This dissertation consists of three essays on the implications of consumer heterogeneity and uncertainty for firms' strategies. The first essay analyzes how firms should develop add-on policies when consumers have heterogeneous tastes and firms are vertically differentiated. The theory provides an explanation for the seemingly counter-intuitive phenomenon that higher-end hotels are more likely than lower-end hotels to charge for Internet service, and predicts that selling an add-on as optional intensifies competition, in sharp contrast to standard conclusions found in the literature. The second essay examines how firms should develop product and pricing policies when customer reviews provide informative feedback about improving product or service quality. The analysis provides an alternative view of customer reviews such that they not only can help consumers learn about product quality, but also can help firms learn about problems with their products or services. The third essay studies the implications of cognitive simplicity for consumer learning problems. We explore one viable decision heuristic - index strategies, and demonstrate that they are intuitive, tractable, and plausible. Index strategies are much simpler for consumers to use but provide close-to-optimal utility. They also avoid exponential growth in computational complexity, enabling researchers to study learning models in more-complex situations.

In this dissertation, we show how the firm can improve its revenue and competitiveness through segmenting the market by exploring consumer heterogeneity. In the first essay, we show that asymmetric assortment breadth among two competing retailers can emerge as an equilibrium when consumers differ in their prior knowledge about their product preferences and their shopping costs. Under this equilibrium, the full line retailer expands the market demand by attracting the uninformed consumers with large shopping costs and the single product retailer passes on the savings from a streamlined assortment to the informed consumers by setting a lower price. Therefore, the two retailers soften the competition between them and both achieve higher profits. In the second essay, we consider a setting in which consumers experience distinct instances of need for a durable product at random intervals and derive random amount of utility from each instance. Consumers are differentiated according to the frequency with which they experience instances of need. For a firm that provides a durable product to such a market, we consider the implications of selling versus renting on a per-usage basis. Selling minimizes transaction costs, but may result in inefficient utilization of units that are produced. Alternatively, per-usage rentals allow more utility to be generated per unit of product that is produced. Focusing on these trade-offs, we identify conditions under which the firm should sell, offer per-usage rentals, or offer a combination of the two. In the third essay, we continue to use the durable good framework to study how various forms of government subsidy programs shift consumer's demand patterns and thus generate different magnitude of additional savings in resource consumption. We give the conditions under which each type of cash rebate programs does the best in generating resource savings per dollar spent.

When purchase and consumption decisions are separated in time and when future utility is state dependent, consumers may desire to pursue consumption flexibility by purchasing different products together (multiple buying). This paper analyzes the effects of consumption flexibility on competing firms' marketing mix decisions, in a model in which future preference uncertainty exists and consumers differ in their preferred product location on a horizontal attribute. The analysis shows that the nature of price competition in such markets is dependent upon whether consumer multiple buying (and thus primary demand) is endogenously induced. When preference uncertainty is important, the firms are involved in a flexibility trap in which primary demand is expanded but profits decrease with the spread of consumer heterogeneity. This counter-intuitive result is caused by the firms being induced to over-cut prices to increase primary demand when consumption flexibility is important. In response to this, the firms may configure their products to alleviate the adverse effect of consumer heterogeneity. For example, if preference uncertainty is important, the firms may choose to minimize differentiation on the horizontal attribute, or extend the current product line, to deal with the flexibility trap. The implications of allowing for positive salvage value, uncertainty heterogeneity, preference correlation, and state-dependent preference configuration are also investigated.

I formulate an econometric model of consumer learning and experimentation about new products in markets for packaged goods that nests alternative sources of dynamics. The model is estimated on household level scanner data of laundry detergent purchases, and the results suggest that consumers have very similar expectations of their match value with new products before consumption experience with the good, but once consumers have learned their true match values they are very heterogeneous. I demonstrate that resolving consumer uncertainty about the new products increases market shares by 24 to 58%. The estimation results also suggest significant switching costs: removing switching costs increases new product market shares by 12 to 23%. Using counterfactual computations derived from the estimates of the structural demand model, I demonstrate that the presence of switching costs with learning changes the implications of the standard empirical learning model: the intermediate run impact of an introductory price cut on a new product's market share is significantly greater when the only source of dynamics is switching costs as opposed to when both learning and switching costs are present, which suggests that firms should combine price cuts with introductory advertising or free samples to increase their impact.