A Model of Product Design and Information Disclosure Investments

Abstract

New technologies such as product simulators and virtual reality now allow firms to provide realistic product usage experiences and reduce buyer uncertainty about product quality. We argue that today's firms should view product design and investments to reduce buyer uncertainty as an integrated process, which is in turn influenced by how much information buyers can obtain from third-party infomediaries. We introduce a game-theoretic model of a competitive market where both quality production and quality disclosure are endogenous decisions, affected by information made available by third parties. We show that quality investment under uncertainty never exceeds the level of quality investment under perfect information. Further, we show that information availability by third parties allows firms to free ride, and especially favors lower quality firms, who can reduce their information disclosure investments more so than higher quality firms. Finally, we show that the intuitive argument that firms must improve their product quality when overall information availability in the market improves does not always hold, and it may in some situations enable them to reduce their quality instead.

Keywords: Buyer uncertainty, information disclosure, product quality, infomediaries

JEL Classification: C72, D43, D82, D83, L19