Effect of Counterfeits and Fake Reviews in Markets for Credence Goods

Abstract

Counterfeits are a persistent problem in online marketplaces, in particular regarding credence goods (e.g., nutritional supplements), as their qualities are difficult or impossible to evaluate even after consumption. Concerned about product quality, customers frequently rely on external signals, such as product badges based on ratings. However, even product ratings are not foolproof as unethical sellers may acquire fake positive reviews to exploit product ratings and badge systems. To analyze the impact fake reviews have on credence goods, we consider a two-stage competition between an authentic seller and a deceptive counterfeiter. The market consists of two types of consumers: savvy customers, who understand that endorsement badges are product-dependent and not seller-dependent, and novice customers, who mistakenly believe product badges testify to a seller's authenticity. In the first stage, both sellers simultaneously decide on whether to acquire fake reviews, which partially influences if the product receives an endorsement badge. In the second stage, both sellers simultaneously set their prices and customers make purchasing decisions. Our results indicate that, in equilibrium, the authentic seller does not acquire fake reviews, while the counterfeiter may do so to mislead customers. Moreover, the amount of fake reviews is decreasing in the fraction of savvy consumers, suggesting that online platforms can combat fake reviews by, for instance, clearly highlighting that badges are product-dependent. We also find that having the option to acquire fake reviews may benefit both sellers but always hurts consumers, emphasizing the need for regulation to protect consumers.