Product reviews by third parties are growing in popularity. This paper examines when and how a manufacturing

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1 Vol. 24, No. 2, Sping 2005, pp issn eissn X infoms oi /mksc INFORMS Thi-Paty Pouct Review an Fim Maketing Stategy Yubo Chen Elle College of Management, Univesity of Aizona, McClellan Hall 320, P.O. Box , Tucson, Aizona , Jinhong Xie Waington College of Business Aministation, Univesity of Floia, 212 Byan Hall, P.O. Box , Gainesville, Floia , Pouct eviews by thi paties ae gowing in populaity. This pape examines when an how a manufactuing fim shoul aapt its maketing stategies to such eviews. Fo example, shoul a fim eceiving an unfavoable eview euce its pice o ajust its avetising? Shoul a winning pouct of a pouct eview (e.g., eito s choice ) boost its avetising expenitue to spea the goo news? How shoul fims stategic esponses to pouct eviews iffe acoss iffeent types of pouct eviews (esciption vs. ecommenation) an iffeent avetising meia (the eviewe s publication vs. othe meia)? We evelop a theoy to aess these issues an eive fims optimal esponses to pouct eviews une iffeent pouct/maket/eview/meia conitions. We show that fims shoul choose avetising athe than pice as a stategic vaiable in esponse to pouct eviews when enough consumes value hoizontal pouct attibutes. Supisingly, we fin that using a eview-enose avetising fomat (i.e., avetisements containing thi-paty awa logos) to boacast its victoy can hut the winning pouct of a pouct eview. Also, it is not necessaily wise fo the winning poucts to boost avetising expenitues to spea the goo news. Data fom two inusties pintes an unning shoes ae use to illustate some of ou finings. Key wos: picing; avetising; thi-paty infomeiaies; pouct eview infomation; infomation asymmety; competitive stategy Histoy: This pape was eceive Febuay 24, 2003, an was with the authos 10 months fo 2 evisions; pocesse by Z. John Zhang. 1. Intouction Thi-paty pouct eviews base on inepenent laboatoy tests o expet evaluations have gown inceasingly popula in ecent yeas. Vaious popula consume magazines (e.g., PC Magazine, PC Wol, Consume Repots, Ca an Dive, Scuba Diving Magazine, Runne s Wol, Entetainment Weekly, Goumet) egulaly publish compehensive eviews of poucts of inteest to thei eaes. Moeove, the Intenet an fast-eveloping infomation technology have significantly euce eviewes infomation-elivey cost an consumes infomation-etieval cost. As a esult, a gowing numbe of Websites (e.g., CNET.com, ZDNET.com, caanive.com, swiminfo.com, wielessesign.com, enjoythemusic.com, golfigest.com) ae offeing online thi-paty pouct eviews. In aition, consumes can now easily access an compae pouct eviews by iffeent souces via specialize pouct-eview sites such as ConsumeSeach. com, which collects eviews on 170 pouct categoies fom tuste publications such as Consume Digest an PC Magazine. Maket obsevations suggest that thi-paty pouct eviews have a significant effect on the success/ failue of poucts. Fo example, USA Toay epote that [a] ba eview in a compute magazine can kill a pouct an often oes [A]fte PC Magazine panne one Nothgate Compute Systems Inc. compute moel in ealy 1988, sales all but ie up Moeove, [a]fte Claion Softwae was awae an Eito s Choice citation fo its atabase pogam, Softsel the USA s lagest istibuto of compute poucts ecie to cay the pogam, which Softsel ha peviously ejecte, [an it] is now a best selle (Lewyn 1989). Thi-paty eviews have playe a vey impotant ole in consumes puchasing ecisions. A suvey by the Wall Steet Jounal in 1994 showe that ove a thi of Ameicans sought the avice of citics when choosing a movie (Simmons 1994). An in a suvey epote by The Los Angeles Times, 44% of online consumes sai they consulte eview websites befoe making a puchase (Rille 1999). Recently, thee has been gowing inteest among maketing scholas in stuying the maketing implications of vaious thi-paty infomeiaies, incluing thi-paty pouct eviewes (e.g., Eliashbeg an Shugan 1997, Rey et al. 1998, Chen et al. 2002, 218

2 Chen an Xie: Thi-Paty Pouct Review an Fim Maketing Stategy Maketing Science 24(2), pp , 2005 INFORMS 219 Shaffe an Zettelmeye 2002, Shugan an Winne 2003). 1 These ecent stuies have avance ou unestaning of the impact of thi-paty eview infomation on pouct success an fims pofits. Howeve, an impotant but une-exploe aea is how manufactuing fims shoul aapt thei maketing stategy in esponse to such eviews. Fo example, shoul a fim eceiving an unfavoable pouct eview euce its pice o ajust its avetising in esponse to the negative effect of the eview on the eman fo its pouct? Shoul a winning pouct of a pouct eview (e.g., eito s choice ) boost its avetising expenitue to spea the news of its victoy o euce its avetising an enjoy the benefit of fee avetising via the pouct eview? It is impotant to evelop a bette unestaning of when an how a manufactuing fim shoul vay its maketing stategy to maximize its benefit (o minimize its loss) fom a thi-paty pouct eview. An ealy exploatoy empiical stuy (Achibal et al. 1983) fins that, in the unning shoes maket, [a]fte the (Runne s Wol eview) atings ae publishe, fims ajust thei avetising consieably but they o not appea to ajust pices to any geat egee. Given that pice is a moe flexible vaiable than avetising, one woul expect a stonge impact of pouct eview on pice than on avetising. The obsevation that pouct eview i not affect fims pices is even moe puzzling given the impotance of Runne s Wol in the unning shoes maket. Runne s Wol was the ominant consume magazine fo unnes an accounte fo moe than 70% maket shae (Aye Diectoy of Publications 1981). The annual unning shoes eview fom Runne s Wol ha a significant impact on pouct eman. Fo instance, the New Balance 320 was anke No. 1 (by the eview), an liteally ovenight the New Balance Company was flooe with oes (Runne s Wol 1980, p. 37). Intuitively, one woul expect picecutting by the losing poucts afte the publication of such an influential pouct eview. It is impotant to povie a theoy that helps us to unestan the consieations unelying a manufactuing fim s ecision on its choice of stategic vaiables. It is moe impotant to unestan how fims shoul ajust thei avetising stategy when it is unpofitable to use pice as a esponse vaiable. In this pape, we consie two popula foms of pouct eviews: (1) a geneal esciption fomat that povies objective pouct infomation while avoiing explicit compaisons of competing poucts, an 1 A iffeent but elate eseach steam is pouct infomation povie by consumes, such as chatoom communication (e.g., Goes an Mayzlin 2004, Mayzlin 2005) an consume-poste online pouct eviews (e.g., Chen an Xie 2004). (2) a ecommenation fomat that selects winning poucts to ecommen to consumes (e.g., eito s choice, best buy ). We consie two types of stategic esponses to pouct eview picing an avetising but give special attention to fims avetising stategy. We examine a manufactuing fim s avetising esponse in two iffeent types of meia: the eviewe s publication (e.g., PC Magazine), which publishes pouct eviews fo pintes, an the noneviewe s publication (e.g., PC Wol). In aition, to vay the level of its avetising spening, we allow the winning pouct of a ecommenation eview to choose whethe to use eview-enose avetising (i.e., avetisements containing thi-paty awa logos such as eito s choice by PC Magazine ). We consie buye heteogeneity in the impotance of taste-elate pouct attibutes in buye puchase ecision as well as in buye pice sensitivity. We aess five specific eseach questions. Fist, une what conitions is it optimal fo a manufactuing fim to vay its avetising stategy, but not its picing stategy, in esponse to thi-paty pouct eviews? Secon, how shoul a fim ajust its avetising spening when it is unpofitable to change pice? Thi, oes a winning pouct of a ecommenation eview always gain by using eview-enose avetising to boacast its supeioity? Fouth, how oes the eview fomat (esciption vs. ecommenation) impact a fim s stategic esponse? Finally, shoul a fim s avetising esponse iffe acoss iffeent meia (the eviewe s publication vs. othe meia)? We fin that when the numbe of consumes who value taste-elate attibutes is sufficiently lage, it is best fo fims to ajust avetising but not picing stategy in esponse to the outcome of a thipaty pouct eview. We also iscove the inteaction effects between fims pice an avetising stategies. Fo example, in esponse to a ecommenation eview, whethe the losing pouct will euce its pice might epen on whethe the winning pouct aopts eview-enose avetising. This is because the eview-enose avetising can significantly incease a winning pouct s avetising effectiveness, which coul foce the losing pouct to aggessively compete on pice in oe to potect its maket shae. Theefoe, boacasting its supeioity via eview-enose avetising is not always beneficial fo the eview-winning pouct. Ou esults eveal that a thi-paty eview has two conceptually iffeent effects on a fim s avetising function. Fist, a thi-paty pouct eview geneates a substitutive effect because it euces consumes nee fo avetising infomation. Secon, a thipaty eview also geneates a complementay effect because it can incease o ecease the effectiveness

