Tuesday, September 27, 2011

INSEAD Working Paper 2011/101/DS revised version of 2011/92/DS

We characterize the effect of anticipated regret on consumer decisions and on firm profits and policies in an advance selling context where buyers have uncertain valuations. Advance purchases trigger \action regret" if valuations turn out to be lower than the price paid, whereas delaying purchase may cause \inaction regret" from missing a discount or facing a stock-out. Consumers whom we describe as \emotionally rational" act strategically in response to the firm's policies and in anticipation of regret. In this context, regret explains two types of behavioral patterns: inertia (delayed purchase) and frenzies (buying early at negative surplus). We show how firms should optimally respond to consumer regret and also characterize a normative regret threshold above which they should not advance sell. Action regret reduces profits as well as the value of advance selling and booking limit policies for price-setting firms; inaction regret has the opposite effects. These effects are diminished by capacity constraints and are reversed for firms facing price pressure in the advance period (owing, e.g., to competition or market heterogeneity). Regret heterogeneity explains premium advance selling for the capacity-constrained firm, which may benefit from larger shares of regretful buyers. Finally, we show how the negative effects of regret on profits can be mitigated by regret-priming marketing campaigns and by offering refunds or options or allowing resales. Our results highlight the importance of assessing the relative strength of regret within and across market segments and of accounting for these factors in pricing and marketing policies.