Money -back guarantees: The case of experience goods

This dissertation investigates the use of money-back guarantees in a market for so-called “experience goods” in the presence of repeat purchases. Chapter One analyzes competition between two firms in a game-theoretic model. The choices of quality, price, and warranty made by the firms are treated as endogenous. We look for equilibria in pure strategies and find that in all the cases when an equilibrium in the quality-warranty-price space exists, firms produce goods of different qualities and charge different prices for those goods, while the warranties chosen by the two firms are the same. We discuss the effects of market structure, the dynamics of the market demand, and specific characteristics of the goods on the choices made by the firms. Chapters Two and Three address the issue of using money-back guarantees as a form of market experimentation in a monopoly model. In Chapter Two, we show that extending the customer base in the second period by using a money-back guarantee can be an optimal strategy only in the presence of uncertainty the firm has regarding the distribution of buyers. We also show that, due to heterogeneity of buyers over valuation space, a money-back guarantee is a better tool for market experimentation than is a price reduction. Chapter Three considers several extensions of the model. We analyze the effects of production costs, the presence of coupons, storability of the good and an increase in the number of periods on the results of the basic model and show that none of the main results is affected.