Consumer search costs and the provision of service quality

In many markets for services, such as financial advice, interior decoration or garden design, service providers incur costly efforts to make attractive offers to their clients, while consumers diligently search until they find a service plan that meets their needs. This paper studies the provision of service quality in such markets. With higher search costs, the gains to the service providers from exerting themselves increase and in equilibrium the market offers more high-quality services. Despite this beneficial aspect of higher search costs, consumer surplus is lower due to higher frictions and the implied higher prices. From the collective viewpoint of the firms, there is too much effort put in the market to increase service quality; from the standpoint of consumers, firms invest too little in service quality. On welfare grounds, the market over-provides service quality when the cost of service effort is low, while it under-provides service quality when the effort cost is high.