Marketing Science current issue

Alleviating the Constant Stochastic Variance Assumption in Decision Research: Theory, Measurement, and Experimental Test

Salisbury, L. C., Feinberg, F. M. — Mon, 01 Feb 2010 10:01:27 PST

Analysts often rely on methods that presume constant stochastic variance, even though its degree can differ markedly across experimental and field settings. This reliance can lead to misestimation of effect sizes or unjustified theoretical or behavioral inferences. Classic utility-based discrete-choice theory makes sharp, testable predictions about how observed choice patterns should change when stochastic variance differs across items, brands, or conditions. We derive and examine the implications of assuming constant stochastic variance for choices made under different conditions or at different times, in particular, whether substantive effects can arise purely as artifacts. These implications are tested via an experiment designed to isolate the effects of stochastic variation in choice behavior. Results strongly suggest that the stochastic component should be carefully modeled to differ across both available brands and temporal conditions, and that its variance may be relatively greater for choices made for the future. The experimental design controls for several alternative mechanisms (e.g., flexibility seeking), and a series of related models suggest that several econometrically detectable explanations like correlated error, state dependence, and variety seeking add no explanatory power. A series of simulations argues for appropriate flexibility in discrete-choice specification when attempting to detect temporal stochastic inflation effects.

Commentary--Discussion of "Alleviating the Constant Stochastic Variance Assumption in Decision Research: Theory, Measurement, and Experimental Test"

Louviere, J., Swait, J. — Mon, 01 Feb 2010 10:01:27 PST

We discuss the Salisbury and Feinberg paper [Salisbury, L. C., F. M. Feinberg. 2010. Alleviating the constant stochastic variance assumption in decision research: Theory, measurement, and experimental test. Marketing Sci. 29(1) 1–17], setting their contribution in the historical context of the wider literature on the role of error variability in discrete choice models. We discuss the seminal nature of their contribution and suggest that the paper should be required reading for current and future Ph.D. students.

Commentary--On the Interpretation of Temporal Inflation Parameters in Stochastic Models of Judgment and Choice

Hutchinson, J. W., Zauberman, G., Meyer, R. — Mon, 01 Feb 2010 10:01:27 PST

The implications of Salisbury and Feinberg's (2010) paper [Salisbury, L. C., F. M. Feinberg. 2010. Alleviating the constant stochastic variance assumption in decision research: Theory, measurement, and experimental test. Marketing Sci. 29(1) 1–17] for the process of model development and testing in the field of intertemporal choice analysis is explored. Although supporting the overall thrust of Salisbury and Feinberg's critique of previous empirical work in the area, we also see their paper as illustrating the dangers of drawing strong inferences about the behavioral interpretation of statistical model parameters without seeking convergent empirical evidence. In particular, we are skeptical about the extent to which the reported effects of temporal distance on the estimated scale parameter, _c, are uniquely, or even primarily, due to unobserved error inflation that reflects consumer's uncertainty about future utility. This interpretation is brought into question by several lines of reasoning. Conceptually, we note that "uncertainty" is different from "error" and that, for choice data, the error inflation model is mathematically identical to a model in which the scale parameter is a deterministic function of the temporal discount rate. Empirically, a reanalysis of data from previously published experiments does not consistently support temporal error inflation, temporal convergence of choice shares, or the scale parameter as an explanation of variety seeking in choice sequences. In our opinion, the cumulative results of research on intertemporal choice require models in which the attributes of choice alternatives are differentially discounted over time. Despite these findings, we advocate that choice researchers should indeed follow Salisbury and Feinberg's advice to not assume that error variances will be unaffected by experimental manipulations, and such effects should be explicitly modeled. We also agree that uncovering effects on error variance is just the first step, and the ultimate goal should be to rigorously explain the reasons for such effects.