3 Chen an Xie: Thi-Paty Pouct Review an Fim Maketing Stategy 220 Maketing Science 24(2), pp , 2005 INFORMS of a fim s avetising. While the two effects jointly etemine a fim s optimal avetising esponse to a pouct eview, thei stength an iection ae vaiously subject to vaious pouct/maket/eview/ meia conitions such as the quality of the poucts, the penetation level of the eview infomation, the fomat of the pouct eview, an the type of meia. As a esult, the outcome of a pouct eview (i.e., winning vs. losing) is neithe the only no the most impotant facto in etemining a fim s optimal avetising stategy. Fo example, we fin that it is not always wise fo the ecommene poucts to boost avetising expenitues to spea the goo news. We also show that fims stategic esponse epens on eview fomat. Fo example, esciption eviews have the same stategic impact on the poucts eceiving favoable an unfavoable eviews, but ecommenation eviews may have iffeent stategic implications fo winning an losing poucts. Finally, we suggest that fims aopt iffeent avetising stategies in the eviewe s publication an othe meia because the impact of pouct eview on eaes iffes acoss iffeent meia. We conucte an exploatoy empiical stuy base on ata fom two inusties: pintes an unning shoes. The esults povie peliminay suppot fo ou theoetical moel. The emaine of the pape is oganize as follows. Section 2 eviews the elevant liteatue on thi-paty pouct eviews an iscusses the two most popula eview fomats. Section 3 pesents ou moel assumptions an setup. Sections 4 an 5 examine fims stategic esponses to a esciption an ecommenation pouct eview, espectively. Section 6 consies iffeent types of avetising meia. Section 7 iscusses empiical esults, an 8 pesents ou conclusions. 2. Thi-Paty Pouct Review The emegence of thi-paty pouct eviews is a maket phenomenon elate to infomation asymmety between selles an buyes selles have pouct infomation that buyes may not shae (e.g., Akelof 1970, Nelson 1974). Maketing liteatue has examine how fims can communicate pouct infomation to consumes via vaious maketing stategies (e.g., Gestne 1985, Wenefelt 1994, Zhao 2000, Iye an Sobeman 2000, Villas-Boas 2004). Economics liteatue (e.g., Faulhabe an Yao 1989, Lizzei 1999) has shown that the poblem of infomation asymmety can also be esolve o mitigate by having infome thi paties (infomeiaies) convey pouct infomation to potential buyes. Seveal ecent stuies in the maketing liteatue have investigate the ole of thi-paty pouct eviews. Eliashbeg an Shugan (1997) show that film citics peict athe than influence movie box office evenue. Rey et al. (1998) fin that newspape citics have a significant impact on the success of Boaway shows. Shaffe an Zettelmeye (2002) analyze how the povision of thi-paty infomation affects the ivision of pofits in a multipouct istibution channel. Shugan an Winne (2003) investigate the impact of fim avetising on thi-paty eviewe s policy. While these ecent stuies have avance ou unestaning of the impact of thi-paty eview infomation on pouct success an fims pofits, the inteaction between thi-paty pouct eview an fim maketing stategies, paticulaly the stategic esponse of manufactuing fims to thi-paty pouct eviews, emains a fascinating but une-exploe aea. Thi-paty pouct eviews usually povie pouct infomation (e.g., basic featues/functions an pices) base on lab testing o expet evaluation using one of seveal iffeent eview fomats. Many thipaty eviewes aopt a esciption fomat to povie etaile attibute facts about a pouct without making oveall ecommenations elative to its competing poucts. Fo example, Auio, the leaing U.S. auio equipment consume magazine, povies an exhaustive list of auio components available in the Unite States in its Octobe issue. Fo each component, the magazine povies manufactue s suggeste etail pice along with an extensive esciption of pouct chaacteistics but avois subjective evaluation o ecommenation. Othe eviewes aopt a ecommenation fomat that not only povies esciptive pouct attibute infomation but also selects winnes to ecommen to consumes base on oveall pouct pefomance an pices. Fo example, PC Magazine, which egulaly povies compaative pouct eviews on vaious PC-elate poucts such as esktop an laptop computes, pintes, scannes, igital cameas, an softwae, bestows its eito s choice seal of appoval base on oveall test scoes an pices. PC Wol applies the phase best buy, Scuba Diving Magazine uses teste s choice, an Runne s Wol awas its five o fou stas to ecommene poucts. Table 1 pesents examples of consume magazines an websites that povie compaative pouct eviews within vaious pouct categoies an inicates which of them uses a ecommenation fomat an which uses a esciption fomat. 3. Assumptions an MoelSetting In this section we specify assumptions an moel setting. Key notations ae summaize in the appenix Thi-Paty Pouct Reviewe We make two assumptions about thi-paty pouct eviewes. Fist, we assume the thi-paty eviewe

4 Chen an Xie: Thi-Paty Pouct Review an Fim Maketing Stategy Maketing Science 24(2), pp , 2005 INFORMS 221 Table 1 Examples of Thi-Paty Pouct Reviews Thi-paty eviewe Pouct categoy Review fomat Recommenation logo Outoo Photogaphe Photogaphic Equipment Recommenation Eito s Choice PC Magazine Compute, Pinte, Digital Recommenation Eito s Choice Camea, Softwae, Web Site, etc. PC Wol Compute, Pinte, Digital Recommenation Best Buy Camea, Softwae, Web Site, etc. Roale s Scuba Scuba Diving Equipment Recommenation Teste s Choice Diving Magazine Runne s Wol Running shoes Recommenation Fou & Five Sta Shoes Wol Tennis Tennis Shoes Recommenation Best an Goo Tennis Shoes CNET.com Compute, Pinte, Digital Recommenation Eito s Choice Camea, Softwae, etc. Eutainingkis.com Toys, Kis Leaning Softwae Recommenation Top Pick an Games, etc. ZDNET.com Compute, Pinte, Digital Recommenation Eito s Choice Camea, Softwae, etc. Auio CDPlaye Desciption N/A Golf Magazine Golf Equipment (Club tests) Desciption N/A Runne s Wol Running Shoes Desciption N/A povies accuate pouct infomation. We o not consie cases in which the thi-paty eviewe might intentionally mislea eaes by poviing faulty infomation because we ae inteeste in the impact of pouct eviews publishe by well-known publishes such as PC Magazine an PC Wol, each of which boasts millions of subscibes. Thei eputation among eaes is citical to these well-known publishes. Futhe, while avetising is often an impotant souce of thi-paty eviewes business evenue, a lage eae base is cucial fo attacting avetises (Chauhi 1998, Chen an Xie 2003). Hence, publishes have little incentive to favo lage avetises at the cost of thei ceibility to eaes. Accoing to Lewis (1989), among most eview publishes [t]he eitoial an avetising staffs ae usually sepaate, an thee is no evience that any majo publication has altee o withhel an unfavoable evaluation une pessue fom the avetises. While it is possible that a eviewe might povie faulty infomation with o without intention, we leave such cases to futue eseach. Secon, we assume patial penetation of eview infomation. Specifically, we assume that in the absence of othe channels of infomation, such as avetising, noneaes of the eviewe s publication will not be pivy to the infomation containe in the eview. Moeove, among eaes of the publication, only pecent of them ea the eview epot. Fo ease of iscussion, we call the penetation ate of the pouct eview Fims We consie two competing fims, H an L. Fist, we allow thei poucts to iffe in two mutually inepenent attibutes: quality (vetical) imension, an taste (hoizontal) imension (e.g., Lancaste 1966, Liu et al. 2004). In the quality imension, consumes agee on the pefeence oe of the attibutes. Fo instance, pouct eliability is an attibute in the quality imension because all consumes agee that the moe, the bette. In the taste imension, howeve, iffeent consumes may have vey iffeent pefeences fo the same attibute, such as esign style o colo (e.g., Aneson an e Palma 1992). In the quality imension, pouct H has the high quality an L has the low quality. In the taste imension, the two poucts offe hoizontal attibutes that match iffeent consumes tastes. Secon, we assume that the fims avetise thei poucts in the eviewe s publication. (In 6, we allow fims to avetise in both the eviewe s publication an in othe meia an examine how fims optimal avetising stategies iffe acoss iffeent types of meia.) Thi, we assume an inceasing convex function of avetising cost. Following Meue an Stahl (1994), we use a cost function, g j = ln 1 j, whee j is the each level of fim j s avetising. Specifically, as efine by Meue an Stahl (1994), j is the faction of consumes who eceive at least one avetisement fom selle j. The paamete, j, can also be egae as the pobability that a consume eceives the avetisement fom pouct j. The constant,, is a positive coefficient ensuing the inteio choices of optimal avetising levels. This cost expession is eive by assuming that avetising technology esembles the classic statistical un moel (Buttes 1977). It is in fact the mio image of the typical

5 Chen an Xie: Thi-Paty Pouct Review an Fim Maketing Stategy 222 Maketing Science 24(2), pp , 2005 INFORMS concave avetising-esponse function in avetising liteatue (e.g., Little 1979). Finally, we allow the poucts to iffe in pouction cost such that the high-quality pouct has a highe maginal cost than the low-quality pouct, c H c L. Without loss of geneality, let the maginal cost of L be nomalize to 0 an the maginal cost of H be nonnegative, c H = c Consumes We allow consume heteogeneity in two imensions. Fist, we allow consumes to iffe in the impotance of taste attibutes in thei puchase ecision. Specifically, we assume that faction of the consumes have a stong pefeence about tasteelate attibutes an make thei puchase ecisions mainly on the basis of these attibutes. The emaining 1 consumes have little concen about the taste-elate attibute an make thei puchase ecisions base mainly on the vetical pouct attibutes. We call these two types of consumes taste-iven an quality-iven consumes, espectively. Fo instance, when making a puchasing ecision fo SUVs, quality-iven consumes ae those who have stong pefeences egaing quality attibutes such as gas mileage, fo which all consumes have the same pefeence oe (i.e., high gas mileage is bette). Taste-iven consumes ae those who have stong pefeences egaing taste attibutes such as ca esign an size, fo which iffeent iniviuals might have iffeent pefeences. Fo example, many consumes stongly pefe Humme because of its lage size an special esign, espite its poo gas mileage. Let enote the faction of taste-iven consumes who have matche taste with L (i.e., 1 is the faction of taste-iven consumes who have matche taste with H). Without loss of geneality, the size of the whole consumes is nomalize to 1. Note that the assumption about consume heteogeneity in thei types implies that if all consumes wee fully infome, L woul be the pefee pouct fo faction of consumes an H woul be the pefee pouct fo faction of consumes. Secon, we allow consumes to iffe in thei pice sensitivity. Assume that is the faction of loyal consumes who ae insensitive to pice an buy only thei pefee pouct (i.e., loyal consumes who pefe H will neve buy L egaless of the pice of L). 1 is then the faction of switching consumes who ae sensitive to pice an woul switch to a nonpefee pouct if the pice is sufficiently low. Let v enote consumes esevation pice fo thei pefee pouct an v enote the switches esevation pice fo thei nonpefee pouct. By efinition, the loyal consumes esevation pice fo thei nonpefee pouct is zeo. This heteogeneity can be intepete as consumes iffeing in the maginal ate of substitution between income an pouct utility (Tiole 1990). We also assume that the high-quality fim s cost is sufficiently high c v that it is unpofitable fo H to seve its least pofitable segment: switches who pefe L. This assumption ensues that the highquality fim will not chage a pice below v in the absence of pouct eviews, which allows us to focus on the moe inteesting cases an euces the complexity of analysis. Relaxing this assumption will not alte ou esults qualitatively. We assume that consumes ente the maket with no infomation about poucts an that avetising an pouct eviews ae the only two souces of infomation available to them. We also assume that avetising can convey full infomation on the taste attibute (e.g., esign, colo), but not necessaily on quality attibutes (e.g., eliability) to consumes. In the absence of pouct eviews, consumes who eceive avetising only fom H ae awae of the existence of H, but only q H of them coectly ientify H to be a high-quality pouct. Consumes who eceive avetising only fom L ae awae of the existence of L, an q L of them incoectly ientify L to be a highquality pouct. Consumes who eceive avetising fom both fims become awae of the existence of both poucts, but only q of them coectly ientify H as a high-quality an L as a low-quality pouct. Note that q can be a function of both fims avetising effectiveness, q = f q H q L, whee q/ q H > 0, q/ q L < 0. Finally, because consumes who eceive avetising fom the high-quality fim alone ae moe likely to coectly ientify H to be a high-quality pouct than consumes who eceive avetising fom both fims, we let q<q H. Similaly, because consumes who eceive avetising fom the low-quality fim alone ae moe likely to incoectly ientify L to be a high-quality pouct than consumes who eceive avetising fom both fims, we let 1 q<q L MoelSetting We allow fims to compete on both pice an avetising. In pactice, thi-paty eviewes often offe pouct eviews fo poucts within a simila pice ange because buye segments ae often etemine by pice level. Fo instance, when poviing eviews on PCs, CNET.com compaes iffeent poucts within thee istinct segments: buget PC (low en), miange PC (mile), an pefomance PC (high en). Runne s Wol eviews unning shoes with categoies such as une $50, $50 to $60, an above $60. Ou ata also eveale an insignificant pice-quality coelation p = fo all pinte moels when they wee eviewe by PC Magazine. Given these maket obsevations, we consie the situation in which the thi paty povies infomation

