Prices and Congestion as Signals of Quality

Successful firms’ demand often exceeds capacity, generating congestion. Given innovative, high-quality products’ ramp-up costs from technological constraints or limited labor supply, a question arises: Why do successful firms not raise prices to increase revenues given excess demand? For new products and experience goods, communicating quality to consumers is challenging, and congestion may serve as a quality indicator. We develop an Erlang-loss model: A firm signals privately observed quality via price to consumers uninformed about its quality. In addition, consumers observe congestion (occupancy level) upon arrival. Separating and pooling equilibria exist in prices: When prices are separating, congestion provides no additional information. When prices are pooling, congestion is informative. We demonstrate an empty-restaurant syndrome with pooling prices: Low congestion makes arriving consumers suspicious about quality; hence, they join less often. The pooling-price range is lower than the separating price, and both highand low-quality firms profit more in the price-pooling equilibrium. This offers high-quality firms a rationale to refrain from signaling quality through price, depending on consumers to learn quality through congestion. When high-quality firms also have cost advantages for ramping up, pooling prices remain an equilibrium, but the empty-restaurant syndrome disappears.