Can Product Recalls Be Profitable? Insights from Behavior Economics Models and Empirical Studies

Product recalls are often associated with quality failures and considered negative with regard to customer satisfaction and firm performance. Motivated by anecdotal evidence and equipped with new development in decision economics, we develop an endogenous consumer reference model to examine the consumer’s willingness to buy in the events of recalls, and construct an empirical study to associate value of recalls with firm profitability. We find that as the consumer forms a different reference point under recalls, she may react positively to the recalls with higher willingness to buy. The positive effect of recalls is substantiated by estimation results from an econometric model of firm profitability in association with recall value, with data collected from public sources in the U.S. A main reason for this counter-intuitive result is that recalls change the quality distribution under which the consumer expects to buy the product, which in turn changes her view of product quality as her reference in making the buying decision. In addition, we find that supply chain offshoring as reflected in consumer loss aversion, may mitigate the effect of recalls on consumer willingness to buy and firm profitability, as demonstrated in both of our analytical model and empirical test.