‘The Company We Keep:’ Endogenous Network Formation and Peer Effects in Customer Churn

Abstract

Online connectivity and other technologies provide academic researchers and practitioners with unprecedented access to data on social interactions between consumers in the process of adoption and consumption of products, services, and ideas. In many cases, the social connections that can be recovered from such data are fundamentally endogenous. This paper addresses the endogeneity in social connections in empirical measurement of peer effects in customer churn. Understanding peer effect in churn decisions is of paramount importance in many industries where products or services are consumed in a socially connected manner, both online and offline, as lost customers hurt revenue streams and are expensive to replenish. Equipped with knowledge of causality, managers can craft effective retention campaigns. To tackle the peer network endogeneity issue, we directly model the process of social network formation based on observed consumer interactions during product use. After accounting for the choice of peers, we model the interdependence of agents' churn decisions and estimate the causal peer effect in churn. Modeling the network formation process first allows us to recover the unobserved individual-specific parameters that might affect both peer network formation and individuals' decisions to churn. The recovered latent individual-specific parameters correct for tie endogeneity in the peer effect model. We use data from the popular massively multiplayer online game World of Warcraft. We find significant evidence of the network formation outcome being largely explained by the latent characteristics of gamers. We also find a strong peer effect in churn decisions after controlling for the network endogeneity. Based on our estimation results, we run counterfactual simulation studies to investigate how churn dynamic in the network is affected by composition of gamers that determines the generated network structure. We provide recommendations to inform a company’s policy of inducing formation of guilds that suffer less from peer effect in churn.