Overcoming the Challenges Faced by Online Marketplaces

XU, Hong | CHEN, Jianqing | WHINSTON, Andrew B.

Online marketplaces are a popular platform for buying or selling products. That said, one of the key challenges of e-commerce is managing the reputation of anonymous users. Online reputation trading is a relatively new phenomenon, which is facilitated by the success of e-commerce and social networks. Due to online anonymity, reputation is regarded as an effective tool to regulate the online activity of users. A good online reputation can be achieved over time by text comments and rating systems. For example, an eBay account can develop a certain level of trust or reputation with consumers, which is based on previous e-commerce transactions. Selling the reputation of an online account – sometimes for thousands of dollars – occurs by simply exchanging a username and password for money.

The exchange of reputation does not implicitly guarantee the quality of resources, as the new owner might not provide the same standards as the previous owner. Therefore, reputation trading has created a number of challenges for online consumers as they often expect a certain level of quality or trust, based on a given reputation. The advantages of a reputation market is that users can purchase a reputation that matches their capabilities. In addition, this market can act as a medium to reward good reputation and online behaviour. Yet, this market could also attract dishonest agents who might take advantage by purchasing good reputations to sell poor quality products.

A study by Hong Xu, Jianqing Chen, and Andrew B. Whinston examined a reputation market in an infinitely repeated game setting, where agents sold products and traded their online reputations. In their experiment, agents provided products, and their reputations were updated based on consumer feedback. It was found that a reputation system could increase market efficiency as agents were less likely to cheat on buyers by selling poor quality products.

That said, to avoid agents exploiting a reputation market, they were categorised as ‘high-type’ or ‘low-type’ agents through random ‘audits’. These audits imposed a contingent contract between sellers and buyers, such as warranty policies. For example, an agent would face a price drop if their reputation was downgraded, which acted as a direct financial incentive to be honest. By discerning between high-type and low-type agents, the study achieved a separating equilibrium, which provided a strong indicator of agents’ types, effort levels, and product quality.  

A combination of reputation and auditing was found to be beneficial to both consumers and sellers. The reason being is that the consumers faced minimal uncertainty due to the separation of agent types and reputation. The researchers explained, “they can effectively reduce low-type agents’ incentive to purchase a good reputation and cheat, while increasing high-type agents’ incentive to work hard”.

Their study provides an important insight into improving online market efficiency through establishing a market to properly realize the value of online reputations like an asset. It also provides a financial incentive for online community participants to maintain their reputation following a change of ownership.

XU, Hong

Assistant Professor
Information Systems, Business Statistics & Operations Management