6 Chen an Xie: Thi-Paty Pouct Review an Fim Maketing Stategy Maketing Science 24(2), pp , 2005 INFORMS 223 about poucts in the same pice level. Specifically, ou analysis focuses on the case in which both fims chage a high pice (i.e., P0 H = P 0 L = v in the absence of pouct eviews. We allow fims to choose whethe to compete on pice afte the publication of the pouct eview. To povie some theoetical justification fo the equal-pice case, we offe a etaile equilibium analysis (see the appenix) to show that P0 H = P0 L = v is an equilibium as long as avetising alone cannot sufficiently convey pouct quality infomation to consumes. An equal-pice equilibium hols une this conition because when avetising is insufficient in conveying quality infomation, some consumes eache by avetising might not be able to coectly ientify the high-quality pouct base on fims avetising. When enough consumes fail to coectly ientify the high-quality fim (o when enough consumes misientify the low-quality fim), the lowquality fim has little incentive to chage a lowe pice. This conition is easonable because thi-paty pouct eviews will be neithe valuable to consumes no influential to fims stategy if avetising can fully convey pouct quality infomation. Note that we o allow both fims to aopt iffeent pices in the pesence of pouct eviews. Let t = 0 enote the thee cases we examine: in the absence of pouct eview, in the pesence of esciption pouct eview, an in the pesence of ecommenation eview, espectively. Let Dt, j P j t, an j t enote fim j s eman, pice, an pofit in case t, espectively j = H L, t = 0. Fim j s pofit in case t is given by j t j t i t Pj t P i t = Dj t j t i t Pj t P i t P j t c j g j t j = H L i = H L j i (1) Fim j s eman, Dt j j t i t Pj t Pt i, is etemine not only by the fim s avetising an picing but also by the availability of a pouct eview. In 4, we fist examine fims picing an avetising stategies in the absence of a pouct eview an then in the pesence of a esciption eview. In both cases we moel competition with a two-stage game. Fims choose avetising each levels in the fist stage an pices in the secon stage. We eive the subgame pefect Nash equilibium (SPNE) of the two-stage game. Fims optimal stategic esponses to esciption pouct eview ae then eive by compaing the two cases (t = 0 an t = ). We examine the ecommenation eview in 5. Diffeent fom the esciption pouct eviews, ecommenation pouct eviews explicitly ientify winning poucts, thus offeing the high-quality fim an oppotunity to incease its avetising effectiveness by incluing thi-paty awa logos (e.g., eito s choice by PC Magazine ) in its as. Dean an Biswas (2001) show that caying thi-paty ecommenation enosements in the avetising can significantly incease consumes peceive quality of the high-quality pouct an fim avetising effectiveness. 2 To allow the high-quality fim to use eview-enose avetising as a stategic vaiable, we consie a thee-stage game. In the fist stage, fim H ecies whethe to use the eview-enose avetising. In the secon stage, each fim chooses its avetising each level. In the thi stage, fims make picing ecisions. We eive the SPNE of the theestage game. Fims optimal stategic esponses to a ecommenation pouct eview ae then eive by compaing the two cases (t = 0 an t = ). 4. Desciption Pouct Review In this section, we fist analyze the eman function in the absence of pouct eviews an then the eman in the pesence of esciption eviews. Finally, we eive fims optimal esponses to thi-paty pouct eviews by compaing fims competitive stategies in the two cases Analysis of Deman in the Absence of Pouct Review t = 0 Fist, fim j s eman is affecte by the size of the infome consumes. In the absence of pouct eview, consumes will make a puchase only when they ae eache by a fim s avetising. Thee ae thee goups of infome consumes: (1) those eache only by L, (2) those eache only by H, an (3) those eache by both fims. Let E 0, A 0, an B 0 enote these thee goups, espectively. The size of each goup is E 0 = L 0 1 H 0 eache only by L s avetising A Size: 0 = H 0 1 L 0 eache only by H s avetising B 0 = H 0 L 0 eache by both fims avetising Secon, fim j s eman is also affecte by whethe infome consumes consie the avetise pouct(s) thei pefee pouct(s) because consumes ae willing to pay a highe pice fo thei pefee pouct. Fo consumes in E 0 (eache only by L), L is a pefee pouct fo all taste-iven consumes 2 While it is also possible to pesent the positive eview infomation in fims avetising in the case of esciption pouct eview, as suggeste by Dean an Biswas (2001), such enosement by limite sentence is less stiking an effective. (2)

7 Chen an Xie: Thi-Paty Pouct Review an Fim Maketing Stategy 224 Maketing Science 24(2), pp , 2005 INFORMS whose tastes match with L (i.e., ) an fo all quality-iven consumes who incoectly ientify L as a high-quality pouct (i.e., 1 q L ). Let L enote the faction of consumes in E 0 who consie L to be a pefee pouct. It is easy to see that L = + 1 q L. Similaly, let H enote the faction of consumes in A 0 (eache only by H) who consie H to be a pefee pouct. H is a pefee pouct fo all taste-iven consumes whose tastes match with H (i.e., 1 ) an fo all quality-iven consumes who coectly ientify H as a high-quality pouct (i.e., 1 q H. Hence, H = q H. Finally, let enote the faction of consumes in B 0 (eache by both poucts) who consie H to be a pefee pouct. It is easy to see that = q. Because consumes in B 0 ae awae of both poucts, the faction of consumes who consie L to be a pefee pouct is 1. We summaize consumes pefeences in (3): E 0 L consie L to be pefee A Pefeence: 0 H consie H to be pefee (3) B 0 consie H to be pefee 1 consie L to be pefee whee L = + 1 q L, H = q H, = q. Finally, fim j s eman is affecte by consumes pice sensitivity (see Table 2). Fo consumes eache only by L E 0, both loyals an switches will buy L if it is thei pefee pouct an if P L v, egaless of thei pice sensitivity. If L is not thei pefee pouct, loyals will not buy but switches will buy if P L v. The consumes in E 0 will not buy H because they ae not awae of H. The puchase behavio of consumes in A 0 about H is simila to the puchase behavio of consumes in E 0 about L. Fo consumes eache by both fims B 0, as shown in Table 2, loyals will buy thei pefee pouct if its pice is not highe than v, an switches will buy the pouct offeing a highe positive suplus. Fims eman can be eive fom Table 2, an the equilibium of the two-stage game in the absence of pouct eviews t = 0 can be eive by maximizing the pofit function (1) Analysis of Deman in the Pesence of a Desciption Pouct Review t = Unlike the case without eview, in this case consumes can be infome not only by fims avetising but also by thi-paty eview infomation. Let R enote consumes who can iectly access the esciption pouct eview infomation. As efine in 3, the size of R is. Consumes in R can coectly ientify thei pefee pouct egaless of whethe they eceive fims avetising. Let E, A, an B enote consumes who o not have access to pouct eview infomation but ae eache by avetising only fom L, only fom H, an fom both fims, espectively. The sizes of the fou infome consume goups ae E = 1 L 1 H eache only by L s avetising A = 1 H 1 L Size: eache only by H s avetising (4) B = 1 H L eache only by both fims avetising R = eache by pouct eview Consumes in E, A, an B have the same pefeences an esevation pices as consumes in E 0, A 0, an B 0 given in (3), espectively. Diffeent fom Table 2 Consume Puchase Decision Infome consume Consume pefeence Consume pice sensitivity Consume puchase ecision Reache by L only E 0 L is pefee L Loyal Buy L if P L v Case 1 Switche 1 L is nonpefee 1 L Loyal No Puchase Case 2 Switche 1 Buy L if P L v Case 3 Reache by H only A 0 H is pefee H Loyal Buy H if P H v Case 4 Switche 1 H is nonpefee 1 H Loyal No Puchase Case 5 Switche 1 Buy H if P H v Case 6 Reache by both B 0 H is pefee Loyal Buy H if P H v Case 7 { Switche 1 Buy H if P H v an v P H v P L Case 8 Buy L if P L v an v P L v P H L is pefee 1 Loyal Buy L if P L v Case 9 { Switche 1 Buy L if P L v an v P L v P H Case 10 Buy H if P H v an v P H v P L

8 Chen an Xie: Thi-Paty Pouct Review an Fim Maketing Stategy Maketing Science 24(2), pp , 2005 INFORMS 225 consumes eache only by avetising, consumes eache by pouct eview ae able to coectly ientify pouct quality. Hence, fo consumes in R, H is a pefee pouct fo all taste-iven consumes whose tastes match with H (i.e., 1 ) an all quality-iven consumes (i.e., 1 ). Let enote the faction of consumes in R who consie H to be a pefee pouct, = We summaize consumes pefeences in the pesence of a esciption eview: E L consie L to be pefee A H consie H to be pefee B Pefeence: consie H to be pefee (5) 1 consie L to be pefee R consie H to be pefee 1 consie L to be pefee whee L = + 1 q L, H = q H, = q, = Consumes in E, A, an B have the same puchase behavio as consumes in E 0, A 0, an B 0 given in Table 2, espectively. Consumes in R who pefe pouct j have the same puchase behavio as consumes in B who pefe pouct j j = H L. The equilibium of the two-stage game in the pesence of esciption pouct eviews t = can be eive by maximizing the pofit function given in (1) The OptimalResponse to a Desciption Pouct Review Compaing the equilibium stategies in the two cases (t = 0 an t = ) allows us to eive fims optimal stategic esponses to the pouct eview. Because maket obsevations have suggeste that thi-paty pouct eviews significantly affect a fim s avetising stategy but not its picing stategy, as iscusse ealie, we evote ou attention to the equilibium whee fims o not ajust thei pice but vay thei avetising. In Poposition 1, we eive conitions une which such an equilibium occus an iscuss how to optimally vay one s avetising stategy when it is unpofitable to change pice (see poofs of popositions in the appenix). Poposition 1 (Desciption Review). When the size of the taste-iven segment is sufficiently lage, both fims (i) Ajust avetising stategy but not picing stategy in esponse to a esciption pouct eview, i.e., P j = P j 0 ; (ii) Reuce thei avetising spening, i.e., g j < g j 0. Whee P j t an g j t ae fim j s optimal pice an avetising expenitue in case t, an is given in (A.18) in the appenix. Poposition 1 eveals that pice will not be use as a stategic vaiable in esponse to pouct eview when thee ae enough consumes who value taste-elate pouct attibutes. This is because pouct eviews eveal infomation on pouct quality that often cannot be conveye fully by fims avetising. With the help of pouct eviews, moe consumes can coectly ientify H as a high-quality pouct. As a esult, a pouct eview eceases the numbe of consumes who ae willing to pay a high pice fo L an motivates the low-quality fim to cut pice in oe to potect its maket. Because only the quality-iven consumes have uncetainty about thei pefee poucts, the impact of pouct eview on a fim s picing stategy epens on the elative size of the taste-iven vs. quality-iven consumes. When the segment of taste-iven consumes is vey small, most consumes make puchase ecisions base on pouct quality. Pouct eview can significantly euce the low-quality pouct s eman an motivate the low-quality fim to euce pice. Howeve, if a sufficient numbe of consumes cae about hoizontal attibutes, it will be moe pofitable fo both fims to use avetising athe than pice as a stategic vaiable in esponse to pouct eview. Poposition 1 also suggests that both high- an lowquality fims shoul euce thei avetising expenitue in the eviewe s publication. This is because a thi-paty pouct eview is an altenative souce of pouct infomation to the eaes of the eviewe s publication that euces the value of avetisement to these consumes. This substitutive effect of pouct eview on fim avetising function has a negative impact on maginal avetising etun. As a esult, a pouct eview euces fims avetising incentive, an all fims benefit fom eucing avetising in the eviewe s publication. 5. Recommenation Pouct Review As state in 3, in the pesence of ecommenation pouct eviews, the high-quality fim might want to take avantage of the positive outcome of the pouct eview by incluing thi-paty awa logos (e.g., Eito s Choice by PC Magazine ) in its as. To moel this, we consie a thee-stage game in which the high-quality fim ecies whethe to use eviewenose avetising in stage 1, both fims choose thei avetising each levels in stage 2, an both fims make pice ecisions in stage Analysis of Deman in the Pesence of a Recommenation Pouct Review t = Fims emans une a ecommenation eviews ae the same as those une esciption eviews if the high-quality fim chooses not to use eview-enose avetising. Theefoe, we nee only analyze the case

