Highlights
- Customer reviews, despite potential biases, can enhance market signalling of prices and consumer welfare by encouraging strategic price adjustments and lower introductory prices.
- Selection bias in reviews may benefit consumers by leading to lower prices and higher surplus, challenging the view that review bias is harmful.
- Effective management of review and pricing information, including platform restrictions, can improve overall market welfare by fostering credible signalling and strategic interactions between sellers and consumers.
In this paper, the researchers proposed an analytical model for investigating the influence of customer reviews and price with the presence of selection bias in marketing an experience good with uncertain quality to consumers. An experience good is a service or product whose quality and value are determined after purchase and use or consumption. Through the model, the researchers examined how the quality of experience goods is communicated through customer reviews and pricing strategies, particularly in the presence of selection bias in reviews.
Customer reviews are recognised as a vital information source for consumers, but often suffer from systematic selection bias, as not all customers voluntarily leave feedback. This bias arises because consumers with notably positive or negative experiences are more likely to post reviews, resulting in a skewed depiction of product performance that does not necessarily reflect the true distribution among all customers.
Given this challenge, sellers employ additional signalling mechanisms, such as adjusting prices, to convey quality. The paper explores how sellers could optimally use both customer reviews and prices as signals, and assesses how review bias impacts on their ability to do so. It also considers the welfare implications for consumers when reviews are biased and how price signalling interacts with review systems.
The analysis is based on an analytical model of a seller offering an experience good over two periods, with consumers in each period making purchase decisions based on available information, including prices and reviews. Consumers in the first period observe the seller’s set price and decide whether to leave reviews, which creates selection bias. Only consumers experiencing significant surplus gains or losses tend to make reviews. The second period’s consumers observe previous reviews, the earlier period’s price if available, and the current price, and they use this information to infer product quality.
An important factor influencing these dynamics is consumers’ aversion to quality uncertainty. Having a review system can help improve total welfare by dampening the influence of information uncertainty. The researchers observed that review systems that operate as in their model deliver incremental welfare for both consumers and sellers. Since biased customer reviews can motivate a seller’s price signalling, consumers benefit from a slightly higher surplus as a result of the seller’s lowered first-period price.
Key findings reveal that customer reviews, despite their potential for information loss due to bias, could indirectly facilitate quality signalling through price adjustments.
Key findings reveal that customer reviews, despite their potential for information loss due to bias, could indirectly facilitate quality signalling through price adjustments. When reviews are biased, high-quality sellers may lower their initial price to induce more unbiased reviews, thereby enhancing the informativeness of the review system and improving market signalling.
If a seller attempts to mimic high-quality pricing without genuine quality, it undermines the signalling process, especially when reviews are biased. The researchers find that price signalling alone does not necessarily increase profits for high-quality sellers because low-quality competitors could mimic high prices, creating a strategic incentive for the high-quality seller to lower prices to induce honest reviews and prevent mimicking.
Interestingly, the presence of selection bias in reviews sometimes benefits consumers. Since biased reviews often lead to lower prices, consumers experience a higher surplus. The research model demonstrated that selection bias could encourage sellers to set lower introductory prices, which serve as credible signals of high quality, especially when there are many reviews that are positive.
The paper highlights that the dual roles of reviews and prices are interconnected. Customer reviews not only directly communicate quality but also enable profitable price signalling, which could be more effective when reviews are biased. The presence of bias, counterintuitively, could enhance consumer welfare by driving prices downward. Moreover, when the market size in the second period is large, high-quality sellers are more inclined to set lower initial prices to effectively signal quality. If the low-quality seller’s market share is significant, the high-quality seller has to lower prices in order to induce unbiased reviews and prevent mimicking by lower-quality competitors.
The study model also discusses how review platforms can influence these dynamics. Limiting access to historical prices and review quantities could manipulate the information environment, redistributing surplus between sellers and consumers. This suggests that platforms might intentionally restrict certain information to foster a market environment conducive to effective signalling and welfare improvements.
The overall welfare gains from review systems are shared between consumers and sellers, presenting a potential win-win scenario.
From a consumer welfare perspective, the analysis indicates that biased reviews, while traditionally viewed as detrimental, could actually enhance consumer surplus by facilitating price signals that lead to lower prices. The overall welfare gains from review systems are shared between consumers and sellers, presenting a potential win-win scenario. Consumers benefit from lower prices driven by strategic signalling, which enables review bias, and sellers improve profits through effective signalling when reviews are biased.
The researchers emphasised that selection bias should not necessarily be seen as purely harmful. Instead, it could serve as a mechanism that encouraged sellers to engage in price signalling. This could help convey quality more effectively. For review platforms, combating bias might not always be beneficial, as some bias could strengthen market signalling and consumer welfare.
The findings also support the popularity of third-party price trackers, which facilitate seller price signalling and could enhance consumer surplus.
The research underscored the complex interplay between customer reviews, pricing strategies, and market signals in the context of experience goods. It challenges conventional wisdom by demonstrating that review bias, rather than solely impairing information transmission, could play a constructive role in signalling quality and benefiting both consumers and sellers.
Keywords:
Customer reviews, Price signalling, quality uncertainty
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