Abstract
By bundling experience goods, a manufacturer can more easily maintain a reputation for high quality over time. Formally, we extend Klein and Lefler's (1981) repeated moral hazard model of product quality to consider multi-product firms and imperfect private learning by consumers. When consumers are small, receive imperfect private signals of product quality, and have heterogeneous preferences over available products, then purchasing multiple products from the same firm makes consumers more effective monitors of the firm's behavior. These consumers observe more signals of firm behavior and detect shirking with a higher probability, which creates stronger incentives for the firm to produce high quality products. By constraining all of the firm's consumers to use more effective monitoring and punishment strategies, bundling creates an even stronger incentive for a multi-product firm to produce high quality products. The impact of bundling on incentives is even greater when consumers cannot identify which of the goods is responsible for poor overall product performance.
Highlights
The latin expression falsus in uno, falsus in omnibus, meaning “false in one, false in everything,” aptly depicts consumers’ expectations about product quality
Iacobucci (2003) refined this argument further, highlighting the importance of attribution errors and the corresponding “confusion externalities.”[6]. Our work provides additional rigor and clarity to these arguments by providing an explicit treatment of the dynamic mechanisms by which consumers learn about product quality and by which firms maintain their reputations over time
Consumers who mix and match their purchases learn about product quality deviations more slowly than consumers who buy multiple branded products
Summary
This paper can be downloaded without charge from: The Harvard John M. Olin Discussion Paper Series: http://www.law.harvard.edu/programs/olin_center/ The Social Science Research Network Electronic Paper Collection: http://ssrn.com/abstract=1349971. Jr. Department of Economics Northeastern University 360 Huntington Avenue
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