Is More Precise Word of Mouth Better for a High Quality Firm? ... Not Always

TL;DR

This paper examines how the precision of third-party information affects firm profits in a monopoly setting, revealing that high-quality firms may not always benefit from more precise word of mouth depending on consumer recognition skills.

Contribution

It challenges conventional wisdom by showing that high-quality firms can profit from less precise information if consumers cannot recognize precision well.

Findings

High-quality firms may prefer less precise information if consumers cannot recognize precision.

More precise information can harm high-quality firms if consumers are skilled at recognizing it.

The impact of information precision depends on consumer recognition ability and firm quality.

Abstract

Consumers often resort to third-party information such as word of mouth, testimonials and reviews to learn more about the quality of a new product. However, it may be difficult for consumers to assess the precision of such information. We use a monopoly setting to investigate how the precision of third-party information and consumers' ability to recognize precision impact firm profits. Conventional wisdom suggests that when a firm is high quality, it should prefer a market where consumers are better at recognizing precise signals. Yet in a broad range of conditions, we show that when the firm is high quality, it is more profitable to sell to consumers who do not recognize precise signals. Given the ability of consumers to assess precision, we show a low quality firm always suffers from more precise information. However, a high quality firm can also suffer from more precise information. The precision range in which a high quality firm gains or suffers from better information depends on how skilled consumers are at recognizing precision.