An Economic Analysis of Online Product Reviews and Ratings

Abstract:     
Many online vendors and third-party firms provide consumers with easy-to-use systems to give product reviews and ratings. Availability of online reviews and ratings may significantly influence a vendor's strategies in terms of pricing and market segmentation. Consumers as well as vendors can potentially benefit or lose from such availability though it is unclear whether the net effect to each party is positive, or who gains or loses most. This paper provides an analytical model to study the impacts of online product review and rating systems on vendor marketing strategies, consumer surplus and social welfare. We also examine the effects of both product-level and vendor-level competition on the impact of online reviews and ratings. We find that consumer surplus, vendor profitability, and social welfare can improve with the availability of consumer reviews and ratings, and that vendors may have an incentive to induce higher product ratings by under-charging in earlier periods. Interestingly, we show that, contrary to the conventional wisdom about competition, with the availability of consumer reviews, consumer surplus and social welfare can in fact be higher in a monopolist market than in a duopolistic market.

Number of Pages in PDF File: 34

Keywords: consumer reviews, online rating, online word-of-mouth

working papers series