Rejoinder--Temporal Stochastic Inflation in Choice-Based Research

Salisbury, L. C., Feinberg, F. M. — Mon, 01 Feb 2010 10:01:27 PST

We examine the specification and interpretation of discrete-choice models used in behavioral theory testing, with a focus on separating "coefficient scale" from "error scale," particularly over time. Numerous issues raised in the thoughtful commentaries of Louviere and Swait [Louviere, J., J. Swait. 2010. Discussion of "Alleviating the constant stochastic variance assumption in decision research: Theory, measurement, and experimental test." Marketing Sci. 29(1) 18–22] and Hutchinson, Zauberman, and Meyer (HZM) [Hutchinson, J. W., G. Zauberman, R. Meyer. 2010. On the interpretation of temporal inflation parameters in stochastic models of judgment and choice. Marketing Sci. 29(1) 23–31] are addressed, specifically the roles of response scaling, preference covariates, actual versus hypothetical consumption, "immediacy," and heterogeneity, as well as key differences between the experimental setup in Salisbury and Feinberg [Salisbury, L. C., F. M. Feinberg. 2010. Alleviating the constant stochastic variance assumption in decision research: Theory, measurement, and experimental test. Marketing Sci. 29(1) 1–17] and those typifying intertemporal choice and construal level theory. We strongly concur with most of the general conclusions put forth by the commentary authors, but we also emphasize a central point made in our research that may have been lost: that the temporal inflation effects observed in our empirical analysis could be attributed to stochastic effects, deterministic influences, or an amalgam; appropriate inferences depend on the nature of one's data and stimuli. We also report on further analyses of our data, as well as a meta-analysis of HZM's Table 1 that is consistent with our original findings. Implications for, and dimensions relevant to, future research on temporal stochastic inflation and its role in choice-based research are discussed.

A Model for Trade-Up and Change in Considered Brands

Allenby, G. M., Garratt, M. J., Rossi, P. E. — Mon, 01 Feb 2010 10:01:27 PST

A common theme in marketing literature is the acquisition and retention of customers as they trade up from inexpensive introductory offerings to those of higher quality. We develop a nonhomothetic choice model to accommodate effects of advertising, professional recommendation, and other factors that facilitate the description and management of trade-up. Our model allows advertising to affect the relative superiority or inferiority of products. This allows for a wide variety of trade-up patterns beyond those obtained from a standard random utility formulation of the logit model. Our nonhomothetic model allows for advertising to affect more than just brand intercepts (perceived quality), but also the rate at which consumers are willing to trade up to higher-quality brands. Advertising effects are measured using a randomized treatment and evaluated by considering their direct implications for firm pricing and profits.

A Larger Slice or a Larger Pie? An Empirical Investigation of Bargaining Power in the Distribution Channel

Draganska, M., Klapper, D., Villas-Boas, S. B. — Mon, 01 Feb 2010 10:01:27 PST

This research aims to provide insights into the determinants of channel profitability and the relative power in the channel by considering consumer demand and the interactions between manufacturers and retailers in an equilibrium model.

We use the Nash bargaining solution to determine wholesale prices and thus how margins are split in the channel. Equilibrium margins are a function of demand primitives and of retailer and manufacturer bargaining power. Bargaining power is itself a function of exogenous retail and manufacturer characteristics. The parties' bargaining positions are determined endogenously from the estimated substitution patterns on the demand side. The more they have to lose in a negotiation relative to an outside option, the weaker the bargaining position. We use the proposed bargaining model to investigate the role of the three main factors that have been blamed for the power shift from manufacturers to retailers in recent years (firm-size increases, store-brand introductions, and service-level differentiation). In our empirical analysis of the German market for coffee, we find that bargaining power varies among the different manufacturer-retailer pairs. This result suggests that bargaining power is not an inherent characteristic of a firm but rather depends on the negotiation partner. We are able to confirm empirically previous theoretical findings that there can be cases where the slice of the pie that goes to one of the channel members may decrease, but the overall pie increases and compensates for the smaller share of profits.

Uncertainty, Risk Aversion, and WTA vs. WTP

Okada, E. M. — Mon, 01 Feb 2010 10:01:27 PST

We examine a previously unstudied category of exchange items in which the true value is unknown to both the buyer and seller at the time of exchange but becomes known to both at a future time after the exchange. Real-world examples of such exchange items as in our study include forward contracts and fixed-fee turnkey contracts. We demonstrate that the discrepancy between the seller's willingness to accept (WTA) and buyer's willingness to pay (WTP) increases with (1) the level of uncertainty about the exchange item's value and (2) the exchange parties' level of risk aversion. In a series of studies, we manipulate and measure the level of uncertainty of the exchange item, measure the level of risk aversion of the exchange parties, and study the respective effects on decreasing the WTP while increasing the WTA.

