Price Signaling and Reputation Building: Evidence from a Service Platform

Abstract

To build a reputation on online platforms, new firms need to accumulate reviews through sales and consider the corresponding pricing strategy. We construct a dynamic model with both price signaling and a review-based reputation system. A high-quality firm can signal its unobserved quality by setting a lower introductory price than that of a low-quality firm because the high-quality firm benefits more from accumulating reviews in early periods. Using data from Zaihang, a service platform, we find empirical evidence that experts with high unobserved ability indeed adopt low introductory prices. We use an expert's performance on another platform as an instrument for the expert's ability to provide evidence for a causal relationship. The price and sales dynamics in the data are also consistent with the model predictions. The platform can accelerate quality revelation by facilitating price signaling. To do so, platforms could make price comparison easier and provide training to new firms about signaling.

Keywords: pricing, signaling, online review, service platform

JEL Classification: D4, L15, L86