Consumer sophistication and firm strategy when social feedback is untrustworthy

This paper analyzes the effect of consumer sophistication on consumer assessment of social feedback (such as user reviews), and ultimately on a firm’s strategic decisions. Consumer sophistication is defined on a continuum of cognitive sophistication, with high levels corresponding to careful deliberation of available information and low levels corresponding to naive information processing. Consumers are aware that social feedback may be untrustworthy, and they tend to trust (distrust) positive (negative) feedback about a product for which they have a higher valuation. Optimal price, profit, and sales decrease (increase) with sophistication at low (high) levels of sophistication. Optimal sales, however, falls for a larger range of sophistication than price. At low levels of sophistication, the firm chooses to serve most consumers, and an increase in sophistication lowers the valuation of the marginal consumer, forcing the firm to cut prices. Marginal revenue also falls, lowering optimal sales. The dynamic reverses when sophistication is high, because an increase in sophistication increases the dispersion of consumer valuations. In an extension, we consider how the results change when consumers know that a firm aggressively suppresses negative feedback. Our results suggest that suppressing negative feedback harms the firm by nullifying the dispersion-enhancing effect of sophistication.