How Service Quality Variability Hurts Revenue When Customers Learn: Implications for Dynamic Personalized Pricing

Abstract

Most service settings involve some degree of variability in the quality of customers’ experiences. An understudied mechanism is analyzed by which this variability can reduce firm revenues when customers do not know true service quality but rather learn about that quality over time based on their experiences. Essentially, customers get stuck with low-quality opinions and low purchase likelihoods after unusually bad experiences. However, high-quality opinions after unusually good experiences are quickly corrected. The authors show that dynamic pricing can help mitigate this effect. Specifically, if the firm can set individual prices so that each customer perceives the same surplus, then the variability impact is entirely eliminated. They also demonstrate that simpler heuristics similar to those observed in practice (requiring less information and pricing flexibility) can partially mitigate the revenue loss.