Data and Reputation Building on Online Platforms

[Sponsored Article]

Reputation systems operated by online platforms play an important role in mitigating the problems caused by asymmetric information in internet marketplaces. Successful reputation systems can crowdsource information from consumers and provide a large volume of reviews about product quality, attributes, seller credibility, and so on. Such review data may take the form of ratings, stars, textual comments, badges, or recommended lists. 

One important reason for the great success of leading e-commerce platforms, such as Amazon, eBay, and Taobao, is their ability to alleviate asymmetric information by their reputation systems. Reviews recorded by online platforms are valuable public goods that greatly improve market efficiency and consumer welfare. For example, scholars have found that online review platforms improve the welfare of restaurant consumers by US$2.50 per person per meal.¹

The Effectiveness of Reputation Systems
The effectiveness of reputation systems depends on two key conditions. First, on the consumer side, reviews are mostly user-generated content and likely to be underprovided due to the nature of public goods. Reviews may suffer from various credibility problems such as loopholes, fraud, manipulation, and bias. Even if reviews are truthful, the information in them usually includes a lot of noise  with regards to assessments of quality. 

For some markets, reviews written by consumers are based on subjective experiences and may not be applicable to consumers with heterogeneous tastes. For example, many Chinese people do not trust the ratings of Chinese restaurants on Yelp because most reviews are provided by non-Chinese people. In some markets, the nature of credence goods can hinder consumers from leaving informative reviews and learning from others' experiences. Hence, the design of the reputation system and quality transparency greatly affect how much consumers can learn from reviews.

Second, on the firm side, a successful reputation system must provide firms with a sufficiently strong dynamic incentive to build a reputation by accumulating reviews. Firms must be eager to improve their quality and maintain good services because they expect to gain benefits from obtaining good reviews. For example, eBay sellers have a strong incentive to compete for the “eBay Top Rated Seller” badge because consumers are willing to pay an average of 8.1% more to these reputable sellers.² However, intense competition can slow down review accumulation and reduce the reputation premium, which weakens the firm’s dynamic incentive of building a reputation.