Demand Fluctuations, Capacity Constraints and Repeated Interaction: An Empirical Analysis of Service Quality Adjustments

We utilize a unique database from a large legal services provider to examine how service quality responds to the firm's available capacity and workload, and to the nature of the firm-client relationship. We develop empirical measures of both the (internal) level of resources available to the firm at different points in time, and of the (external) value creation for customers. Our results indicate that a service provider can use quality adjustment as a substitute for price adjustment in order to tackle demand fluctuations in the presence of capacity constraints, and to foster long-term relationships with customers. Specifically, we show that service quality increases with the amount of the firm's available resources, decreases with the firm's workload, and increases with the number of previous successful interactions with the client. By documenting these relationships, we wish to shed light on the limitations of current estimates of consumer surplus in service industries, as well as on potential inefficiencies in such industries.