Customer-Base Valuation in a Contractual Setting: The Perils of Ignoring Heterogeneity

Fader, P. S., Hardie, B. G. S. — Mon, 01 Feb 2010 10:01:27 PST

The past few years have seen increasing interest in taking the notion of customer lifetime value (CLV) and extending it to value a customer base (with subsequent links to corporate valuation). The application of standard textbook discussions of CLV leads to calculations based on a single retention rate. However, at the cohort level, retention rates typically increase over time. It has been suggested that these observed dynamics are due, in large part, to a sorting effect in a heterogeneous population. We show that failing to recognize these dynamics yields a downward-biased estimate of the residual value of the customer base (compared to an aggregate analysis that ignores these dynamics). We also explore the implications of failing to account for retention dynamics when computing retention elasticities and find that the frequently reported values underestimate the true effect of increases in underlying retention rates in a heterogeneous world.

In-Store Media and Distribution Channel Coordination

Dukes, A., Liu, Y. — Mon, 01 Feb 2010 10:01:27 PST

We study the effects of retailer in-store media on distribution channel relationships. Retailers open in-store media (ISM) and allow manufacturers to advertise to shoppers. Our results suggest that ISM has an important role in coordinating a distribution channel on advertising volume and product sales, and on mitigating supplier competition. Improved channel coordination is achieved through the internalization of advertising decisions from commercial forms of media (e.g., radio, TV, newspaper). A retailer may strategically subsidize manufacturers for their advertising on ISM. This subsidy is optimal even if ISM is more effective than commercial media. With manufacturer competition, a retailer can strategically use a "competitive premium" to ration excessive advertising between competing suppliers in a category. When manufacturers are asymmetric with preadvertising brand awareness, a retailer has an incentive to price discriminate by charging lower prices to manufacturers whose brand awareness is higher.

Optimal Referral Bonuses with Asymmetric Information: Firm-Offered and Interpersonal Incentives

Kornish, L. J., Li, Q. — Mon, 01 Feb 2010 10:01:27 PST

Referral bonuses, in which an existing customer gets an in-kind or cash reward for referring a new customer, are a popular way to stimulate word of mouth. In this paper, we examine key firm decisions about such bonuses. Others have studied referral bonus programs; a key difference is that we study the role of recommendations not just in spreading awareness (as they do) but also in providing assessments. We start with the idea that people have a variety of reasons for making product recommendations, including placing a value on a friend's outcome with a product they recommend. We apply that idea in a context of asymmetric information: A customer combines his knowledge about the product and his familiarity with friends' tastes, making him more informed than the friends. Thus, the recommendation is a signal about the value of the product to the friend. In this setting, we consistently find that the greater the concern for others' outcomes, the higher the referral bonus should be, as long as the firm cannot more efficiently motivate recommendations with a lower price. Moreover, if price is the more efficient lever, the optimal bonus is zero, and the optimal price is low. We also show that greater concern tends to reduce firm profit and, in some cases, actually reduces consumer welfare as well.

Information Provision in a Vertically Differentiated Competitive Marketplace

Kuksov, D., Lin, Y. — Mon, 01 Feb 2010 10:01:27 PST

This paper examines the interaction of information provision, product quality, and pricing decisions by competitive firms to explore the following question: in a competitive market where consumers face uncertainty about product quality and/or their preference for quality, which firms—those that sell higher- or lower-quality products—have the higher incentive to provide what type of information? We find that while the higher-quality firm should always provide information resolving consumer uncertainty on product quality, the lower-quality firm under certain conditions will have the higher incentive to and will be the one to provide information resolving consumer uncertainty about their quality preferences. In the analysis, we trace the latter result to competition and to free-riding on the information provision. Specifically, in a monopoly market or when consumer free-riding is restricted by the costliness of store visits, the lower-quality firm would have a lower incentive to provide information resolving consumer preference uncertainty than otherwise. The model is also adapted to examine product returns as a possible strategy of information provision.

