Underpromising and Overdelivering: Strategic Implications of Word of Mouth
40 Pages Posted: 19 Oct 2011 Last revised: 27 Mar 2012
Date Written: March 25, 2012
We analyze a firm's optimal communication strategy for setting consumer expectations when consumers are uncertain about product quality and word of mouth is prevalent in the market. We derive three main results: [i] Extant signaling theory argues that advertising should be costly for it to be informative of product quality. We show that in the presence of negative word of mouth, even costless advertising can serve as an informative signal for quality. [ii] Conventional wisdom suggests that as the consequences of negative word of mouth become stronger, a firm should become more cautious in setting high consumer expectations, to prevent future disappointment. We show that this need not always be the case: interestingly, when negative word of mouth is prevalent and its consequences become stronger, a firm might become more aggressive in setting high expectations given consumer rationality. [iii] Disconfirmation (defined as a stronger shift in beliefs when experiences are inconsistent with messages) serves as an adequate mechanism for preventing quality misrepresentation by a firm in its communications to consumers. But when markets are characterized by confirmation effects (a tendency to discount experiences inconsistent with messages) and future sales are important, we observe firms might entirely misrepresent their quality.
Keywords: managing expectations, experience goods, word of mouth, disconfirmation, game theory, signaling, behavioral industrial organization
JEL Classification: D8, L15, M3
Suggested Citation: Suggested Citation