Managing Service Systems with Unknown Quality and Customer Anecdotal Reasoning

Abstract

We consider service systems where customers do not know the distribution of uncertain service quality and cannot estimate it fully rationally. Instead, they form their beliefs by taking the average of several anecdotes, the size of which measures their level of bounded rationality. We characterize the customers’ joining behavior and the service provider's pricing, quality control, and information disclosure decisions. Bounded rationality induces customers to form different estimates of the service quality and leads the service provider to use pricing as a market segmentation tool, which is radically different from the full rationality setting. As customers gather more anecdotes, the service provider may first decrease and then increase price, and the revenue is U‐shaped. Interestingly, a larger sample size may harm consumer surplus, although it always benefits social welfare. When the service provider also has control over quality, we find that it may reduce both quality and price as customers gather more anecdotes. In addition, a high‐quality service provider may not disclose quality information if the sample size is small, while a low‐quality service provider may disclose if the sample size is large. Furthermore, as the expected waiting cost increases, information non‐disclosure is more attractive, thereby highlighting the importance of incorporating customer‐bounded rationality in congested settings.