Jeopardizing brand profitability by misattributing process heterogeneity to preference heterogeneity

Abstract

Brands develop strategies based on forecasts that allow for individual differences, usually attributed empirically to heterogeneity in consumers' preferences. Behavioral theories propose choice process heterogeneity as the conditioning stage for choice outcomes, and suggest that not accounting for it causes biases in parameters and policy measures. We conduct a Monte Carlo simulation to study how underlying choice process heterogeneity generates substantively significant biases in different market contexts if analysts (erroneously) channel heterogeneity solely into tastes. We extend the literature by using a game theoretical analysis, driven by the results from the demand simulation, to explore demand mis-specification effects on brands' profitability and market equilibrium. Through mixed strategies we examine necessary conditions for market equilibrium when managers have access to different demand representations but are uncertain about which is true. We demonstrate that biases generated by representing consumer response heterogeneity solely through preference heterogeneity are enough to significantly jeopardize brands' profits due to misalignment of firms' products and resources with demand. Our work forcefully demonstrates to both marketers and econometricians/data scientists the necessity of modeling choice process heterogeneity given its impacts on brands’ performance.