Online cash-back shopping with network externalities

Abstract Along with the popularity of online shopping, the cash-back industry is witnessing dramatic development. Under this backdrop, retailers who sell products with network externalities make different decisions about affiliating with cash-back sites. In this paper, we set up a cash-back model considering network externalities. Our goal is to identify the condition under which it is profitable for retailers whose products exhibit network externalities to affiliate with a cash-back site and to find out the driving force of the profitability. We find that only when there are more low-type consumers than high-type consumers and the degree of network externalities is lower than a certain threshold is it profitable for such a retailer to affiliate with an independent cash-back site, because the cash-back rate is decreasing in the intensity of network externality. It is the price discriminative effect instead of the promotive effect that makes it profitable. We show that the double-marginalization problem between the retailer and an independent cash-back site leads to the cash-back paradox where all consumers pay more for the product in the presence of a cash-back channel. We also show that when the retailer affiliates with two cash-back sites, each site has the incentive to lower the cash-back rate to take advantage of network externalities, which makes the cash-back paradox more likely to happen and makes it less likely for a retailer to benefit from cash-back channels. Furthermore, we suggest the retailer establish his own cash-back channel. Our work provides implications for retailers as well as for cash-back sites and consumers.