June 28, 2023
Market design and third-party certificates
How do certification thresholds impact quality and prices in markets?
From credit ratings to eco-friendly labels, third-party certifications are a regular feature of today’s highly complex markets. And for consumers, they have become a critical tool for gaining information before making purchases.
But certification badges do more than help inform consumers, according to a paper in the American Economic Journal: Microeconomics. Authors Xiang Hui, Maryam Saeedi, Giancarlo Spagnolo, and Steven Tadelis say that third-party certificates can also play a key role in determining the prices and the range of quality offered in markets.
“When you raise the bar, when you make the certification requirements more stringent, you're going to have more new sellers of very high quality,” Hui told the AEA in an interview. “But somewhat surprisingly, you're also going to see more entry of very low-quality sellers.”
The authors’ findings come from analyzing a change that eBay, one of the world’s largest online marketplaces, made to its system of certifying sellers.
Previously, eBay awarded “Powerseller” badges to particularly virtuous sellers. In particular, Powersellers had to sell at least 100 items or at least $1,000 worth of items every month for 3 consecutive months, while maintaining a high level of positive feedback from buyers. In return, they received discounts on shipping fees.
But in 2009, the company scrapped the old badge and replaced it with more stringent requirements. To qualify as an “eBay Top-Rated Seller” (eTRS), sellers had to surpass the Powerseller requirements by also having at least 100 transactions and at least $3,000 in sales over the previous 12 months, as well as keeping the number of complaints from buyers to a specified minimum. The eTRS certification offered even more perks for sellers, such as lower transaction fees and higher positions in search result pages.
Proprietary data from eBay, which covered the period from October 2008 to September 2010 when the changes were implemented, allowed the authors to fully ascertain the impact of the new requirements.
First the researchers created an asymmetric information model of a marketplace in which sellers can choose product quality in response to certification thresholds, but buyers cannot directly observe the quality of products on the market.
According to their model, more stringent certification leads to changes in the distribution, which increase the average quality of both certified and uncertified sellers.
This is due to the fact that when the threshold for a badge is low, not being badged is a signal of very poor quality to consumers. But when the threshold is increased, that signal of poor quality becomes weaker due to more midrange quality sellers becoming unbadged. And of course on the high end, sellers with the new, more stringent badge are of even higher quality.
As a result of the perceived average quality being higher, the sellers on the low and high ends benefit from higher relative prices, while the midrange quality sellers, unable to adjust to meet the new threshold, have to sell at the lower unbadged prices. This arrangement in turn encourages more entry of sellers in the low and high end of the quality distribution and fewer in the middle.
The predictions of the model were confirmed by the eBay data. After eBay increased its certification requirements, the dispersion of quality increased across markets, especially in product categories that were more sensitive to the new policy.
On ridesharing platforms like Uber, you don't need a superstar driver; people just need a ride. So you might want to weed out the super low-quality drivers and increase drivers of midrange quality. In cases like that, you might actually want to lower the bar to achieve your goal.
Overall, this increase in the range of quality made marketplaces more attractive to consumers. However, the gains for consumers largely occurred in markets with more complaints. If complaints indicate a higher preference for quality, then stringent certification requirements will be more beneficial in markets where quality matters more.
The researchers’ work highlights the important role that certification thresholds can play in market design, which may translate into key insights for online marketplaces.
“For instance, on ridesharing platforms like Uber, you don't need a superstar driver; people just need a ride. So you might want to weed out the super low-quality drivers and increase drivers of midrange quality,” Hui said. “In cases like that, you might actually want to lower the bar to achieve your goal.”
“Raising the Bar: Certification Thresholds and Market Outcomes” appears in the May 2023 issue of the American Economic Journal: Microeconomics.