Pricing Online Banking Services amid Network Externalities

Using the particular example of online banking services, we examine the effects of pricing strategies on the demand for different modes of online banking given that the market exhibits network externalities. Most literature concerning the economics of networks deals with a single durable good where, in a multi-period setting, the consumer decides whether or not to purchase the good. Once the decision to buy is made, there are no further decisions to make. In online banking, and in most electronic service contract arrangements, customers can change their decisions in later periods, moving to another choice if they are not satisfied with the existing choice. The model presented in this paper allows such reversing of decisions, and thus, dynamically captures the effects of changes in service fees, reservation prices, and strength of network externalities on the decisions of the customer. The model also accounts for switching costs that the customer may incur when she moves from one mode to another. Departing significantly from previous literature, we assume that network externality follows a stochastic proces, making the model more realistic and comprehensive. With a stylized example and numerical simulation of the dynamic stochastic program, we illustrate the use of the model in pricing online banking services.