Managing word-of-mouth through capacity and advertisement level decisions

Date

2025-01-01

Author

Batun, Sakine
Çavdar, Bahar
Dipkaya, Asya

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Advancements in the service sector and growing online platforms are intensifying the information exchange between customers through (electronic) word-of-mouth (WoM). The information obtained by WoM affects customers’ purchase decisions, creating an endogenous demand, and the integration of this structure into operational decisions offers great benefits. We study a service system where the access to a bottleneck capacity is the main factor determining the service quality. Customers form a belief about the quality based on the information obtained by WoM communication and the advertisement. Depending on the service environment, service capacity can be flexible or constant. We consider two types of service providers: an informed firm that has complete information on endogenous demand structure and an uninformed firm that has partial information. Our main contributions are (i) presenting a mathematical model for simultaneous capacity and advertisement level decisions integrating the relationship between operational decisions and demand that takes place through WoM, (ii) partial characterization of the optimal policy, and (iii) extensive numerical study to evaluate the value of information on WoM’s impact on demand. Using our results, we show that for firms with flexible capacity, it is optimal to employ higher advertisement levels in the early stages. Myopic uninformed firms often misinterpret the market conditions and may prematurely cease operating. Under constant capacity, negative WoM may be unavoidable. Therefore, the service provider is forced to keep the advertisement levels more compatible with the actual quality of the service.

Subject Keywords

Advertisement, Capacity level, Service systems, Value of information, Word-of-mouth

URI

https://www.scopus.com/inward/record.uri?partnerID=HzOxMe3b&scp=86000290807&origin=inward
https://hdl.handle.net/11511/113854

Collections

Department of Industrial Engineering, Article