Platform Refund Insurance or Being Cast Out : Quantifying the Signaling Effect of Refund Options in the Online Service Marketplace

Online service marketplace consumers face more quality uncertainty due to the intangibility, variability, and unreturnable nature of the services sought, which potentially leads to the “lemons” problem (Akerlof 1970). To alleviate this problem, the platform employs refund options as quality indicators that are either endorsed by the platform or individual sellers. Our work draws from signaling theory to develop the signaling mechanism of platform refund insurance and seller-guaranteed refunds, as well as builds a demand estimation model that uses aggregate data to examine such signaling effects. The model is developed to accommodate heterogeneous risk preferences, the endogeneity of the sellers enrolling in refund options, and the competitive nature of the marketplace. We further leverage the model to conduct a policy analysis that investigates the effectiveness of the platform by using a “platform refund insurance or being cast out” policy (i.e. retaining platform refund insured sellers but expelling uninsured ones) to filter out “low-type” sellers and, thus, to improve the platform's overall performance. Our findings show that both types of refund options increase demand, with platform refund insurance being the more effective option. This suggests a more effective signaling mechanism of platform refund insurance as a third-party assurance and, thereby, justifies the platform's use of platform refund insurance to filter out sellers during the period of policy change. Our reduced-form analysis further suggests sellers with a better reputation or fewer scales might benefit less from refund options. Our policy analysis, on one hand, shows improved quality of sellers on the platform due to the changes of sellers (i.e. expelled sellers leaving and newcomer sellers entering). On the other hand, our analysis reveals that the platform incurs a cost as a result of the characteristic changes (e.g. price) of sellers. The cost harms platform demand and consumer welfare, but to a limited degree and is offset by the improved quality of the sellers. The consumer welfare of the online service marketplace, along with the marginal effect and externalities of reducing a seller are further calculated. The study provides comprehensive analyses and practical insights for stakeholders in the service online marketplace, including sellers, consumers, and platform operators