Quality assurance Quality assurance The three problems of
Quality assurance
Quality assurance
The three problems of quality ▪ Defining it right ♦ Multidimensional ♦ Optimum ≠ Maximum ▪ • “Total quality”, “Zero defects” Controlling it ♦ Quality control & Standardization • • ▪ Old in manufacturing: interchangeable components (19 th century) New in services: e. g. , mail, courier “Just in Time” production ♦ Contractual or “motivational” problem Assuring it ♦ Adverse selection & moral hazard ♦ Managing reputation and brands • • • Crisis management: “Tylenol” vs. “Perrier” Role of advertising Role of specialists: certifiers, auditors, etc.
Types of goods considering when users know quality ▪ Search: before purchasing ♦ Apartment ▪ Experience: after purchasing ♦ Car ▪ Credence: never ♦ Surgery ▪ Problem: This classification is ambiguous
Think it in terms of product attributes Attributes Goods Search Experience Credence Apartment Place Noise Asbestos Car Space, color Breakdowns Accident risk Surgery Accessibility Waiting time Real need of surgery
Ambiguities remain ▪ Is a sexy ad informative (associated to “search” attributes)? ♦ Or is it persuasive (linked to “experience”)? ▪ Are credence attributes really never observed? ♦ With zero probability?
Exercise: Identify search, experience and credence attributes in: ▪ Decaffeinated coffee ▪ Pet with pedigree ▪ Husband ▪ Wife ▪ Roommate ▪ Newspaper ▪ Graduate school ▪ Political party in an election
Four situations in Economics Fixed Quality adverse selection Variable Quality moral hazard One-shot transaction “Lemons’” problem: Used cars Home renovation, conveyancing? Repeated transactions ? New cars
The 4 th situation is the most (perhaps the only? ) relevant ▪ Firms provide repetition ♦ Carmax (large seller of used quality-guaranteed cars)—visit http: //www. carmax. com/ ♦ “Crear Hogar” (“Build Home”—Corte Ingles’ home renovation division) ▪ Quality is not fully “given”—e. g. , Carmax: ♦ inspects and recondition cars ♦ sells many cars, of different quality ♦ guarantees (therefore, increases quality to a given standard when the car turns out to be a lemon)
How Reputation Works ▪ Reputational investment = start by selling good ▪ quality (q) at price of observable quality (q 0) Motivates producer to sell good quality (q) in future periods b/c she earns a quasi-rent: ♦ Price ♦ p(q) = = Cost + c(q) + Quality Premium r {c(q) - c(q 0)} ▪ Quality premium is the normal return (r) on the ▪ reputational investment Other reputational investments: e. g. , advertising, “renting” reputation
Supply as a function of quality
“Renting” reputation ▪ Specialists in “lending” reputation ♦ Examples in capital markets: • ▪ Starting up venture capitalists and, for IPOs, investment banks Continuous basis auditors and financial analysts Bankruptcy restructuring specialists • • Non specialists: mainly large retailers ♦ Retailers’ as signal producers ♦ Retailers’ brands
The logic of guarantees ▪ Solution to sellers’ information advantage ♦ Provide assurance adverse selection ♦ Motivate quality moral hazard ▪ As most solutions, causes new problems ♦ Adverse selection: e. g. , intensive users ♦ Moral hazard: misuse
Efficiently limiting guarantees’ coverage ▪ Avoids moral hazard ♦ Requiring due care ♦ No covering indirect damage (cost of accident) ▪ Avoids adverse selection ♦ Use limit (e. g. , 100 k km) ♦ Requiring non-professional use
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