Recommender System Rethink: Implications for an Electronic Marketplace with Competing Manufacturers

Abstract

Recommender systems that inform consumers about their likely ideal product have become the cornerstone of eCommerce platforms that sell products from competing manufacturers. Using a model of an electronic marketplace in which two competing manufacturers produce substitutable products and sell the products through a common retail platform, we study the eect of recommender systems on the marketplace, manufacturers, and consumers. Consumers are heterogeneous with respect to their preference for and awareness about the two products. The recommender system recommends the product that oers a higher expected consumer net utility. Our analysis shows that the recommender system may benet or hurt the retailer and the manufacturers, depending on the tradeo between two opposing eects of recommender systems. The demand eect of the recommender system increases the proportion of consumers that are aware of at least one of the products, thus increasing the overall market size and beneting the sellers. The substitution eect of the recommender system causes the demand function to be more price elastic through two forcesone that shifts some consumers that are aware of a single product to ones that are aware of both products, thus making them comparison shoppers, and another that induces manufacturers to use price to gain informational advantage among consumers that are unaware of either product. The magnitudes of these two eects depend on the relative sizes of consumer segments with dierent awareness levels and the recommender system precision. An increase in precision mitigates the substitution eect of the recommender system. However, even perfect precision cannot guarantee that the recommender system benets the retailer and manufacturers. On the other hand, regardless of the precision, the recommender system benets the consumers and social welfare. We further show that by strategically committing to not recommend any product to some consumersthose whose preference for a product is distorted by prices, the retailer can mitigate the substitution eect and benet more or lose less from the recommender system.

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