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Rotman Insights Hub | University of Toronto - Rotman School of Management

Pay to play? How e-commerce sites influence customer steering

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Heski Bar-Isaac

Online retail platforms like Amazon and Alibaba can be battlegrounds for sellers to get their products noticed – and purchased – by customers.

Placement of a product on a marketplace’s website matters: The higher a product is on a page or in a search result, the better the seller’s chances of making a sale.

Where things end up in a shopper’s feed is entirely up to the marketplace. So-called “organic” results arise from algorithms that are determined by the marketplace — presumably in a way that is profitable, and which are likely to rely on information on popularity and prices. A marketplace earns revenues through a percentage of the seller’s sales (called an “ad valorem fee”). In addition, it can earn further revenue by selling prime spots (typically through auctions).

“Access [to consumers] is critical, and access is controlled by these platforms,” says Heski Bar-Isaac, a distinguished professor of economics and finance at the Rotman School of Management.

In a recent working paper, Bar-Isaac and professor Sandro Shelegia from the Barcelona School of Economics studied multiple steering mechanisms across different scenarios.

Bar-Isaac and Shelegia first developed a simplified, baseline model of a competitive retail market with identical retailers where consumers only pay attention to an item in a top spot on the platform. In this scenario, Bar-Isaac says the marketplace can earn the same (monopoly) profits using either form of steering (algorithms or auctioning spots). However, in variations that include uncertainty about demand, market power from resellers, and consumers with less susceptibility to placement, this equivalence breaks.

The paper illustrates that the ways in which platforms choose to steer can have impacts on both sellers and customers, and these platforms can monetize their gatekeeping power – whether they are making money from using algorithms or auctioning top advertising spots to sellers.

Bar-Isaac says this gatekeeping power through the algorithm design can, in effect, allow the platform to do things like “dictate” prices they charge sellers for access and refuse access to sellers.

“There’s an awful lot (these platforms) can do,” he says. “But I don’t think this is news to sellers. If you go on sellers’ forums, a lot of these online sellers are trying to figure out how the algorithms work so that they can try and respond to the algorithms appropriately. They know it’s desperately important for them to appear on the front page of search results.”

Marketplace gatekeeping can also have an impact on consumers, the paper finds. For example, if platforms charge higher fees for steering, those fees could be passed along to the consumer through higher prices for their item.

He adds that among policymakers, there is also the issue of online marketplaces using steering practices to give preferential treatment to their own product label, and this preferential treatment might be an unfair practice for third-party sellers.  

Bar-Isaac says policy discussions are continuing to evolve internationally, pointing to the new Digital Markets Act in the European Union, which regulates digital platforms, and protects consumers and businesses from unfair practices.

The United States is also exploring bills regulating gatekeeper platforms, which includes auditing their algorithms to check whether they are steering customers towards the appropriate sellers.

As governments begin to adapt policies and regulations for online platforms, Bar-Isaac says his paper shows that they need to take a more holistic approach when introducing new measures – and shouldn’t just focus on regulating fees from algorithms or auctions.

“One observation [coming out of the paper] is that online platforms have a lot of tools at their disposal, so you have to worry a bit about ‘whack a mole,’” he explains. “If you regulate the fees, that’s all well and good, but then that might get them selling more ads and it might be self-defeating . . . it might make things worse for consumers, or for performance as a whole.”

Heski Bar-Isaac is a professor of integrative thinking, finance, and economic analysis and policy, and a distinguished professor of economics and finance