Customer Relationship Management: A Database Approach

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Customer Relationship ManagementA Database
Approach
MARK 7397 Spring 2007
Class 12 Lemons and Signals
James D. Hess C.T. Bauer Professor of Marketing
Science 375H Melcher Hall jhess_at_uh.edu 713
743-4175
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Lemons and Peaches
Number of
Computers
bpart-worth of quality for owners
bV - P ? 0
N
Supply of Lemons
V, Value of
b
Remaining
P/
1
Product Life
aV - P ? 0
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Suppose Quality is Observable
Price depends on value of computer PV
A mutually beneficial exchange is possible if bV
Suppose the highest value computer is sold to
buyer with highest taste for quality at the
highest willingness to pay. Then all V above b
will be sold, and total exchange will be (1-b)N.
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Suppose Quality is Known only by Seller
Price is the same for all computers, P.
Supply is
Number of
Computers
Expected quality ½ P/b
Buy if a ½ P/b - P ? 0
N
Demand is
Supply of Lemons
V, Value of
b
Remaining
P/
1
Product Life
Equilibrium Price and Exchanges
If b SupplyDemand(1-2b)N If
b ½ , P0 and SupplyDemand 0
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Akerlofs Theorem Differences in information
about the quality of products cause the market to
perform poorly or even stop operation entirely.
George Akerlof, Nobel Prize Winner
2001 "I submitted it (The Market for Lemons) in
June, 1967 to the American Economic Review. I got
a reply from the editor which said that the
article was interesting but the American Economic
Review did not publish such trivial stuff." The
article next went to the Journal of Political
Economy. Again it was rejected. Akerlof kept
trying. "I next sent the article to the Review of
Economic Studies. I had been urged by one of its
co-editors to do that. Instead it went to another
editor whose view of 'The Market for 'Lemons" was
decidedly less favorable. It was rejected on the
grounds again that it was 'trivial.' Finally I
sent it to the Quarterly Journal of Economics
which accepted it with some degree of
enthusiasm." Akerlof believes that journal
editors refused the article both because they
feared the introduction into economics of
informational considerations and ...they also
almost surely objected to the style of the
article which did not reflect the usual solemnity
of economic journals."
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Talk is cheap, but cheaper for high quality brands
A new brand is about to be introduced that can
have high or low quality VH2 or VL1. The
company learns the quality of its brand from
pre-test markets but the general consumer does
not and thinks the probability of a high quality
brand is a.
Cost of advertising A/2 for the high quality
firm A for the
low quality firm, where A is the target
advertising rating points.
Profit p(A,PV)P-A/V, where V?1,2.
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Separating Low and High Quality
P
Iso-profit of V1
Iso-profit of V2
2
H
L
1
A

-
ì
1
V
for
1
/
A
P

p
í

-
î
2
V
for
2
/
A
P
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Separating Equilibrium
P
Iso-profit of V1
Iso-profit of V2
2
1
A

-
ì
1
V
for
1
/
A
P

p
í

-
î
2
V
for
2
/
A
P
Spences Theorem The only intuitive Nash
equilibrium in the signaling game is the
separating strategies (AL,PL)(0,1) and
(AH,PH)(1,2).
Michael Spence won the 2001 Nobel Prize in
Economic Science (sharing it with George Akerlof
and Joseph Stiglitz). This was unusual because
the award cited his doctoral dissertation, Market
Signaling. Unlike Akelof, whose Market for
Lemons was not well-received immediately, Spence
was a superstar out of the gate. He wrote his
dissertation in 1972 and by 1975 was a Full
Professor at Harvard normally this takes a dozen
years. In fact, after that dozen years, Spence
was the Dean of the Faculty at Harvard.
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Spences work created lots of heat. Why?

• The total welfare of the economy is the sum of
  expected profits of the company and the consumer
  surplus TWEpCS(2-1/2)a(1-0)(1-a) 01a/2.
  
• Suppose that advertising was not legally
  permitted. Then the total welfare would come
  from a pooled equilibrium where price is 1a. It
  is always the case that 1a/2
• The use of advertising by the seller as a signal
  of quality dissipates societys resources.
• The use of higher education as a signal of
  personal talent dissipates societys resources.

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Capital One Signaling Model
Tteaser rate for transfer of balances CAchecking
account balance (signal) Cost of
funds10 Segment 1 sizea, would contribute
beyond a 0 teaser year by holding debt for 2
more years Segment 2 size1-a, would break even
with teaser rate of 10 and payoff all
balances Cost of maintaining checking account
balances for segment 2 twice as high as for
segment 1. U1 V T
½ CA versus U2 V T 1.0 CA
T
A
.10
D
C
CA
.00
.10
.20
B
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T
A
.10
D
C
CA
.00
.10
.20
B
Offer A and B both segments choose B (pooling)
profit
a(-.10.10.10)(1-a)(-.10) -.10 .20a Offer
A and D segment 1 chooses D and segment 2
chooses A (separating)
profit a(-.10.10.10)(1-a)(.10-.10) .10a
Separating is preferred to pooling by CapOne so
long as a
Competition may force D down to C.