Photo by Giorgio Tomassetti / Unsplash
Platform Ratings as Informal Regulation
In a world with countless substitutes for almost every good or service, how do consumers know which ones are of sufficient quality? Today, most consumers look at online reviews and ratings to ascertain the likely quality of a good or service, crowdsourcing the wisdom of hundreds (or thousands) of previous customers. Customer reviews have become so widely used that sellers frequently point to them in their advertisements, such as highlighting reviews that are particularly flattering. What economic role do ratings and reviews have in our modern markets?
Economics of Reviews and Ratings
Before Easy-to-Access Reviews: Rampant Asymmetric Information
Reviews and ratings have been around for generations, but previously utilized experts to give singular opinions. Consumers could purchase magazines, guides, and books of experts’ professional reviews to, hopefully, steer them toward goods and services of the highest quality. Those who could not afford to purchase these guides had little to guide them beyond localized word-of-mouth, personal inspection of products, and the [probably] biased advertisements of the sellers themselves. Retail employees might offer more honest assessments than producer advertisements, but could also be incentivized to praise products to sell more units and potentially receive bonuses or raises.
As a result of this asymmetric information, with customers knowing relatively little unbiased information about goods and services, there was a considerable amount of economic inefficiency. Many consumers might refuse to buy, leading to deadweight loss where neither the consumer (demand side) or producer (supply side) benefits. Other consumers might buy and be quickly dissatisfied with the product, leading to lack of future purchases. Sellers would be deprived of income, and the lack of convenient consumer feedback (part of a feedback loop) would result in few or no improvements made to products over time, allowing inefficiency to continue over the long run.
Easy-to-Access Reviews: Improved Efficiency
The Internet revolutionized reviews and ratings by allowing consumers to read the opinions of common customers like themselves rather than experts. No longer did consumers have to pay for expert reviews, and they could use filtering and sorting options to find reviews that best fit their circumstances. For example, professional reviews could be months or years old, but online customer reviews could have been posted from just days before. Customers could also search for consumer reviews of a specific model or trim line, which may not have been reviewed by experts. Additionally, an expert review of a product may have been done on a dry summer day, while consumer reviews can report on the product’s performance on a wet winter day.
Are Ratings and Reviews a Substitute or Complement for Government Regulations?
Substitute
Although customer reviews and ratings are not intended to replace government regulations, their increasing prevalence may be used by policymakers to reduce funding for regulators. The argument would be that customer reviews and ratings are reliable enough to steer consumers away from unsafe or low-quality products and create feedback loops that force producers to improve their quality. Politically, the use of customer reviews and ratings instead of regulators helps neutralize debates about bias toward or against specific industries or companies, allowing policymakers to simply point to market forces pushing companies to change their ways.
Complement
The Coase theorem suggests that government regulation is necessary when transaction costs are high (purchases are complex), property rights are difficult to discern, and the number of third parties affected is large. When faced with this level of complexity, customer reviews and ratings are unlikely to be thorough or accurate enough to educate consumers. Harms to third parties, known as negative externalities like pollution or environmental degradation, are unlikely to be limited by customers. Customer ratings and reviews, by definition, focus on products’ costs and benefits to customers themselves, not third parties.
Realistically, relying on customer reviews and ratings to push companies to self-regulate quality and behavior only works in industries where little government regulation is needed. Thus, in industries where regulation is currently needed, based on the Coase theorem, customer reviews and ratings can only serve as a complement to regulators. As a result, policymakers cannot reasonably reduce regulations by allowing customer reviews and ratings to educate the public and pressure producers.
A Second Look at Asymmetric Information: Fake Reviews
While customer reviews and ratings have tremendously benefited consumers by giving them up-to-date information on how goods and services perform under real-world circumstances, there are increasing chances of consumers being misled by falsified reviews. Producers, competitors, sellers, and disgruntled buyers all have an incentive to post customer reviews under false pretenses. Sites like Google and Amazon may be rife with well-written reviews that are fraudulent, hoping to either entice or drive away prospective customers.
AI has made it easier than ever for fraudsters to post mass reviews, hoping to flood the review portals and affect the overall ratings. Businesses that notice fake and harmful reviews about their products and services can report the fraud to regulators, such as the Federal Trade Commission (FTC) in the United States, but it is unlikely that swift action will be taken to remove those reviews. Small businesses may be especially vulnerable to this type of fraud due to their relatively low volume of reviews: a rival firm or disgruntled customer can drive down their overall customer rating by continually posting fraudulent negative reviews.
Using Identification Verification as a Tool to Improve Reviews
Policymakers can combine the power of government regulation with the immediate benefit of customer reviews by passing laws and regulations requiring reviews made by anonymous or unverified sources to be flagged as such. Many platforms now signify whether reviews are made by verified customers, allowing prospective customers to quickly see which reviews are worth reading. On some retail sites, users can filter reviews by “verified purchase only” to ensure they are only reading the reviews of consumers who actually purchased the product.
As the pendulum swings toward allowing only verified customers to post reviews, this can increase market efficiency by reducing the huge volume of reviews for prospective customers to read. Today, many consumers are struck with decision paralysis due to the sheer number of competing and conflicting reviews. Many of these excessive reviews, however, may be created by bots or “review farms” paid for by firms to either praise or criticize a product. When unverified purchasers are allowed to post reviews of a product, a prospective customer may spend hours reading conflicting reviews written by AI…with no product having ever actually been reviewed at all!
