Search Costs and Investment in Quality

Abstract

In this paper we analyze how lower search costs affect firms' incentives to invest in quality. We identify two conflicting effects. On the one hand, lower search costs increase incentives to invest in quality by eroding the market share of low quality firms and increasing the market share of high quality firms. On the other hand, by intensifying price competition, lower search costs adversely affect high quality firms more than low quality firms. The net effect of a change in the search cost on quality is shown to depend on the initial quality distribution. There is a critical value such that, if the proportion of high quality firms is initially below this value, lower search costs increase this proportion, whereas if the initial quality is above this value, lower search cost decreases the proportion of high quality firms. We show that our results are consistent with a ‘superstar effect.’

Endogenous Product Design and Quality with Rationally Inattentive Consumers

“…A recent strand of the literature began using this consumer search framework to examine product positioning also in terms of attributes: Kuksov (2004), Bar-Isaac, Caruana and Cuñat (2012), Larson (2013), and Fishman and Levy (2015). Kuksov (2004) assumes a setting in which products are di¤erentiated by design, consumers are imperfectly informed about prices, but may engage in costly search to reduce their uncertainty.…”

“…Finally, Fishman and Levy (2015) augmented Bar-Isaac, Caruana and Cuñat (2012)'setting by considering that, in addition to designs and prices, consumers are also imperfectly informed about qualities. Under Fishman and Levy (2015)'s formulation, the strategic problem of each …rm is to select its quality and price (taking design as exogenous) so to maximize its own pro…t, recognizing that the other …rm is doing exactly the same.…”

“…Lach (2002), Lewis (2008), and Dubois and Perrone (2015) all …nd compelling evidence, across a variety of markets, that even information on price, which is typically the easiest attribute to gather (since it is typically the most communicated aspect of a product) and process (since it does not involve any subjective or personal evaluation), remains not freely and readily available. 1 A signi…cant and growing literature has sought to examine the consequences of consumer information costs on …rms' product attribute and pricing decisions (Kuksov, 2004;Bar-Isaac, Caruana and Cuñat, 2012;Larson, 2013;Fishman and Levy, 2015). This literature typically assumes that, before entering the choice situation, consumers are not in contact with any product and use a sequential step-wise search procedure to gather and process information about the di¤erent products.…”

The impact of online low search costs on firms' incentives to invest in quality

“…In our model, the main objective is to study how lower search costs can modify the firm's incentives to invest in quality. We suppose that goods are differentiated as in the models of Wolinsky (1986), Anderson and Renault (1999), and Fishman and Levy (2015), knowing that both high‐quality goods and low‐quality goods are present in the market. We also assume that firms that offer low‐quality goods have a larger market share than firms who offer high‐quality goods.…”

Optimal targeting with entry

“…Johnson () and Anderson and Gans () study the situation when consumers have access to some ad‐avoidance technology, whereas Hoffmann, Inderst, and Ottaviani () study how firms may use targeted advertising to explore consumers' bounded rationality. Lastly, our analysis is also related to the literature on the long‐tail and superstar effects on the Internet, which can result from targeted search (Yang, ) or lower search cost (Bar‐Isaac, Caruana, & Cunat, ; Fishman & Levy, ). Our result also shows that as targeting technology improves, more firms enter with niche products, and firms in the market with general products tend to have higher quality.…”