extension 2 – Close & Distant Network

The Ambassador revenue is equal to ρα (1−q ) (P−c ) λ for the distant network, and

ραq ( P−c ) λ−DCL ρqλ for the close network. For both networks if the Ambassador fee is sufficient,

=1. This results in two different Ambassador fee boundaries. For the distant network, as there are no

negative consequences, the Ambassador will accept any >0. To sever ties with the close network, the

Ambassador will accept any α >

DCL

(P−c ) .

Because of the two thresholds for Ambassador fee, I will examine both cases, where W=L.

For the first case, the Ambassador will only reach out to the distant network, due to the lower fee. If the

Ambassador would reach out to the close network it would signal W=H, however compensation is not

adequate so the Ambassador will not do so. The firm profit is equal to ρ (1−a ) (1−q ) ( P−c )−F . The

firm will opt for Ambassador advertising if

a 1 1 F A P c P c .

If the firm offers the higher Ambassador fee, the firm profit is equal to

1 P c F .

Thus, ρ(1−

DCL

(P−c ) ) ( P−c )−F. The firm will opt for Ambassador advertising if

a A F P c , or DCL<

A−Fρ .

The firm will offer the higher fee if

1 A F A F P c , if this is not the case the lower fee will be offered,

or if it is more profitable conventional advertising will be used.

The firm will offer the higher fee, if the profit obtained is higher than if the lower fee is offered.

If W=H, the purchasing probability for the close network becomes one, whilst it remains for

the distant network, as there are no negative consequences, as the Ambassador fee becomes any fee

where a>0. The firm will minimize its cost and offer the minimum acceptable fee to the Ambassador.

This signals to the close network that W=H and for the close network =1. However the distant

network does not receive this signal, and the purchasing probability remains .

This model shows that credibility increases and profitability increases if there are negative

consequences. Furthermore, the market can be segregated based on the Ambassador fee, and the

Ambassador’s reaction to this. However if the highest fee is offered, the entire network will be

exposed. Thus only the individuals that have a weak tie with the Ambassador, distant network, can be

singled out and targeted. The same does not hold for the close network.

Dependent on the close network size, it becomes unlikely the firm will opt for Ambassador

advertising if W=L, either distant or close and distant. A large share of the market remains untapped,

therefore the opportunity cost rises and conventional advertising becomes more attractive. However as

the number of close contacts increase, it becomes more profitable to offer the higher profit.

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Product Worth Consumer Utility Ambassador profit Min.

Ambassador fee

(Ambassador

limit)

Max. Ambassador

fee (firm limit)

W=L (distant) L-P<0 ρα (1−q ) (P−c ) a>0

a 1 1 F A P c P c

W=L (close) L-P<0 ραq ( P−c )−DCL qρ α >DCL

(P−c )

a A F P c

W=H (distant) H-P>0 ρα (1−q ) (P−c ) a>0

a A F P c

W=H close H-P>0 αq ( P−c ) a>0α <1−

A−F( P−c) +ρ

q

If the firm wants to reach both the close and the distant network, the higher fee related to each product

worth has to be offered. For W=L, this does not constitute a problem, the firm will offer the fee related

to the close network for the entire network. For W=H, the Ambassador fee for both networks is the

same; a>0.

The Ambassador does not need to be compensated to tell the truth to his/her network, or if he/she does

not value the relationship. If the relationship is valued, compensation must be offered in order to

incentivize the Ambassador to lie. This would mean that individuals take their relationship with the

Ambassador as a signal. If the relationship is a close relationship, the probability that the Ambassador

will lie decreases significantly (especially assuming the close network is the smaller of the two

networks). However if the relationship is a distant one, the negative consequences to lying disappear

and even a minimal fee can incentivize the Ambassador to lie.

5 – Conclusion and Discussion

The model in the previous section has revealed several phenomena that have already been

examined in other papers or scopes of economics. However, these are now placed in a new context and

in a theoretical framework.

The base model shows the minimum Ambassador fee needed to incentivize the Ambassador to

tell his/her network of the existence of the product. The Ambassador is willing to accept a fee that is

marginally higher than zero, given that marginal costs are equal to zero. Though realistically, marginal

costs will be larger than zero, as Ambassadors will have to be compensated for the effort they exert to

reach out to their network, the notion remains the same. The costs to incentivize an Ambassador will be

significantly lower than a commercial advertising campaign, even for niche markets. Perhaps altruism

also plays a role, the Ambassador values his network and would thus derive utility from increasing

their utility, thus not needing the Ambassador fee to be incentive to share useful information with the

network. The cost of telling someone you frequently talk to about a useful new product, will be

relatively low, whereas the cost will increase as frequency decreases (and thus Tie Strength decreases).

