  Word-of-Mouth (WoM) communication, via online reviews, plays an important
role in customers' purchasing decisions. As such, retailers must consider the
impact of WoM to manage customer perceptions and future demand. In this paper,
we consider an online shopping system with premium and regular customers.
Building on the behavioral and operations management literature, we model
customer preferences based on the perceived service quality indicated by WoM
and integrate this into the retailer's operational problem to determine a
shipment policy. First, we study the e-tailer's problem when she has no
knowledge of WoM, and only reacts to the changes in demand. We analyze the
long-term behavior of customer demand and show that potential market size and
customer sensitivity are the key parameters determining this behavior. Then, we
build a model to integrate knowledge of WoM into operational decision making
and partially characterize the optimal solution. We show that (i) beating the
competition in the market may not always benefit the company under strict
operational constraints as it can result in undesired customer switching
behavior, (ii) relaxations in operational constraints may hurt profitability
due to the associated difficulties of managing perceptions, and (iii) seeking a
stationary policy can lead to suboptimal solutions, therefore cyclic policies
should also be considered when appropriate.