9 Chen an Xie: Thi-Paty Pouct Review an Fim Maketing Stategy 226 Maketing Science 24(2), pp , 2005 INFORMS whee the high-quality fim aopts eview-enose avetising. Simila to the esciption eview, in the pesence of a ecommenation eview, thee ae fou goups of infome consumes: {E, A, B, R }. Thei efinitions an sizes ae E = 1 L 1 H eache only by L s avetising A = 1 H 1 L Size: eache only by H s avetising (6) B = 1 H L eache only by both fims avetising R = eache by pouct eview The high-quality fim s ecision to use eviewenose avetising oes not affect consumes eache only by the low-quality fim s avetising (E ) because these consumes o not ea the high-quality fim s as. Such a ecision also oes not affect consumes eache by the pouct eview (R ) because these consumes ae infome about quality attibutes by eaing pouct eview an ae not affecte by avetising. Hence, consumes in E an R have the same puchase behavio as consumes in E an R, espectively. Howeve, the high-quality fim s ecision to use eview-enose avetising will affect consumes eache by the high-quality fim s avetising (A an B ) because eview-enose avetising allows these consumes to lean the outcome of the pouct eview. Hence, when eview-enose avetising is use, all thee goups, A, B, an R ae awae of pouct quality. Consumes pefeences in the pesence of a ecommenation eview an eview-enose avetising ae E L consie L to be pefee A consie H to be pefee B consie H to be pefee Pefeence: (7) 1 consie L to be pefee R consie H to be pefee 1 consie L to be pefee whee L = + 1 q L, = Table 3 highlights the iffeences in the size of infome consumes an consumes pefeence among the thee cases t = 0. Note that the case of ecommenation eview t = without using eviewenose fomat is the same as the case of esciption eview t = as shown in Table The OptimalResponse to a Recommenation Pouct Review In the pesence of a ecommenation eview, the high-quality fim nees to ecie whethe to aopt eview-enose avetising. Examination of fims equilibium stategies an pofits when the highquality fim aopts an oes not aopt eviewenose avetising leas to the following poposition egaing the eview-enose avetising. Poposition 2 (Review-Enose Avetising). (i) Thee exists an inteaction effect between fims avetising an picing stategies. Specifically, the low-quality fim is moe likely to cut pice if the high-quality fim aopts eview-enose avetising than if the high-quality fim oes not. (ii) Aopting eview-enose avetising can lea to a lowe pofit fo the high-quality fim. Table 3 Consume Infomation an Pefeence Reache only by L s as Reache only by H s as Reache by H/L s as Reache by eview In the absence of pouct eview t = 0 E 0 = L 0 1 H 0 A 0 = H 0 1 L 0 B 0 = H 0 L 0 H is pefee L is pefee H is pefee L is pefee H is pefee L is pefee N/A L H N/A 1 In the pesence of a esciption eview t = E = 1 L 1 H A = 1 H 1 L B = 1 H L R = H is pefee L is pefee H is pefee L is pefee H is pefee L is pefee H is pefee L is pefee N/A L H N/A 1 1 In the pesence of a ecommenation eview t = (with eview-enose avetising) E = 1 L 1 H A = 1 H 1 L B = 1 H L R = H is pefee L is pefee H is pefee L is pefee H is pefee L is pefee H is pefee L is pefee N/A L N/A 1 1 Note. L = + 1 q L, H = q H, = q, = The case of the ecommenation eview is the same as that of the esciption pouct eview if eview-enose avetising is not aopte.

10 Chen an Xie: Thi-Paty Pouct Review an Fim Maketing Stategy Maketing Science 24(2), pp , 2005 INFORMS 227 Poposition 2 eveals an inteesting stategic inteaction between fims avetising an picing stategies the low-quality fim is moe likely to engage in pice-cutting if the high-quality fim aopts eviewenose avetising. This inteaction is the esult of the complementay effect of the ecommenation eview on fim avetising function. A eview enosement has a significant impact on avetising effectiveness. This complementay effect can be positive o negative, epening on whethe the avetise is a high- o low-quality fim. As shown in Table 3, fo consumes who o not have iect access to the eview infomation but ae eache by H s avetising (A an B ), H (in A ) an (in B ) pefe H when eview-enose avetising is not use, but (in both A an B ) pefe H if such avetising is use. Because > H an >, eview-enose avetising has a positive complementay effect on a high-quality fim s avetising function. Futhemoe, fo consumes eache by both fims avetising B,1 pefe L when eviewenose avetising is not use, but 1 pefe L if such avetising is use. Because 1 >1, eview-enose avetising has a negative complementay effect on a low-quality fim s avetising function. 3 The positive complementay effect on H s avetising implies that a lage numbe of consumes (incluing switches who woul buy L une a sufficiently low pice) pefe H when eview-enose avetising is use than when it is not use. Fo this eason, the benefit of pice-cutting fo the low-quality fim is highe in the fome than in the latte case. The negative complementay effect on L s avetising implies that a smalle numbe of consumes (incluing loyals who ae willing to pay a pemium pice fo L) pefe L when eview-enose avetising is use than when it is not use. Fo this eason, the cost of pice-cutting fo the low-quality fim is lowe in the fome case than in the latte. Theefoe, picecutting becomes a moe pofitable stategy fo the low-quality fim when the high-quality fim aopts eview-enose avetising. The inteaction effect between fims avetising an picing stategies leas to a supising fining the high-quality fim can be hut by incluing a thi-paty enosement in its avetisement. Review-enose avetising is a ouble-ege swo. On one han, it inceases the high-quality fim s avetising effectiveness an leas moe consumes to pefe H. On the othe han, eviewenose avetising inceases the low-quality fim s 3 Negative complementay effect on low-quality fim iniectly comes fom the incease ceibility an effectiveness of highquality fim s avetising. incentive to cut pice. When the size of the tasteiven consumes is small, fim L may have to cut its pice aggessively to compete fo switches who pefe H, which can significantly euces H s pofit. By compaing the equilibium stategies in the absence of pouct eview t = 0 an in the pesence of a ecommenation pouct eview t =, we eive the following poposition egaing fims optimal esponses to a ecommenation pouct eview. Poposition 3 (Recommenation Review). When the size of the taste-iven segment is sufficiently lage, (i) Both fims ajust avetising stategy but not picing stategy in esponse to a ecommenation pouct eview; (ii) It is optimal fo the high-quality fim to aopt eview-enose avetising; (iii) Fims aopt asymmetic avetising esponses such that (a) the low-quality fim euces its avetising expenitue, (b) the high-quality fim inceases its avetising expenitue if the eview penetation ate is sufficiently low, but eceases its avetising expenitue, othewise. Mathematically, Low-quality fim: g L <g L 0 g H g H 0 if = 1 1 L 0 High-quality fim: H + L 0 / g H <g H 0 othewise whee g j t is fim j s optimal avetising expenitue in case t j= H L t = 0, an is given in (A.28) in the appenix. Poposition 3 eveals that, simila to the case of the esciption eview, if sufficient numbes of consumes cae about hoizontal pouct attibutes,itis optimal fo fims to vay avetising but not pice in esponse to a ecommenation pouct eview. In this case, because the low-quality fim has no incentive to cut pice, the high-quality fim benefits fom using eview-enose avetising. Poposition 3 also shows that, in contast to the case of a esciption eview, whee both fims euce thei avetising expenitues in esponse to pouct eview (see Poposition 1), in the pesence of a ecommenation eview, the high- an low-quality fims may aopt iffeent avetising stategies. Specifically, in esponse to a ecommenation eview, while it is best fo the low-quality fim to euce its avetising, the high-quality fim may benefit fom inceasing o eceasing its avetising spening, epening on the eview penetation ate. The asymmetic impact of the ecommenation pouct eview on high- an low-quality fims can

