Impact of loyal and new customer segments on product upgrades: The role of quality differentiation through online reviews

Firms often strive to expand their market share beyond their established customer base by launching quality upgrades in their products. They recognize that customers often gauge product quality through online reviews. We develop an analytical model to examine the quality upgrade strategies of two competing firms, revealing two potential market equilibria. In the unilateral upgrading equilibrium where only one firm upgrades, the upgrading firm sees an initial increase in loyal demand, leading to higher prices. This price adjustment, however, may deter potential new customers who turn to the more affordable non-upgrading competitor, referred to as the substitution effect. Despite attracting more loyal customers, the upgrading firm may experience a net loss in broader market share due to the substitution effect. In the bilateral upgrading equilibrium where both firms upgrade and engage in quality competition, the situation becomes akin to a prisoner’s dilemma if loyal customers show indifference to quality improvements. The gains from loyal customers are outweighed by fierce competition for new customers, ultimately disadvantaging both firms. Furthermore, our findings indicate that review-revealed quality difference between the two products leads to a higher degree of quality improvement effort by the high-quality firm, while reducing that of the low-quality firm. Intriguingly, in the unilateral equilibrium, the high-quality firm may not benefit from its review-revealed superior quality, while the low-quality firm may not be disadvantaged, depending on the substitution effect relatively.