When Do Buyer Protection Mechanisms Help Low-Reputation Sellers? --- The Strategic Interaction between Buyer Protection Mechanism and Reputation Systems

Online reputation systems are critical in reducing information asymmetry in online market places. How will the introduction of buyer protection program, such as guaranteed return, third-party escrow services and credit card protections, influence the effect of online reputation on seller competition? Does it benefit more those low-reputation sellers than high-reputation sellers, since consumers are more assured buying from the low-reputation sellers? Does such mechanism help promote a more competitive market among sellers with different reputation levels? We first develop a theoretical model to study the joint effect of online reputation systems and buyer-protection mechanisms, where products are characterized by both different quality levels (vertical differentiation) and misfit cost (horizontal differentiation). Surprisingly, we find that such mechanisms are effective only in a market with forward looking sellers who maximize long-term profits. When sellers are myopic, such mechanisms benefit the low-reputation sellers only in a short term, and can be detrimental in the long term when the high-reputation seller responds to the introduction of such mechanisms by adjusting their pricing strategies. As a result, consumers rely more on reputation systems, and the online market can be more unevenly distributed in the long run in the sense that high-reputation sellers occupies a larger market share. Using a dataset from one of the largest online B2C markets in China, we also empirically evaluate these theoretical predictions.