Post-Sale Service and the Limits of Reputation

Abstract

In the standard durable-goods-quality model (e.g., Klein and Leffler, 1981; Shapiro, 1982, 1983), the prospect of repeat sales is often adequate to support the provision of high-quality durable goods even when quality is not observable at the time of purchase. We show that when durable goods require costly post-sale service, a reputational equilibrium may not exist at any price, even with a flow of profitable new sales indefinitely into the future. More generally, we characterize the size of the premium needed to make promises to provide post-sale service self enforcing. We then apply the model to United Shoe Machinery, IBM, and Xerox, using historical records to estimate the self-enforcing post-sale service premia that would have been necessary for each of these companies.

Keywords: reputation, durable goods, post-sale service

JEL Classification: L14, L15, L63, L64