Quality Investing and Pricing Strategies by Startups: Impacts of Demand Uncertainties and Capital Constraint

Abstract

Investing in product quality for future growths or conserving cash flow to avoid bankruptcy is an important trade-off faced by many capital-constrained startups. Focusing on the trade-off, this paper proposes a two-stage model where a startup firm must earn profit above the survival threshold by the end of every stage. Considering impacts of the uncertainty of demand responsiveness to quality (DRQ), market shocks, and survival threshold, a hedge with price setting and quality investing is established against the bankruptcy risk. Besides, this paper stresses the necessity of identifying the operational decisions of startups under both profit-seeking and survival-seeking objectives. Results illustrate that, under stochastic environment, the profit-seeking startup makes conservative (aggressive) investment on quality by setting lower (higher) price and investing in lower (higher) quality than the deterministic case, while the survival-seeking startup always sets its price linked to quality in positive direction. In addition, the profit-seeking startup always improves its investment on quality when either the mean or the variance of DRQ increase, while the survival-seeking startup reduces its investment when either the mean of DRQ increases to a certain level or the variance of DRQ increases. Other factors are also examined. Finally, this paper provides the startup managers some guidance on the quality investing strategy under capital constraints.