Due to these extremely low Ambassador costs, the result is that the firm will always opt for

Ambassador advertising. However, the networks reaction to the advertisement remains the same. The

same proportion of the network purchases the product, whilst the other proportion refrains due to

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uncertainty concerning the worth of the product. The use of an Ambassador alone is not enough to

convince the network that W=H, due to the Ambassador receiving a monetary incentive from the firm.

By offering an incentive, the firm ultimately removes all credibility from the Ambassador, as the

incentive aims to align the preferences of the firm and the Ambassador; selling as many products

regardless of the worth. From the model and extensions introduced, this model is most unrealistic and

making the results most distinct.

Contrastingly, the extensions reveal more of a decision-making process when it comes to the

advertising campaign. The first extension treats lying to the close and distant networks as equally

unfavourable to the Ambassador. The model reveals that a third party can validate the value of the

product and create a new better (for all parties) equilibrium. This is quite similar to the mechanism

described in Akerlof’s ‘The market for lemons’ paper, as the same uncertainty about quality and

asymmetric information conditions apply (1970). In his paper, Akerlof has a section referring to his

Lemons Principle in relation to the costs of dishonesty, and he concludes that the costs are not limited

to the consumer’s disutility, but also include the legitimate business that is driven out of the market

(1970). The latter is not found here as one firm in isolation is examined. Akerlof comes to the same

conclusion that these effects can be countered using a guarantee (1970). For the third party to be able to

validate the product, we have to ensure that the third party remains unbiased, even when receiving

payment for their services. However this third party will only be credible if their actions are unaltered

by the monetary incentive they receive (they would give the same advice when prompted by their

network, not the firm). If this is not the case, the third parties advice has the same effect as

conventional advertisement, there is no credibility but it does expose the market to the new product.

Therefore two important elements of WOM are an impartial third party and negative consequences to

bad advice.

Naturally a guarantee can only be given by the Ambassador if W=H, if the firm compensates

for W=L, the network will realize this and the firm will not be able to sell any products. Thus this

extension shows that WOM is most useful if W=H, and it can be shown that this is the case. For W=L,

WOM can still be more profitable compared to conventional advertising, however the same share of

individuals will purchase the product, thus not showing a large difference between the two methods.

This extensions has shown that WOM can act as a signal that W=H, resulting in an increase in the

purchasing probability. The same cannot be achieved with conventional advertising. Based on the

findings, the first hypothesis is accepted; the use of Brand Ambassadors increases the firm’s

credibility and revenue, if the Ambassador is credible.

The second extension model allows the Ambassador to attach different values to different

networks. The close network has a higher value compared to the distant network. This has resulted in

more possible equilibrium. However the additional information this extension reveals is the firm’s

ability to ‘skim’ the market. Setting the fee at different levels either incentivizes the Ambassador to

approach the distant network or both the close and distant network and sends a signal about the quality

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or not. Having different values for displeasure associated with severing ties for the two networks can

allow the firm to target one share of the market, leaving the other share unexposed.

Salop and Stiglitz create a model in which imperfectly informed consumers can become

informed at a certain cost, which can differ for consumers, quite similar to the model introduced here

(1977). Their findings are that having to pay for information will lead to price dispersion, due to this

firms will attempt to price discriminate. The findings in this paper differ slightly. As the firm’s price is

assumed to be constant, the cost to inform a consumer can differ but is paid by the firm. The firm will

attempt to ‘cost discriminate’ leading to different profits associated with the consumer networks. Due

to this difference in customer acquisition costs, it may only be profitable for the firm to reach out to a

share of the Ambassador’s network. This can be useful if the firm only requires a share of the

Ambassador’s network, or if the Ambassador advertising is done together with conventional

advertising. Such that the firm only wants to reinforce advertisement for the individuals who are unsure

about the product.

The relationship to the Ambassador influences the networks buying decision. Being in the

close network increases the probability the network will purchase, due to the increase in Tie Strength

the Ambassador will have to be compensated additionally for severing this tie and it becomes more

likely upon receiving knowledge of the product that W=H. For the individuals in the close network the

purchasing probability can increase to one, whilst this is not the case for the distant network. This

shows that the network (and thus Tie Strength) influences the networks decision to purchase. Using the

results found in the second extension, the second hypothesis is accepted.

