Competition Through Recommendations

Abstract

Consumers rely on recommendations of platforms when purchasing products. I examine a platform's decision to provide product recommendations which are informative of value-for-money. More informative recommendations have two effects: (i) a screening effect, where lower quality firms exit the platform; and (ii) a ranking effect, where consumers interact more with higher quality firms. Of the remaining firms, screening benefits higher quality firms, while ranking benefits only the highest quality firms. Both effects increase consumer surplus, attracting more consumers to the platform. However, more informative recommendations lead to fierce price competition between firms. Hence, a platform has to balance volume and commission fees. When facing competition, a platform's recommendation becomes more informative when it's competitor's recommender system is more informative.