11 Chen an Xie: Thi-Paty Pouct Review an Fim Maketing Stategy 228 Maketing Science 24(2), pp , 2005 INFORMS be explaine by two effects: a substitutive effect an a complementay effect. On one han, as an altenative souce of pouct infomation, a ecommenation eview has the negative substitutive effect on a fim s avetising function. On the othe han, as iscusse peviously, a ecommenation pouct eview has a positive complementay effect on high-quality fims avetising function an a negative complementay effect on low-quality fims avetising function when the high-quality fim aopts eview-enose avetising. It is inteesting to note that the magnitue of the substitutive an complementay effects epens on the size of the eview penetation ate,. This is because the substitutive effect applies only to the consumes who iectly access eview infomation, i.e.,. These consumes lean about pouct quality fom eaing the pouct eview an theefoe o not nee to ely on avetising infomation to make quality infeences. The complementay effect, howeve, applies to consumes who cannot iectly access eview infomation, 1. Those consumes still ely on avetisements as thei infomation souce in making quality infeences. Hence, the size of affects both substitutive an complementay effects. A lage leas to a stonge substitutive effect an a weake complementay effect. Clealy, the oveall effect of pouct eview on fims avetising function is etemine by the combine impact of the substitutive an complementay effects. Poposition 3 shows that fo low-quality fims, the optimal avetising esponse to the thi-paty eview is to euce avetising. This is because the low-quality fim suffes fom both a negative substitutive effect an a negative complementay effect, an the pouct eview euces the low-quality fim s incentive to invest in avetising. Hence, the optimal avetising spening is lowe in the pesence than in the absence of pouct eview. Fo high-quality fims, the optimal avetising esponse epens on the penetation ate of the eview infomation,. Fo high-quality fims, the substitutive an complementay effects take iffeent iections, an is positively elate to the stength of the substitutive effect but negatively elate to the stength of the complementay effect. When the eview penetation ate is sufficiently high, a lage numbe of eaes become awae of pouct quality an will not benefit fom the high-quality fim s avetising. Although the pouct eview can make a high-quality fim s avetising moe pesuasive fo consumes, this positive complementay effect may be too weak to ovecome the negative substitutive effect because the fome applies to a vey small 1 an the latte a vey lage popotion of consumes. As a esult, when a lage numbe of consumes ae awae of the eview infomation, the high-quality fim will benefit by eucing avetising spening. When the eview penetation ate,, is sufficiently low, the high-quality fim s avetising can be vey pofitable because it will affect a lage numbe of consumes an will have high ceibility. In this case, the positive complementay effect can ominate the negative substitutive effect. Theefoe, when the eview penetation ate is vey low, the high-quality fim will benefit by inceasing avetising. 6. Othe Avetising Meia In the peceing sections, we assume that the eviewe s publication is the fims only avetising outlet. Now we allow the fims to avetise in two iffeent types of meia: the eviewe s publication an othe publications. We also allow the fims to aopt iffeent avetising stategies in esponse to a pouct eview in these two types of meia to etemine whethe it affects each type of meia iffeently. We call the noneviewe s publication othe meia. Let be the pecentage of consumes who ea the eviewe s publication; hence, 1 ea the othe meia. To istinguish the cases without othe meia (iscusse in pevious sections), we use an m subscipt to enote all the vaiables fo the case with both the eviewe s publication an othe meia. Fo example, j tm an j tm enote fim j s avetising each levels in the eviewe s publication an in othe meia in case t t= 0, espectively. Unlike the pevious cases, consumes can now get pouct infomation via the fims as fom both the eviewe s publication an othe meia. This will change the composition of iffeent infome consume goups. Fo instance, the popotion of consumes who can access eview infomation iectly was R t = in pevious sections, but R tm = in this section, whee t =. As a esult, the size of the consumes eache only by H s avetising in case t, A tm,is A 0m = H 0m 1 L 0m + 1 H 0m 1 L 0m Size: A m = 1 H m 1 L m + 1 H m 1 L m A m = 1 H m 1 L m + 1 H m 1 L m (8) The size of the othe goups of consumes in iffeent cases also changes accoingly. (See the appenix fo etails.) Consumes pefeences an esevation pices in each goup emain the same. Examining the fims equilibium stategies an pofits leas to the following poposition egaing thei avetising stategies in iffeent meia. Poposition 4 (Othe Avetising Meia). (i) The existence of othe meia oes not affect fims avetising esponses to pouct eview in the eviewe s publication.

12 Chen an Xie: Thi-Paty Pouct Review an Fim Maketing Stategy Maketing Science 24(2), pp , 2005 INFORMS 229 (ii) In the pesence of a esciption eview, fims o not ajust thei avetising expenitue in othe meia. (iii) In the pesence of a ecommenation eview, (a) fims o not ajust thei avetising expenitue in othe meia if the high-quality fim oes not aopt eviewenose avetising, an (b) the low-quality fim euces but the high-quality fim inceases avetising expenitue in othe meia if the high-quality fim aopts eviewenose avetising. Taking Popositions 1, 3, an 4 togethe, we now ae able to povie a summay of the fims optimal avetising stategies (see Table 4) in the pesence of iffeent eview fomats (esciption vs. ecommenation) an in iffeent avetising meia (eviewe s publication vs. othe meia). The uppe pat of Table 4 shows the impact of pouct eview on avetising function in tems of substitutive an complementay effects, an the lowe pat of Table 4 shows the optimal avetising stategy in esponse to pouct eview. Note that both esciption an ecommenation eviews have the same effect on the fims avetising stategies if the high-quality fim oes not aopt eview-enose avetising afte the publication of a ecommenation eview. To focus on the iffeences between the two types of eviews, in the iscussion below, a ecommenation eview efes to the case whee the eview is pesente in a ecommenation fomat an eview-enose avetising is aopte. As shown in Table 4, the substitutive effect epens on the type of meia use. The negative substitutive effect applies only to avetising in the eviewe s publication an not to avetising in othe meia, because eaes of the fome have iect access to the eview infomation wheeas eaes of the latte o not. The complementay effect epens on the type of eview fomat use an the quality of the fim s pouct. It applies to the ecommenation fomat but not to the esciption fomat. It is positive fo high-quality fims but negative fo low-quality fims. Table 4 shows that the esciption fomat has a symmetic effect such that it affects both fims in the same iection. Convesely, the ecommenation fomat has an asymmetic effect such that it affects highan low-quality selles in iffeent iections. The combine impact of substitutive an complementay effects leas to the optimal avetising esponse shown in the lowe pat of Table 4. Fo example, fims shoul not change thei avetising spening in othe meia afte the publication of a esciption pouct eview because such eviews have neithe a substitutive no a complementay effect on thei avetising in othe meia. Fims shoul ecease thei avetising in othe meia ue to the negative substitutive effect of the esciption fomat. Fims optimal avetising esponse to the ecommenation fomat epens on the pouct s quality, the type of meia, an the penetation ate of the eview infomation. The optimal avetising esponse vaies fo fims with poucts of iffeent quality because the complementay effect is positive fo high-quality poucts but negative fo low-quality poucts. Low-quality fims shoul euce avetising in all meia povie that both substitutive an complementay effects ae negative. High-quality fims shoul incease avetising in othe meia ue to a positive complementay effect. Thei avetising stategy in the eviewe s publication epens on the eview penetation ate which eceases the positive complementay effect an inceases the negative substitutive effect. Inceasing avetising is optimal when fewe people ae awae of the eview infomation, but eceasing avetising is optimal when most eaes of the eviewe s publication ae infome consumes. Table 4 Avetising Response to the Thi-Paty Pouct Review Recommenation fomat eview (with eview-enose avetising) Desciption fomat eview Low-quality fim High-quality fim Low-quality fim High-quality fim Reviewe s Reviewe s Reviewe s Reviewe s publication Othe meia publication Othe meia publication Othe meia publication Othe meia Substitutive effect Negative None Negative None Negative None Negative None Complementay effect Positive Positive Negative Negative None None None None Optimal avetising esponse Incease o Same (Low eview penetation) Decease (High eview penetation) Incease Decease Decease Decease Same Decease Same The optimal avetising stategy in the case of ecommenation eview is the same as that in the case of esciption pouct eview if eview-enose avetising { is not aopte. Substitutive effect: pouct eview can euce consume s nee fo avetising infomation. Complementay effect: pouct eview can stengthen o weaken avetising effectiveness.

13 Chen an Xie: Thi-Paty Pouct Review an Fim Maketing Stategy 230 Maketing Science 24(2), pp , 2005 INFORMS It is impotant to note that some thi-paty eviewes o not accept fims avetising. Rathe, they chage consumes fo the pouct eview infomation (e.g., Consume Repots, Zagat). We call this type of thi-paty infomation guiebooks. Although guiebooks cay no as, ou moel can be applie to this type of thi-paty eviewe by making two moifications. Fist, the faction of infome consumes who eceive avetising fom the eviewe s publication is set to zeo (i.e., is zeo athe than positive). Secon, by puchasing guiebooks, a faction of eaes of othe meia can iectly access the eview infomation (i.e., is efine as the pecentage of eaes of othe meia who can iectly access the eview infomation, athe than the pecentage of eaes of the eviewe s publication who can iectly access the eview infomation). These mino moifications o not affect ou esults on fims picing stategy because fims still face the same tae-offs in eciing whethe pice shoul be a stategic vaiable in esponse to pouct eview the benefit (cost) of using pice as a esponse vaiable is low (high) when many consumes value hoizontal pouct attibutes. Because a guiebook oes not accept avetising, fims nee to consie thei avetising stategy only in othe meia. Given the moifie efinition of, fims avetising ajustments in othe meia in the guiebook case is the same as fims avetising ajustments in the eviewe s publication shown in Table 4. In aition, some guiebooks such as Consume Repots o not allow fims to cay the publications awa logos in avetising. Hence, eview-enose avetising might not be possible. In this case, the impact of a ecommenation eview will be simila to that of a esciption eview. 7. EmpiicalEvience To emonstate some extenal valiity fo ou theoetical moel, we conuct an exploatoy empiical stuy on the impact of thi-paty pouct eviews on fims maketing stategies. In selecting pouct categoies, the following citeia must be met. (i) Thi-paty pouct eview. (a) The categoy nees to have the thi-paty pouct eviews publishe by eputable consume magazines; (b) the eviews must povie compehensive infomation on all newly launche moels in thei espective makets; an (c) the eviews must use iffeent fomats in evaluating oveall pouct pefomance. (ii) Meia an avetising ata. (a) The categoy nees to have two ominating consume magazines in the inusty: the eviewe s publication an a epesentative of othe meia ; an (b) avetising ata fo all the eviewe moels must be available fom both magazines befoe an afte the eview appeas. (iii) Picing ata. Picing ata fo all the eviewe moels must be available befoe an afte the eview appeas. We ae able to fin two pouct categoies that met all these equiements: pintes an unning shoes. Although we wee unable to obtain etaile pice infomation fo unning shoes iectly, Achibal et al. (1983) collecte etailing pice ata on most of the unning shoes moels an epote the esults of thei examination of the impact of the eview infomation on picing in the unning shoes maket. In the emaine of this section, we povie etaile infomation on the ata collecte fom these two inusties an iscuss ou empiical finings Data Pinte. In the pinte inusty, we collecte eview ata fom PC Magazine, which is consiee one of the most influential compute consume magazines in the wol (Loh 1993). PC Magazine was launche in 1982, an in 1999 it ha a ciculation of ove 1.23 million an the highest avetising evenue among all U.S. consume magazines (Fost 1999). Twenty-two issues of the magazine ae publishe each yea. Between 1984 an 1992, a special issue appeae evey Octobe o Novembe in which all new moels of pintes wee eviewe. These special issues pesente etaile infomation on cuent pice, pint spee, gaphics output, an text output fo each moel. Each of the special eview issues also esignate some moels as Eito s Choice selections base on oveall pefomance an pice. We collecte the pinte eview ata fom one of the special issues (Novembe 14) publishe in This issue eviewe 106 new moels, esignating 20 moels an Eito s Choice selections. Among the moels eviewe, 27 exite the maket the following yea. To ule out the impact of pouct stategy on avetising spening, we use the emaining 79 moels fo ou analysis. Among these moels, we classifie the 16 Eito s Choice pintes as high-quality poucts an the emaining 63 pintes as low-quality poucts. To examine the fims avetising esponses to pouct eviews, we collecte avetising ata in two magazines: the eviewe s publication, PC Magazine, an its leaing ival, PC Wol. These two magazines wee the ominant playes in thei maket uing the peio we stuie. Accoing to the Fishe (1988), in 1988 the subsciption size was 502,700 fo PC Magazine an 475,000 fo PC Wol, an the ciculation of these two magazines accounts fo 75% of oveall 4 We use the eview ata fom this issue because we wee able to fin complete avetising ata fo 12 months befoe an 12 months afte the publication of this issue to complete ou analysis.