Having analysed the model and examined the hypothesis, I am now able to answer the research

question: To what extent does Tie Strength make Brand Ambassadors a profitable advertising

decision for firms? Tie Strength is pivotal both in the consumer’s choice to purchase and the

minimum fee the Ambassador is willing to accept. It is what distinguishes WOM from conventional

advertising and allows for Ambassadors to be credible. The base model shows a situation in which Tie

Strength has no effect on the consumer’s or Ambassador’s decision. The result is a WOM with less

revenue that conventional advertisement, however also possibly lower costs. Here I want to emphasize

that the costs can in fact be higher. Opting for WOM does not allow the firm to convince the share of

the market that does not buy without assurance, so the two methods do not differ significantly when

Tie Strength is not introduced. Upon the introduction several effects of interest present itself. Tie

Strength and the Ambassador fee (which is a function of Tie Strength) influence the actions of the

Ambassador and in turn the consumer.

However, Tie Strength can make it more expensive to reach certain parts of the network. If

W=L, compensation is necessary and Tie Strength is harmful to the firm’s profit. Tie Strength would

drive up the Ambassador fee, thus signalling the worth of the product to the network. Though in some

cases this might still be more profitable than conventional, in the same cases as found in the base

model, the main benefit of WOM, the increase in purchase probability is not present for W=L.

The model shows that a lower advertising budget is more profitable. The lower Ambassador

fee signals W=H, and also lowers advertising costs whilst making the purchasing probability equal to

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one. By lowering the advertising budget, the firm signals it beliefs in its product. Contrastingly, it can

be argued that if the firm has a large advertising budget, it can signal that they are willing to spend

money acquiring consumers as the products worth is high and thus would sell. But this would send the

wrong signal to the consumers, because it would remove the credibility from the third party.

This paper is in line with a large amount of the empirical findings discussed in the literature

review. Brown and Reinigen found that if both weak and strong ties were available, strong ties would

be approached for information. The theoretical explanation this paper offers is that the Ambassador is

more likely to be truthful if the tie with the individual is a strong one. Levin and Cross’ finding of

trustworthiness in strong ties is theoretically proven, as the displeasure associated with severing ties is

greater for strong ties. Granovetter’s finding that weak ties lead to more new information is implicitly

shown, the Ambassador is willing to approach the distant network regardless of the worth of the

product, due to the lower Tie Strength. Even if W=L, and the Ambassador approached the network,

new (dishonest) information is received by weak ties, of which will purchase the product.

Limitations

Human behaviour cannot be successfully modelled, and this model is merely an approximation of what

would occur. In order to estimate the effect, many assumptions were made and the models simplified

several aspects. This explains why marketing and advertising journals rarely have theoretical papers

and when this does occur the models are relatively simple.

The model assumes homogeneity of preferences for the network and the ambassador. Though

this gives clear-cut results, it is not realistic. In certain niche markets homophily of preferences can

approach a level such that homogeneity can be a useful estimate, it is likely to heterogeneity will give a

much more realistic view. If this is the case, the Ambassador does not have to lie to his/her network,

possibly increasing or decreasing profits. Though this model does not tackle heterogeneity, it is a

suggestion for future theoretical research.

The models have been based on a product, however research has shown that services

potentially require more reinforcement as the perceived risk is larger. This variable could therefore lead

to firms opting for WOM rather than conventional due to the flexibility of communication.

Additionally, with services it would become more difficult for an individual to discover the

Ambassador that recommended the service in fact dislikes the firm. Hereby also making WOM more

feasible and profitable, both for the Ambassador and the firm. Contrastingly, conventional becomes

less likely due to the lower purchasing probability and possibly reach. A share of the customers reached

through conventional advertising was personally looking for a product, and thus found the

advertisement. Though due to the increased risk they will look for other sources (individuals in their

network) to find information. Thus the conclusions drawn in this paper are only applicable for

(durable) products.

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Implications

The WOM strategy has shown some benefits throughout this paper, however for this strategy to fully

show its merits, the Ambassador has to have credibility. Firms should be aware of the opinion leaders

in their target market. Start-ups using the Brand Ambassador model can manage their budget better and

estimate their expenditures and income better. Furthermore, as the Ambassador is paid on a pay per

performance basis, the fee is to be paid after the customer is brought on. More and more firms (start-

ups especially) are stimulating WOM through Brand Ambassadors using a monetary incentive.

Through social media, such as Instagram, opinion leaders are easier to find and then employ. Firms can

still benefit from employing Ambassadors that dislike the product, thus the moral hazard problem is not

relevant.

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Appendix 1

Glossary

- purchasing probability

- Ambassador fee

- Reach, binary

- fraction network that is close

A – Conventional advertising cost

c – marginal cost, constant

D – displeasure associated with severing ties

F – Training & maintenance cost Ambassador

P – Price

W – worth of the product

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web viewthis case is an example of word of mouth (henceforth wom) advertising, a well-established...

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