A DYNAMIC SERVICE QUALITY COST MODEL WITH WORD-OF-MOUTH ADVERTISING

A dynamic cost model is developed which describes the evolution of demand for a service from its beginning transient phase to its long-term equilibrium. The model includes parameters which relate to word-of-mouth advertising; this advertising causes transitions between unaware, positively aware, and negatively aware states of consumers and thus affects service demand. Model simulations reveal some generally useful guidelines for service providers: 1) it is unwise to expand service operations excessively during the early phases of the service offering in order to handle strong demand. The model shows that the demand typically peaks at this early stage before settling down to an equilibrium rate, 2) because of customer sensitivity to service quality, cost reductions that deteriorate service quality are likely to be a poor policy, and 3) it is a good strategy to adopt a high service quality from the beginning, rather than to improve it later; this is because the impact of good service on the customer base is more rapid in the startup phase than in the long-term equilibrium phase.