Download Exploiting Social Networks

Bachelor Thesis
Erasmus 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
2
F. Heckman | Bachelor Thesis | Economics & Business Economics | Exploiting Social Networks | July 2015
this is not the case for start-up firms entering the market and potential consumers. Tie Strength will be
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 several
3
F. Heckman | Bachelor Thesis | Economics & Business Economics | Exploiting Social Networks | July 2015
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.
Tie Strength
4
F. Heckman | Bachelor Thesis | Economics & Business Economics | Exploiting Social Networks | July 2015
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).
5
F. Heckman | Bachelor Thesis | Economics & Business Economics | Exploiting Social Networks | July 2015
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.
6
F. Heckman | Bachelor Thesis | Economics & Business Economics | Exploiting Social Networks | July 2015
-
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  H  1 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,   0 or  1

2
However, negative WOM can be a consequence, though it is not examined in this paper.
7
F. Heckman | Bachelor Thesis | Economics & Business Economics | Exploiting Social Networks | July 2015
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
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
8
F. Heckman | Bachelor Thesis | Economics & Business Economics | Exploiting Social Networks | July 2015
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.
Model3
4
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
Min. Ambassador
Max.
profit
fee (Ambassador
Ambassador
limit)
(firm limit)
W=L
L-P<0
 P  c
>0
  APFc
W=H
H-P>0
 P  c
>0
  APFc

fee

Extension 1 - Credibility


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:

3

Due to the large amount of terms introduced, all can be found in the Appendix 1 rather then the text
9
F. Heckman | Bachelor Thesis | Economics & Business Economics | Exploiting Social Networks | July 2015
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  PD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
1 P  c  F  P  c  A . This is the case if  

fee for the Ambassador gives D 

A F

for
A F
 P c
Ambassador
advertising
if
. Substituting the minimum acceptable
. 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  PD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  APF
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
Max.
fee (Ambassador
Ambassador
limit)
(firm limit)
  APFc
W=L
L-P<0
P  c  D
a
W=H
H-P>0
 P  c
>0


D
P c 
a
fee
A F
P 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 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
10
F. Heckman | Bachelor Thesis | Economics & Business Economics | Exploiting Social Networks | July 2015
The
Ambassador
revenue
is
equal
to
 1  P  c for
the
distant
network,
and
 P  c  DCL  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   PDCL
.
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 1 a1  P  c  F . The firm
   P c 
will opt for Ambassador advertising if a  1  1  FA
.
P c 
If the firm offers the higher Ambassador fee, the firmprofit is equal to 1 P  c  F . Thus,


D
 will opt for Ambassador advertising if a  APFc , or DCL  A F . The firm
 1 P c P  c  F . The firm


CL
1A F 

will offer the higher fee if   A F
, if this is not the case the lower
fee will be offered, or if it is
   P c

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.
11
F. Heckman | Bachelor Thesis | Economics & Business Economics | Exploiting Social Networks | July 2015
Product Worth
Consumer
Ambassador profit
Utility
Min.
Max.
Ambassador
Ambassador fee
fee (firm limit)
(Ambassador
limit)
W=L (distant)
L-P<0
 1  P  c
a>0
W=L (close)
L-P<0
 P  c  DCL
  P c
W=H (distant)
H-P>0

 1  P  c
a>0

W=H close
H-P>0

 P  c
a>0


a 1
DCL
1  F A    P c
 P c 
a
  P c
a
  P c
A F
A F
A F
 1
P c 




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
12
F. Heckman | Bachelor Thesis | Economics & Business Economics | Exploiting Social Networks | July 2015
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 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.
13
F. Heckman | Bachelor Thesis | Economics & Business Economics | Exploiting Social Networks | July 2015
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 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.
14
F. Heckman | Bachelor Thesis | Economics & Business Economics | Exploiting Social Networks | July 2015
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.
15
F. Heckman | Bachelor Thesis | Economics & Business Economics | Exploiting Social Networks | July 2015
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.
16
F. Heckman | Bachelor Thesis | Economics & Business Economics | Exploiting Social Networks | July 2015
Bibliography
Akerlof, G. (1970). The Market for "Lemons": Quality Uncertainty and the Market
Mechanism. The Quarterly Journal of Economics, 84(3), 488-500.
Arndt, J. (1967). ‘Role of Product-Related Conversations in the Diffusion of a New
Product.’ Journal of Marketing Research, 4(3), 291-295.
Brooks, R. (1957). ‘"Word-of-Mouth" Advertising in Selling New Products.’ Journal
of Marketing, 22(2), 154-161.
Brown, J., & Reingen, P. (1987). ‘Social Ties And Word-of-Mouth Referral
Behavior.’ Journal of Consumer Research, 14(4), 350-362.
Buttle, F. (1998). ‘Word Of Mouth: Understanding And Managing Referral Marketing.’
Journal of Strategic Marketing, 6(3), 241-254.
Day, G. (1971). ‘Attitude change, media and word of mouth.’ Journal of Advertising
Research, 11(6), 31-40.
Duffy, D. (2005). ‘Direct selling as the next channel.’ Journal of Consumer Marketing,
22(1), 43-45.
Granovetter, M. (1973). ‘The Strength of Weak Ties.’ American Journal of
Sociology, 78(6), 1360-1380.
Hartline, M., & Jones, K. (1996). Employee performance cues in a hotel service
environment: Influence on perceived service quality, value, and word-of-mouth intentions.
Journal of Business Research, 35, 207-215.
Hogan, J., Lemon, K., & Libai, B. (2004). ‘Quantifying the Ripple: Word-of-Mouth
and Advertising Effectiveness.’ Journal of Advertising Research, 271-280.
Instagram: Most-followed accounts worldwide 2015. (2015). Retrieved from
http://www.statista.com/statistics/421169/most-followers-instagram/
Iuliana-Raluca, G.(2012). Word-of-Mouth Communication: A Theoretical Review.
Unpublished Manuscript. Academy of Economic Studies, Bcuharest.
Levin, D., & Cross, R. (2004). ‘The Strength of Weak Ties You Can Trust: The
Mediating Role of Trust in Effective Knowledge Transfer.’ Management Science, 50(11),
1477-1490.
Marsden, P., & Campbell, K. (1984). ‘Measuring Tie Strength.’ Social Forces, 63(2),
482-501.
Papasolomou, I., & Melanthiou, Y. (2012). Social Media: Marketing Public Relations’
New Best Friend. Journal of Promotion Management, 18(3), 319-328.
Schumann, J., Wangenheim, F., Stringfellow, A., Yang, Z., Blazevic, V., Praxmarer,
S., . . . Jiménez, F. (2010). ‘Cross-Cultural Differences in the Effect of Received Word-of-
17
F. Heckman | Bachelor Thesis | Economics & Business Economics | Exploiting Social Networks | July 2015
Mouth Referral in Relational Service Exchange.’ Journal of International Marketing, 18(3),
62-80.
Smith, A., & Cannan, E. (1904). In An Inquiry into the Nature and Causes of the Wealth
of Nations (5th ed.). London: Methuen &.
Villanueva, J., Yoo, S., & Hanssens, D. (2008). ‘The Impact of Marketing-Induced
Versus Word-of-Mouth Customer Acquisition on Customer Equity Growth.’ Journal of
Marketing Research, 45, 48-59.
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
18