Predicting Joint Choice Using Individual Data

Aribarg, A., Arora, N., Kang, M. Y. — Mon, 01 Feb 2010 10:01:27 PST

Choice decisions in the marketplace are often made by a collection of individuals or a group. Examples include purchase decisions involving families and organizations. A particularly unique aspect of a joint choice is that the group's preference is very likely to diverge from preferences of the individuals that constitute the group. For a marketing researcher, the biggest hurdle in measuring group preference is that it is often infeasible or cost prohibitive to collect data at the group level. Our objective in this research is to propose a novel methodology to estimate joint preference without the need to collect joint data from the group members. Our methodology makes use of both stated and inferred preference measures, and merges experimental design, statistical modeling, and utility aggregation theories to capture the psychological processes of preference revision and concession that lead to the joint preference. Results based on a study involving a cell phone purchase for 214 parent-teen dyads demonstrate predictive validity of our proposed method.

"Call for Prices": Strategic Implications of Raising Consumers' Costs

Desai, P. S., Krishnamoorthy, A., Sainam, P. — Mon, 01 Feb 2010 10:01:27 PST

Many consumer durable retailers often do not advertise their prices and instead ask consumers to call them for prices. It is easy to see that this practice increases the consumers' cost of learning the prices of products they are considering, yet firms commonly use such practices. Not advertising prices may reduce the firm's advertising costs, but the strategic effects of doing so are not clear. Our objective is to examine the strategic effects of this practice. In particular, how does making price discovery more difficult for consumers affect competing retailers' price, service decisions, and profits?

We develop a model in which a manufacturer sells its product through a high-service retailer and a low-service retailer. Consumers can purchase the retail service at the high-end retailer and purchase the product at the competing low-end retailer. Therefore, the high-end retailer faces a free-riding problem. A retailer first chooses its optimal service levels. Then, it chooses its optimal price levels. Finally, a retailer decides whether to advertise its prices. The model results in four structures: (1) both retailers advertise prices, (2) only the low-service retailer advertises price, (3) only the high-service retailer advertises price, and (4) neither retailer advertises price.

We find that when a retailer does not advertise its price and makes price discovery more difficult for consumers, the competition between the retailers is less intense. However, the retailer is forced to charge a lower price. In addition, if the competing retailer does advertise its prices, then the competing retailer enjoys higher profit margins. We identify conditions under which each of the above four structures is an equilibrium and show that a low-service retailer not advertising its price is a more likely outcome than a high-service retailer doing so. We then solve the manufacturer's problem and find that there are several instances when a retailer's advertising decisions are different from what the manufacturer would want. We describe the nature of this channel coordination problem and identify some solutions.

The Price Precision Effect: Evidence from Laboratory and Market Data

Thomas, M., Simon, D. H., Kadiyali, V. — Mon, 01 Feb 2010 10:01:27 PST

We examine two questions: Does the roundness or precision of prices bias magnitude judgments? If so, do these biased judgments affect buyer behavior? Results from five studies suggest that buyers underestimate the magnitudes of precise prices. We term this the precision effect. The first three studies are laboratory experiments designed to test the existence of the precision effect and examine the underlying psychological processes. In Study 1, we find that precise prices are judged to be smaller than round prices of similar magnitudes. For example, participants in this experiment incorrectly judged $395,425 to be smaller than $395,000. In Study 2, we show that precision is more likely to affect magnitude judgments under conditions of uncertainty. Study 3 demonstrates that manipulating prior experience with the pattern of roundness and precision in numbers can moderate the precision effect. Studies 4 and 5 examine whether the precision effect influences buyers' willingness to pay for negotiated purchases (e.g., houses). In Study 4, we conduct an experiment on a nationally representative sample of homeowners to demonstrate that participants are willing to pay more for houses when the sellers use precise (e.g., $364,578) instead of comparable round (e.g., $365,000) prices. In Study 5, we analyze data from residential real estate transactions in two separate markets and find that buyers pay higher sale prices when list prices are more precise. These empirical results enrich our understanding of the psychological processes that underlie price magnitude judgments and have substantive implications for buyer and seller behavior.

Focus on Authors

Mon, 01 Feb 2010 10:01:27 PST

No abstract available.

2009 Ad Hoc Reviewers

Mon, 01 Feb 2010 10:01:27 PST

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