14 Chen an Xie: Thi-Paty Pouct Review an Fim Maketing Stategy Maketing Science 24(2), pp , 2005 INFORMS 231 ciculation size of the top five compute magazines. Moeove, eseach showe that thee-fouths of PC Wol s eaes i not ea PC Magazine (Loh 1993). We counte the numbe of avetising pages fo all pintes in both magazines one yea befoe an one yea afte publication of the eview issue of PC Magazine. Because selles might avetise seveal moels in one avetisement, when counting avetising pages we ivie whole pages of this type of avetisement by the numbe of moels an obtaine the avetising level fo each iniviual moel. In aition, in each yea s eview issue on pintes, PC Magazine also povies the cuent pices fo all pinte moels that wee eviewe in pevious yeas an ae still available on the maket. Theefoe we wee able to obtain pice ata fo all 79 moels befoe an afte the eview. Running Shoes. In the unning shoes inusty, we collecte eview ata fom Runne s Wol magazine. Runne s Wol ha a ciculation of 410,000 in 1981, an since the 1980s it has ha the highest ciculation among U.S. unnes magazines. Runne s Wol publishe eviews of unning shoes once a yea in the Octobe issue fom 1975 to 1985 an twice a yea in the Apil an Octobe issue fom 1986 to pesent. Befoe 1985, it employe a ecommenation fomat with a five-sta system to ate all shoes an ecommene 5- an 4-sta shoes to buyes. Since 1985, the magazine has aopte a esciption eview fomat, poviing only attibute facts on poucts without making ecommenations. We collecte ecommenation eview ata fom the Octobe 1979 issue of Runne s Wol. Of 177 shoe moels eviewe, 71 moels wee categoize as 5-sta an 4-sta. We classifie these moels as high-quality an the emaining 106 moels as low quality. We collecte esciption eview ata on unning shoes fom the Octobe 1985 issue of Runne s Wol. The eview pesente etaile pouct infomation an pictues of 52 moels. Avetising ata wee collecte both fom Runne s Wol an fom its leaing competito Runne. Accoing to Aye Diectoy of Publications, in 1981 the ciculation fo Runne s Wol was about 410,000 while fo Runne it was 85,000, an togethe these two magazines accounte fo 90% of the maket shae in thei maket. Fo the ecommenation eview fomat, we collecte avetising ata by counting the numbe of avetising pages foun in all issues of Runne s Wol fo six months befoe the eview issue (May 1980 to Octobe 1980) an fo six months afte the eview issue (Novembe 1980 to Apil 1981). Likewise, we gathee avetising ata fom all issues of Runne fo fou months befoe an fou months afte the eview (July 1980 to Febuay 1981). 5 Fo the 5 The length of this time seies is constaine by the availability of ata. esciption eview, we collecte avetising ata fom all issues of both magazines fo six months befoe an six months afte the eviews appeae (May 1985 to Apil 1986). Fo the pice ata, we wee unable to iectly obtain the pice ata fo the unning shoe moels afte the eview. Howeve, Achibal et al. (1983) collecte etailing pice ata on most of the unning shoes moels eviewe in the Octobe 1979 issue both befoe an afte the eview issue an investigate the impact of the eview infomation on picing EmpiicalFinings Impact of Pouct Review on Picing. In the unning shoes maket, Achibal et al. (1983) epot that the manufactues of unning shoes i not ajust pices to any significant egee afte the publication of a eview by Runne s Wol. In the pinte maket, ou ata eveal the same patten. Fo example, we fin that the publication of the pouct eview by PC Magazine i not have a significant impact on the pice-quality coelation p = In fact, the picequality coelation is neithe significant befoe no afte the publication of the eview (p = 0 85 an p = 0 95). These obsevations ae consistent with ou theoetical esults. In ou basic moel, we assume both highquality an low-quality fims chage a high pice an pove that fims will not ajust thei picing policy in esponse to thi-paty pouct eview if the size of taste-iven consume population is sufficiently lage. This theoetical esult peicts that, given the low pice-quality coelation pio to the publication of the pouct eview, the pice-quality coelation will not incease afte the publication of the pouct eview when enough consumes value hoizontal pouct attibutes. We use pice-quality coelations instea of absolute pice levels to evaluate the impact of the pouct eview on the fims picing stategies also because the latte might be subject to a negative fixe time effect. A ecent empiical stuy of the pinte maket (Melnikov 2000) povie evience of such a negative fixe time effect on pinte pice. If pouct eview ha a significant impact on the fims picing stategy, we woul expect an incease in the pice-quality coelation afte the publication of the pouct eview. This is because a pouct eview inceases (eceases) the numbe of consumes who ae willing to pay a high pice fo the high-quality (low-quality) poucts, povie that the pouct eview is infomative. The fact that the pice-quality coelation i not change coul suggest that the pouct eview has an insignificant impact on the fims picing stategies. Ou moel povies a possible explanation fo this inteesting obsevation. Ou theoetical esults suggest that if thee ae enough consumes who cae

15 Chen an Xie: Thi-Paty Pouct Review an Fim Maketing Stategy 232 Maketing Science 24(2), pp , 2005 INFORMS about hoizontal pouct attibutes, it is unpofitable fo fims to use pice as a esponse vaiable in the pesence of a pouct eview. This is because when thee ae enough consumes whose puchase ecisions ae iven mainly by thei iiosyncatic pefeences, pice competition is neithe necessay (i.e., a pouct eview oes not pose a cucial theat to lowquality fims eman) no efficient (i.e., pice-cutting offes little help in gaining maket shae). When buying unning shoes, fo some consumes quality attibutes such as flexibility, weight, sole taction, an injuy pevention ae citical to thei puchase ecision. Fo othe consumes, taste attibutes such as esign style an fit with foot type (ponatos, supinatos, o nomal) may play a ominant ole in thei puchase ecisions. When making a puchase ecision about pintes, many consumes focus on quality attibutes such as pint spee, memoy buffe size, an image esolution. Howeve, othe consumes may have a stong pefeence towa a paticula ban ue to pesonal taste, o concens about hoizontal attibutes such as colo, size, esign, softwae compatibility, an special optional functions. Hoizontal attibutes such as softwae compatibility an special functions (e.g., Postscipt compatibility, small compute system inteface (SCSI), an special size pape hanling) wee impotant factos in consumes puchase ecisions in the ealy stage of the pinte maket we examine. We foun that fims tene to emphasize these hoizontal attibutes in thei avetisements, especially fo poucts that wee not esignate an Eito s Choice selection. The obsevation that pouct eviews i not significantly affect fims picing stategies in both unning shoes an pinte makets may suggest that hoizontal attibutes wee impotant to many consumes in these two makets, which weakene the benefit but incease the cost of using pice as a esponse vaiable in the pesence of pouct eview. Impact of Pouct Review on Avetising. We now examine the impact of pouct eview on the avetising levels of fims in the two makets. Ou moel (see Table 4) suggests that avetising stategy in the pesence of pouct eview is etemine by fou factos: (1) eview fomat, (2) type of meia, (3) pouct quality, an (4) penetation ate of the eview infomation. In ou empiical stuy, we ae able to measue the fist thee factos in both inusties iectly but unable to measue the last facto iectly. The penetation ate of eview infomation is efine as the pecentage of those subscibes of the eviewe s publication who ea the eview infomation. Seveal factos may affect the eview penetation ate. Fo example, ue to limite time an seach cost, a eae is moe likely to lean the eview infomation if (1) the eviewe publishes a small athe than a lage numbe of issues pe yea, (2) each issue has fewe athe than moe pages, an (3) the annual eview is publishe in a fixe issue (e.g., each Octobe) athe than in iffeent issues evey yea. Compaing the two thi-paty pouct eviewes, we fin majo iffeences in these factos. PC Magazine has 22 issues each yea, while Runne s Wol is issue 12 times a yea. Reviews of pintes appeae in iffeent issues of PC Magazine in iffeent yeas, but eviews of unning shoes appeae egulaly in the Octobe issue of Runne s Wol. Futhemoe, PC Magazine uns almost 400 pages pe issue, but Runne s Wol has fewe than 100 pages in each issue. These facts suggest that it is easie fo eaes of Runne s Wol to fin an emembe the eview infomation than it is fo eaes of PC Magazine. In othe wos, Runne s Wol may have a highe eview penetation ate,, than PC Magazine. Futhemoe, ou inteviews with eaes of Runne s Wol suggest that most eaes of this magazine ae seious unnes who have sophisticate knowlege of unning shoes an ae capable of unestaning the technical etails of the eview epot. Given the single-pouct categoy focus of the magazine (unning shoes), the ease of seaching the pouct eview infomation (fewe issues pe yea, fewe pages pe issue, a fixe issue fo pouct eview), an the high egee of eae sophistication, we consie that Runne s Wol has a high penetation ate of pouct eview infomation in eveloping ou peictions fo fims avetising esponses. Base on Table 4, we povie 10 peictions about fims avetising esponses to the thi-paty pouct eviews in the two inusties (P1a-P6), which ae summaize in Table 5. We use P# to esignate the numbe of ou peiction in Table 5. We use the symbols, +,, an 0 to inicate ou peicte changes in avetising level (i.e., incease, ecease, o maintain the same level) afte the publication of the eview. Fo example, Peiction 1a implies that the avetising level of high-quality pintes in PC Magazine (the eviewe s publication) is no lowe afte than befoe the ecommenation eview appeae in PC Magazine. Peiction 6 implies that thee is no iffeence in the avetising level of unning shoes in Runne (othe meia) befoe an afte the esciption pouct eview appeae in Runne s Wol. These peictions iectly follow Table 4 (Peictions 1a an 1b assume Runne s Wol has a highe eview penetation ate, m an PC Magazine has a lowe eview penetation ate. Peictions base on ecommenation eview assume the use of eview-enose avetising by the high-quality fims given that most winning poucts in ou ata i so). Table 6 pesents the empiical esults (mean avetising levels befoe an afte the publication of pouct eviews).

