The Impact of Quality Perception and Consumer Valuation Change on Manufacturer's Optimal Warranty, Pricing, and Market Coverage Strategies

Abstract

ABSTRACTWe consider a manufacturer who produces and sells a new product in a monopoly market. The new product quality is unobservable to consumers before purchase. Consumers make purchase decisions based on their perception of product quality. In addition, consumer valuation toward the product will be reduced if a product failure is experienced. We formulate a two‐period model to analyze the impact of consumer quality perception and consumer valuation change on manufacturer's optimal decisions over quality, warranty, price, and market coverage strategies. We find that it is optimal for the manufacturer to offer warranty compensation that is higher than the purchase price when he has a low quality reputation but is offering a high‐quality product. We also identify the optimal strategy for the manufacturer in terms of market coverage. Specifically, when the consumer valuation discount factor due to product failure experience is high, it is optimal for the manufacturer to serve only the high segment in the second period. Otherwise, serving both the high and the low segments generates more profit. We further investigate consumer welfare and identify win‐win conditions, where the optimal strategy of the manufacturer benefits the consumers as well.