The weight of the crowd, social information credibility, and firm strategy

Abstract

When considering a purchase, consumers often augment their private information about a product with anonymous online social information (reviews, etc.). We examine the impact on firm strategy of how consumers weight these two information sourcesprivate and social-in their purchase decisions. An increase in weight on private information always results in higher prices at the interior equilibrium. However, the effects on profits, consumer, and total surplus are nonmonotonic: all increasing with the weight on private information when weight is high but decreasing when weight is low. Profit and surplus decrease with weight when weight is low because a marginal increase in a low weighting leads to a contraction of demand. The dynamic reverses when weight is high. Besides weighting of information sources, our model incorporates the questionable credibility of social information. A firm's optimal investment to improve social information credibility depends on whether consumers process information in a Bayesian or non-Bayesian manner. We show that, compared to Bayesian consumers, non-Bayesian consumers endogenously trust (distrust) social information from firms with high(low)-positivity ratings. This distinction in information processing results in a stark contrast in how firms manage social information credibility: when facing Bayesian consumers, with an increase in the positivity of its social information, a firm with high(low) positivity spends less (more) to improve credibility. On the contrary, when facing non-Bayesian consumers, a firm with high(low) positivity spends more (less) to improve credibility. Product quality also affects optimal credibility investment, following an inverted U-shape.