16 Chen an Xie: Thi-Paty Pouct Review an Fim Maketing Stategy Maketing Science 24(2), pp , 2005 INFORMS 233 Table 5 Peictions of Avetising Response Recommenation fomat High-quality poucts Low-quality poucts Desciption fomat Pintes Magazine PC Magazine PC Wol PC Magazine PC Wol (Reviewe) (Othe Meia) (Reviewe) (Othe Meia) Peiction +/0 + (P#) (P1a) (P2a) (P3a) (P4a) Running shoes Magazine Runne s Wol Runne Runne s Wol Runne Runne s Wol Runne (Reviewe) (Othe Meia) (Reviewe) (Othe Meia) (Reviewe) (Othe Meia) Peiction + 0 (P#) (P1b) (P2b) (P3b) (P4b) (P5) (P6) Recommenation Review Fomat. As peicte by Peictions 3a an 4a, the avetising levels of low-quality pintes ae significantly lowe in both the eviewe s publication (PC Magazine, p<0 01) an in the noneviewe s publication (PC Wol, p< 0 1) afte than befoe the pinte eview appeae. The same conclusion hols fo unning shoes. Makes of low-quality unning shoes significantly euce avetising levels in both Runne s Wol p < 0 01 an Runne p < 0 01, suppoting Peictions 4a an 4b. Poposition 3 suggests that, in the pesence of a ecommenation eview, high-quality fims will espon iffeently than low-quality fims. Poposition 4 suggests that they may aopt iffeent avetising ajustments fo the eviewe s publication an othe meia. Consistent with Peictions 1b an 2b, high-quality unning shoes significantly ecease thei avetising levels in the eviewe s publication (Runne s Wol, p<0 05) but significantly incease thei avetising levels in the noneviewe s publication (Runne, p<0 01). Also, as shown in Table 5, the change of high-quality pintes avetising in the noneviewe s publication (PC Wol) is in the iection peicte (P2a), though not to a significant egee. It is possible that the insignificant esult is ue to the small sample size of the high-quality pintes. The change in high-quality pintes avetising in the eviewe s publication (PC Magazine) is also in the iection peicte (P1a) but is insignificant. One possible eason fo this insignificant esult is that the penetation ate of the eview is close to the theshol penetation level. If this is the case, then the insignificant esult is consistent with Popositions 3 an 4, which suggest that the high-quality fims will not change thei avetising levels in the eviewe s publication if the eview penetation ate is in the theshol level. Table 6 Empiical Results of Avetising Responses Recommenation fomat High-quality poucts Low-quality poucts Desciption fomat Pinte Magazine PC Magazine PC Wol PC Magazine PC Wol (Reviewe) (Othe Meia) (Reviewe) (Othe Meia) Befoe Afte T-statistic 1 04 ns 0 49 ns Conclusion P1a: Suppot P3a: Suppot P4a: Suppot Running shoes Magazine Runne s Wol Runne Runne s Wol Runne Runne s Wol Runne (Reviewe) (Othe Meia) (Reviewe) (Othe Meia) (Reviewe) (Othe Meia) Befoe Afte T-statistic ns Conclusion P1b: Suppot P2b: Suppot P3b: Suppot P4b: Suppot P5: Suppot P6: Suppot Note. Avetising level is measue by the numbe of avetising page. p<0 01, p<0 05, p<0 1. ns: not significant at 0.1 level.

17 Chen an Xie: Thi-Paty Pouct Review an Fim Maketing Stategy 234 Maketing Science 24(2), pp , 2005 INFORMS Desciption Review Fomat. As shown in Table 6, the avetising levels of fims that make unning shoes ae significantly lowe afte the publication of the esciption eview in the eviewe s publication (Runne s Wol, p<0 01), suppoting Peiction 5. Futhemoe, thee is no significant iffeence in avetising level befoe an afte the publication of a esciption pouct eview in the noneviewe s publication (Runne), suppoting Peiction 6. 6 In summay, ou empiical stuy base on ata fom two pouct categoies povies some peliminay empiical suppot fo ou theoetical moel. Howeve, it is impotant fo futue eseach to povie moe empiical evience fom a lage numbe of pouct categoies. 8. Conclusion In this pape, we investigate a new eseach aea: fims maketing stategies in esponse to thi-paty pouct eviews. Specifically, we stuy how fims shoul aapt thei picing an avetising stategies to thi-paty pouct eviews une iffeent conitions. We evelop a nomative moel to analyze fims stategic esponses to pouct eviews an illustate ou finings with ata fom compute pintes an unning shoes inusties. This pape contibutes to the maketing liteatue by eveloping a nomative theoy that incopoates thi-paty pouct eviews into fims maketing stategies. This theoy explains the stategic impact of thi-paty pouct eviews on fims picing an avetising stategies, ientifies key factos affecting fims ecisions, examines the inteaction between picing an avetising esponse, an eives the fims optimal stategies in the pesence of pouct eviews une vaious pouct/maket/eview/ meia conitions. Ou finings povie the following implications fo fims maketing stategies in the pesence of thipaty pouct eviews. Although pice is geneally consiee to be moe flexible than avetising, vaying pice in esponse to pouct eview can be unpofitable if thee ae enough consumes who value hoizontal pouct attibutes. In such makets, the optimal esponse to pouct eview is to ajust avetising athe than change pice. Fims stategic esponses nee to be eviewfomat specific. Fo example, with eview-enose as, a ecommenation pouct eview geneates a 6 Because the esciption eview i not povie quality categoization, we also aske a 10-yea amateu maathon unne an long-time subscibe to Runne s Wol as the juge to pick 20 out 52 moels as high-quality moels. The analysis base on this categoization is also consistent with ou peiction. complementay effect, which inceases winnes but eceases loses avetising effectiveness. Such a complementay effect oes not apply to esciption pouct eviews because esciption pouct eviews o not explicitly istinguish winnes fom loses. As a esult, the best avetising esponse to a pouct eview epens not only on the outcome (i.e., winning vs. losing) but also on the fomat (i.e., ecommenation vs. esciption). Fims nee to be awae of the potential inteaction between thei picing an avetising esponses. Fo example, it is not always optimal fo a winning pouct of a ecommenation eview to use eviewenose avetising to spea the goo news about its pouct. This is because eview-enose avetising not only inceases the winning poucts avetising effectiveness, but it also motivates pice-cutting by the losing poucts. As a esult, using eviewenose avetising coul hut winnes ue to intensifie pice competition. To esign avetising esponse to thi-paty pouct eview, fims nee sepaate stategies fo avetising in the eviewe s publication vesus othe meia. This is because a pouct eview geneates a substitutive effect on avetising in the eviewe s publication but not (o to a lesse egee) on avetising in noneviewes publication. In esponing to a ecommenation pouct eview, fims with winning poucts nee to pay attention to the penetation ate of the eview infomation. Inceasing avetising to spea the goo news is pofitable fo winning poucts only if the eview infomation has a low penetation ate. When the eview penetation ate is high, winnes ae bette off taking the same stategy as loses: eucing avetising. In geneal, in the pesence of a esciption eview, both fims shoul euce avetising spening in the eviewe s publication but not vay avetising spening in othe meia. In the pesence of a ecommenation eview, the low-quality fim shoul euce avetising spening acoss all meia. Howeve, the high-quality fim shoul incease avetising spening in othe meia, but shoul always euce spening in the eviewe s publication unless the eview penetation ate is sufficiently low. While this eseach impoves ou unestaning of thi-paty pouct eview s impact on picing an avetising stategy, many othe inteesting questions emain unanswee an equie futhe investigation. One limitation of this pape is that we examine only two maketing stategies: picing an avetising. Pouct eview may also inteact with othe maketing stategies such as new pouct evelopment, pouct line ecisions, an the timing of new pouct launches.

18 Chen an Xie: Thi-Paty Pouct Review an Fim Maketing Stategy Maketing Science 24(2), pp , 2005 INFORMS 235 Secon, this pape oes not consie the possible inteaction between manufactuing fims stategic esponses an the eviewe s policy. Fo example, given manufactuing fims esponses to iffeent types of pouct eviews (e.g., esciption o ecommenation eview), the thi-paty eviewe can stategically aopt iffeent eview fomats to maximize its evenue income une iffeent maket an pouct conitions. Ou static moel limits ou capability to aess these issues consieing the ynamic natue of such stategic inteactions. Futue eseach nees to evelop ynamic moels to examine these issues. Thi, one limitation of ou empiical stuy is that it is base on only two pouct categoies. Moe empiical eviences fom moe pouct categoies ae esiable to fully test ou theoy. Data fom moe pouct categoies will not only test the geneality of ou theoetical finings but will also allow the examination of the impact of pouct chaacteistics on fims avetising esponse to thi-paty pouct eviews. Futhemoe, it is impotant to evelop appopiate measuements fo the egee to which consumes ae taste iven vs. quality iven fo a given pouct. Finally, it is esiable fo futue empiical stuies to collect ata on aitional contol vaiables such as the numbe of new poucts launche, the thi-paty eviewe s maket shae, an manufactuing fims financial pefomance. Thee ae many othe inteesting questions that might be aesse in futue eseach. Fo instance, what can a fim o to incease the chance of obtaining a favoable thi-paty eview? How o consumes pocess infomation fom multiple simultaneous pouct eviews? Finally, what ae the stategic impacts of othe types of inepenent pouct infomation, such as eviews poste by consumes? Acknowlegments The authos thank Joseph Alba, Yuxin Chen, Joel Demski, Eitan Gestne, Yong Liu, Richa Lutz, Davi Sappington, Steven Shugan, Baton Weitz, an paticipants in the Waington College of Business Wokshop at the Univesity of Floia, the Univesity of Houston Doctoal Symposium, an the Maketing Science Confeence in Albeta (2002) an in the seminas at Conell Univesity, Iniana Univesity, Singapoe Management Univesity, Univesity of Aizona, an Univesity of Cental Floia fo thei helpful comments on ealie afts of this pape. They ae gateful to the eito, aea eito, an fou eviewes fo constuctive suggestions. Appenix Summay of Notations j Selle, j = H L t t= 0 (0: without eview; : ecommenation fomat; : esciption fomat). j t Avetising each level of selle j in the eviewe s publication in t j t Avetising each level of selle j in othe meia in t P j t Pice of the selle j in t j t Pofit of the selle j in t D j t Deman of the selle j in t c L Maginal cost of selle L (c L is nomalize to 0) c H Maginal cost of selle H (c H is nomalize to c) g Avetising cost fo an avetising each level Avetising cost coefficient Penetation ate of the thi-paty pouct eview The pecentage of the eviewe s publication subscibes The pecentage of pice-insensitive consumes v Consumes evaluation on thei pefee pouct v Pice-sensitive consumes evaluation on thei nonpefee pouct The pecentage of the taste-iven segment The pecentage of taste-iven consumes with matche taste with L A t The size of consumes who eceive pouct infomation only fom H s avetising in t B t The size of consumes who eceive pouct infomation only fom both fims avetising in t E t The size of consumes who eceive pouct infomation only fom L s avetising in t R t The size of consumes who ea eview infomation in t q H The faction of consumes who coectly ientify H to be high quality among those eceiving as only fom H in the absence of eview q L The faction of consumes who incoectly ientify L to be high quality among those eceiving as only fom L in the absence of eview q The faction of consumes who coectly ientify H to be high quality among those eceiving as fom both fims in the absence of eview H The faction of consumes who consie H to be pefee among those eceiving as only fom H in the absence of eview L The faction of consumes who consie L to be pefee among those eceiving as only fom L in the absence of eview The faction of consumes who consie H to be pefee among those eceiving as fom both fims in the absence of eview The faction of consumes who consie H to be pefee among those ea eview Equilibium Analysis in the Absence of Pouct Review In following, we eive conitions une which equal-pice, P0 H = P 0 L = v, is an equilibium. In the absence of pouct eviews, fim H s potential eman comes fom two segments: (1) the loyal consumes, l0 H, who only buy H, an (2) the switches, sh 0, who will buy H if H povies a highe positive suplus than L. H s loyals, l0 H, inclue pice-insensitive consumes who eceive avetising fom both fims an consie H as the pefee pouct (case 7 in Table 2), an all consumes who eceive avetising only fom H an consie H as the pefee pouct (case 4 in Table 2). Note that v c, an

