Three events last week reminded me of the importance of
Information Economics in the Web Commerce 2.0 environment.
Firstly - last week but one I bought an item (value c £150, $300) over an internet website, but not a well known one - seemed OK though. But 2 days before the delivery I was informed the date had slipped by a day. This went on every day for a few days until a note arrived telling me the delivery had slipped 2 weeks. At this point (last week) I was furious and cancelled the order, accusing them of being a scamsite. This may or not have been true, and had probably just run out of stock, but they hadn't told me.
They had lost my trust.
Secondly, last week we were chatting with an entrepreneur who wanted to launch a website that sort of combined a Yellow Pages with a rating engine so you can tell who is a good plumber, lousy gardener, etc (such a thing apparently does not exist in the UK).
Both are cases of needing to get some fix on the quality of unknown entities via the Web, and I was thus reminded especially of Akerlof's
"Law of Lemons". To summarise, George Akerlof wrote a paper in 1970 describing how asymmetrical information markets can lead to the disappearance of good quality. This is where there is (from Wikipedia):
(i) Asymmetry of information
- no buyers can accurately assess the value of a product through examination before sale is made
- all sellers can more accurately assess the value of a product prior to sale
(ii) An incentive thus exists for the seller to pass off a low quality product as a higher quality one
(iii) Sellers have no credible disclosure technology (sellers with a great car have no way to credibly disclose this to buyers)
As a consequence markets may fail to exist altogether in certain situations involving quality uncertainty.
Akerlof's paper uses the market for used cars as an example of the problem of quality uncertainty. There are good used cars and defective used cars ("lemons"). The buyer of a car does not know beforehand whether it is a good car or a lemon. So the buyer's best guess for a given car is that the car is of average quality; accordingly, he/she will be willing to pay for it only the price of a car of known average quality.
This means that the owner of a good used car will be unable to get a high enough price to make selling that car worthwhile. Therefore, owners of good cars will not place their cars on the used car market. The withdrawal of good cars reduces the average quality of cars on the market, causing buyers to revise downward their expectations for any given car. This, in turn, motivates the owners of moderately good cars not to sell, and so on. The result is that a market in which there is asymmetrical information with respect to quality shows characteristics similar to those described by Gresham's Law: the bad drives out the good
Thirdly, another interesting application of this law is for dating sites (relevant as we met with one last week). Again, quoting Wikipedia:
Online dating sites, in which people post a personal profile, have become popular ways for people to find dates in their community. To protect individuals posting their descriptions on the site from unwanted contact or harassment, online dating sites only identify participants with a code number. People with advertisements on a dating site are notified with a message when another dating site member would like to contact them, and it is up to the person receiving the notification to decide, based on the message (and on the personal description of the other person on the dating site) whether they wish to make contact.
However, the limited description of an individual in an online dating advertisement is “...likely to be a careful selection of qualities and possibly false,” which leads to a situation of asymmetrical information; the person "selling" themselves as a potential dating partner knows far more about their qualities and defects than the recipient of the notification.
Unlike Internet markets (like eBay), where buyers can assess the trustworthiness of a pseudonym-identified seller by looking at how many positive and negative comments other buyers have made, in many online dating products, “there are no public reputation systems.” This means that users of online dating services have no official way-through the online system- of finding out additional information about an individual, or in other words assessing the value of the product.
In other words, Akerlof's law predicts that any quality in a datesite will be driven out by the liars over time - an interesting result, given the increasing reliance of such services.
The thing is, the vast majority of web services offered are just like these examples - you just cannot trust them as there is no independent verification.
This is what makes trusted brands like Amazon so useful - you know what they stand for. Its also why eBay is so valuable - hordes of small businesses (and customers) can be rated, so higher quality can come out and drive Lemons away.
So what can the small Quality Website without a brandname do to de-lemonise itself?
The small website's best option is to signal its quality by making itself rateable by its customers, and otherwise exposing as much information about itself to build trust as it can. Now, this data can be spoofed by false websites - hence the impact of Web 2.0 and interactive blog styles, where authenticity is harder to fake (as people like Walmart found out). But there is no doubt that companies and their PR companies are continually upgrading their ability to fake authenticity - however for now the cost of using this is probably higher than a small business can afford, so fairly simple methods should suffice for a while yet.
The average Web Customer needs to be wary of larger companies however, as they certainly can (and some are) abusing such social media to spoof trust.
As it all eventually becomes Caveat Emptor, how then can the Customer get information from sites sufficient to decide whether they flog lemons or not?.
One way is to use independent review services (where they exist), or set them up like the second example above. These can either be done via user subsidies, or via advertising sponsorship. There is however a risk using sponsors or advertisers who also manufacture the items being reviewed, as this is likely to lead to a perception of conflict of interest.
However, this still needs a level of organisation. The best approach is probably a whinge site (like F*cked Company) where people can slag off cr*p companies (or praise them, but the amount of praise compered to abuse is typically an order of magnitude lower). Not perfect information, but better than nothing.
The difficulty is, as always, trusting the inputter - rating the commenters is as critical as the comments itself. This is not always possible on any one site, so we believe that over time a need to have a trusted identity over multiple sites will grow (why for example can I not take my trusted status over eBay as a way of displaying my general trustworthiness elswhere, for example?)
Overall therefore, as the Web becomes a bigger site of our public and commercial life, we expect the application of Information Economics to grow, and the drive to solve Information Asymmetry to become increasingly important to customers.
But it is also in the interest of the producers of quality goods to aid in this process of disclosure. It can also be shown that giving the customer more information actually drives out the cr*p, which means that the best prices can be achieved. To quote Wikipedia again:
Ironically, there is no reciprocal danger of a market for a good product collapsing in this manner when the asymmetry is in favour of the buyer, that is to say, when the buyers can assess more accurately the quality of the products than the sellers. In this case, regular market forces of supply and demand will prevail, the sellers will get the highest price paid, and the trend will be to weed out products with prices in excess of their quality. This is likely the basis for the idiom that an informed consumer is a better consumer.
We don't know how all this will pan out, but a good rule of thumb in future would seem to be that if the quality of a site is in any way uncertain, it will increasingly be ignored.
Postscript
Realised that no discussion of Akerlof is complete without referring to the other 2 nobel prizewinners, Spence and Stiglitz (from Wikipedia):
Michael Spence originally proposed the idea of signaling. He proposed that in a situation with information asymmetry, it is possible for people to signal their type, thus believably transferring information to the other party and resolving the asymmetry.
Joseph E. Stiglitz pioneered the theory of screening. In this way the underinformed party can induce the other party to reveal their information. They can provide a menu of choices in such a way that the choice depends on the private information of the other party.
Post Postscript
This article by Chris Pirillo sort of shows the sort of things small sites may practically do, though its not clear if he is aware of the economic game theory behind it all.
