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Published in:
2020 | OriginalPaper | Chapter
Assessing Strategic Customer Behavior under Bounded Rationality: An Abstract
Authors : Jihoon Cho, Anocha Aribarg, Puneet Manchanda
Published in: Marketing Opportunities and Challenges in a Changing Global Marketplace
Publisher: Springer International Publishing
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Abstract
In service markets, customers are often uncertain about future service outcomes. To resolve this uncertainty, customers update their expectations of what is to come and use the updated expectations to generate responses or judgment (Hintzman 1988). Accordingly, firms make efforts to deliver free service upgrades to meet or exceed customer expectations (Schneider and Bowen 1999). Such efforts, however, may not necessarily improve the firm’s profitability as customers elevate their expectations over time and become strategic to “cherry-pick” the offers.
This paper provides empirical evidence on such strategic choice behavior via the use of individual-level cross-sectional and time-series data from the auto rental industry. Given that customer strategy is driven by their expectations based on the past events retrieved from memory (Bettman 1979), we also investigate the extent that time-dependent forgetfulness, the similarity and recency effects (Bordalo et al. 2017; Murdock 1967), affects customer expectations and the subsequent strategic choice over time.
To model the bounded customer expectations, we follow the adaptive expectation framework where customers recursively update their expectations based on prior service experiences. To describe the unobserved customer expectations and their impact on strategic choice behavior in a single framework, we adapt a state-space model based on the Kalman filter algorithm (Hamilton 1994), which allows us to separate out the effect of (recalled) service encounters from that of prior expectations accrued through service usage over time (Akçura et al. 2004).
The results suggest evidence of bounded customer expectations. First, memories similar to the current event facilitate customer recall and recent experiences are more easily remembered than remote ones. Further, we observe the presence of positive expectation carryover and its considerable decay. We also find the presence of customers’ strategic choice behavior followed by free upgrades, that is, customers tend to strategically request a car-class lower than or equal to the one that previously resulted in a free upgrade.
Building on the theoretical literature in memory, our research provides an empirical framework that accounts for customers’ bounded rationality in customer expectations, which has received less attention from the previous research. Further, our empirical findings via a series of counterfactual analyses provide managerial insights such that free upgrade offers can hurt the firm’s profitability. With no bounded rationality in consideration, however, the firm is likely to be misled to provide more free upgrades in order to increase its profitability.