Word-of-Mouth on Action: Analysis of Operational Decisions When Customers are Resentful

TL;DR

This paper models how online reviews influence customer preferences and operational decisions in e-commerce, revealing complex effects of competition, constraints, and policy strategies on profitability and customer behavior.

Contribution

It introduces a novel integration of WoM effects into operational decision models, analyzing long-term demand behavior and optimal policies under customer perception influences.

Findings

Market size and customer sensitivity drive demand dynamics.

Beating competitors may harm profitability under strict constraints.

Cyclic policies can outperform stationary ones in managing perceptions.

Abstract

Word-of-Mouth (WoM) communication, via online reviews, plays an important role in customers' purchasing decisions. As such, retailers must consider the impact of WoM to manage customer perceptions and future demand. In this paper, we consider an online shopping system with premium and regular customers. Building on the behavioral and operations management literature, we model customer preferences based on the perceived service quality indicated by WoM and integrate this into the retailer's operational problem to determine a shipment policy. First, we study the e-tailer's problem when she has no knowledge of WoM, and only reacts to the changes in demand. We analyze the long-term behavior of customer demand and show that potential market size and customer sensitivity are the key parameters determining this behavior. Then, we build a model to integrate knowledge of WoM into operational decision making and partially characterize the optimal solution. We show that (i) beating the competition in the market may not always benefit the company under strict operational constraints as it can result in undesired customer switching behavior, (ii) relaxations in operational constraints may hurt profitability due to the associated difficulties of managing perceptions, and (iii) seeking a stationary policy can lead to suboptimal solutions, therefore cyclic policies should also be considered when appropriate.