19 Chen an Xie: Thi-Paty Pouct Review an Fim Maketing Stategy 236 Maketing Science 24(2), pp , 2005 INFORMS it is not pofitable fo H to cut its pice to attact picesensitive consumes who o not pefe H (case 6 an case 10 in Table 2). Hence, the switches, s0 H, ae the pice-sensitive consumes who eceive avetising fom both fims an consie H as the pefee pouct (case 8 in Table 2). Fom Table 2, l0 H an sh 0 ae given in the following equations: l H 0 = B 0 + H A 0 (A.1) s H 0 = 1 B 0 (A.2) Thee ae thee segments of consumes who might buy L: (1) all infome consumes who consie L as a pefee pouct, l0 L (cases 1, 9, an 10 in Table 2), (2) pice-sensitive consumes who eceive avetising only fom L but consie L as a nonpefee pouct, l0 L (case 3 in Table 2), an (3) the switches, s0 H (case 8 in Table 2). Simila to s0 H, l0 L will buy fom L only when L s pice is below v. Howeve, s0 H might still choose H if they eceive a highe fom H than fom L, while l0 L will always choose L as long as L s pice is below v. Fom Table 2, l0 L an ll 0 ae given in the following equations: l L 0 = 1 B 0 + L E 0 (A.3) l L 0 = 1 1 L E 0 (A.4) When both fims chage a pice of v, thei pofits ae H 0 P H 0 = P L 0 = v = lh 0 + sh 0 v c g H 0 = B 0 + H A 0 v c g H 0 (A.5) L 0 P H 0 = P L 0 = v = ll 0 v g L 0 = 1 B 0 + L E 0 v g L 0 (A.6) If L ecies to cut its pice below v to attact the switches fom H, the maximum of pofit to gain is Max L 0 P L 0 v = l L 0 + sh 0 + ll 0 v g L 0 = 1 B 0 + L + 1 L 1 E 0 v g L 0 (A.7) Note that q can be a function of both fims avetising effectiveness, i.e., q = f q H q L, whee q/ q H > 0, q/ q L < 0, q<q H, an 1 q<q L. Fom (A.6) an (A.7), when q H q H o q L q L, 0 L P 0 H = P0 L = v Max L 0 P 0 H v, an P0 H = P0 L = v is the unique pice equilibium, whee q H an q L satisfy the following elationship: f q H q L B 0 v v E 0 1 v E 0 q L 1 B 0 v v B 0 [ E ] 0 1 = 0 (A.8) 1 B 0 Both selles maximize thei pofits with espect to avetising. Accoing to (A.5) an (A.6), the fist-oe conitions ae H 0 / H 0 = 0 1 L 0 H + L 0 v c / 1 H 0 = 0 (A.9) L 0 / L 0 = 0 1 H 0 L + H 0 1 v / 1 L 0 = 0 (A.10) It is staightfowa that both secon-oe conitions ae negative. Solutions of Equations (A.9) an (A.10), H 0 an L 0, ae the equilibium avetising each levels when q H q H o q L q L. Theefoe, when q H q H o q L q L, i.e., when the highquality fim s avetising cannot sufficiently convey quality infomation to consumes, o when the low-quality fim s avetising is sufficiently misleaing, ( H 0, L 0 ; P 0 H = P0 L = v ) is the SPNE fo the moel. Poof of Poposition 1 Simila to the case in the absence of eviews, fim H s potential eman comes fom two segments: (1) the loyals, l H, who will buy only H, an (2) the switches, s H, who will buy H only if H s pice is low enough. Fom Equations (4) an (5) in the pape, l H an sh ae given in the following equations: l H = + B + H A (A.11) s H = 1 + B (A.12) Similaly, fim L s potential eman comes fom thee segments: (1) all infome consumes who pefe L, l L, (2) pice-sensitive consumes who eceive avetising only fom L but o not pefe L l L, an (3) the switches, sh. l L an ll ae given in the following equations: l L = B + L E (A.13) l L = 1 1 L E (A.14) Fims pofits, when chaging a pice of v, ae H P H L P H =PL = v = lh +sh v c g H = + B + H A v c g H (A.15) =PL = v = ll v g L = B + L E v g L (A.16) IffimL ecies to cut its pice below v to attact the switches fom fim H, the maximum of pofit to gain is Max L P L v = ll + sh + ll v g L = ( B + L + 1 L 1 E ) v g L (A.17) Theefoe, Max L P L v L P H = P L = v when, whee v v v v = 1 + B v v +E v 1 + v + B 1 1 v v B q E q L / (A.18) The fim L has no incentive to unecut to attact switche fom fim H. The picing equilibium is P H = P L = v. Hence, both fims o not ajust picing when.

20 Chen an Xie: Thi-Paty Pouct Review an Fim Maketing Stategy Maketing Science 24(2), pp , 2005 INFORMS 237 Accoing to (A.15) an (A.16), the fist-oe conitions ae H / H = L H + L v c / 1 H = 0 (A.19) L / L = H L + H 1 v / 1 L = 0 (A.20) Fom (A.9), (A.10), (A.19), an (A.20), we fin that H 0 ae the solutions of the function a H 2 + b H + an H e = 0, whee a = v c v 1 H L 1, b = H v c v c v 1 H L + + L 1 v, an e = v c v 1 H + v c H v. Let = b 2 4ae. Then H = b /2a. H 0 = H =1 an H = H =1. Notice H / = v c 1 H 1 L 1 H 1 H / >0. Because 1 <1, H < H 0. Also note that avetising cost <g H 0. < L 0 an g L <g L 0. function g j t is inceasing in j t. Hence g H Similaly, we can show L Poposition 1 hols. Poof of Popositions 2 an 3 In the pesence of the ecommenation eview, in the subgame whee H oes not use eview-enose avetising, the picing an avetising equilibia ae the same as those in the esciption eview case. In the pesence of the ecommenation eview, in the subgame whee H aopts eview-enose avetising, similaly to pevious cases, fim H s potential eman comes fom two segments: (1) the loyals, l H, an (2) the switches, s H. Fom Equations (6) an (7) in the pape, lh an s H ae given in the following equations: l H = + B + A (A.21) s H = 1 + B (A.22) Fim L s possible eman comes fom thee segments: (1) infome consumes who pefe L, l L, (2) pice-sensitive consumes who eceive avetising only fom L but o not pefe L, l L, an (3) switches sh. ll an l L ae given in the following equations: l L = 1 + B + L E (A.23) l L = 1 1 L E (A.24) Fims pofits, when chaging a pice of v, ae H P H = P L = v = lh + s H v c g H = + B + A v c g H (A.25) L P H = P L = v = vl L g L = 1 + B + L E v g L (A.26) Fim L s maximum pofit when cutting its pice is Max L P L v = v ll + ll + s H g L (A.27) Fom (A.26) an (A.27), when, L P H = P L = v Max L P L = v, whee = 1 v v v v + E v 1 + v +B v v 1 E q L / + B (A.28) Theefoe, both fims maintain the same pice of v when, povie that fim H aopts eview-enose avetising. Accoing to (A.25) an (A.26), the fist-oe conitions ae H / H = 0 1 v c / 1 H = 0 (A.29) L / L = H L + H 1 v / 1 L = 0 (A.30) Both secon-oe conitions ae negative. Fims optimal avetising each levels afte the publication of the ecommenation fomat eview ae given in the following equations: H = 1 / 1 v c (A.31) / ( ) L = L 1 + v (A.32) v c Fom (A.9) an (A.29), we have H H 0 an g H g H 0 if, an H < H 0 ; an g H <g H 0 othewise, whee = 1 1 L 0 H + L 0 /. Fom (A.32), we know L / < 0. The maximum of L, L = L =0. Notice H =0 > H 0 because = 0. Fom (A.10) an (A.30), given L/ L H = H =0 L = L = 0, we know 0 L/ L 0 L 0 = L = 0 L/ L 0 L 0 = L L/ L H = H =0 L = L = v H =0 L 1 H 0 L 1 > 0. Notice 0 L/ L 0 L 0 = L 0 = 0. Hence, 0 L/ L 0 L 0 = L 0 = 0 < 0 L/ L 0 L 0 = L. Because 2 0 L/ L 0 2 < 0, we have L 0 > L L. Theefoe, g L <g L 0 ; hence Poposition 3(iii) hols. Given equilibium levels j, fom (A.18) an (A.28) we fin = j = j j = j. Hence L = j = j = L P H = P L = v = j = j Max L P L v = j = j > 0. Notice B / L > 0, B / H > 0, E / L > 0, an E / H < 0. Theefoe, L / L > 0, an L / H = 1 L 1 L 1 v v <0. Fom (A.19) an (A.29) we fin the maginal avetising cost g H >g H noticing > 1 L H + L. Because g >0, we have H > H. Similaly, fom (A.20) an (A.30), we have L < L. Theefoe, L = j = j > L = j = j > 0. Hence Max L P L v = j = j < L P H = P L = v = j = j. Theefoe, the theshol level fo L s pice cut is highe if H aopts the eview-enose as than if H oes not aopt (i.e., in the equilibium). Hence Poposition 2(i) hols. Note. Theefoe, when, P H = P L = v is the SPNE picing equilibium of the thee-stage game; hence Poposition 3(i) hols. Fom (A.15) an (A.25) it is staightfowa that H P H = P L = v H = H H P H = P L = v H = H. Note H = H P H = P L = v H = H H P H = P L = v H = H. We have H = H P H = P L = v H = H H P H = P L = v H = H = H. Theefoe, when, H always aopts eview-enose avetising. Poposition 3(ii) hols. In the following, we pove Poposition 2(ii) by showing a sufficient conition fo the case when fim H is less pofitable to aopt the eview-enose avetising, i.e., H H.