Welfare Properties of Profit Maximizing Recommender Systems: Theory and Results from a Randomized Experiment

Abstract

Recommender systems have been introduced to help consumers navigate large sets of alternatives. They usually lead to more sales, which may increase consumer surplus and firm profit. In this paper, we ask whether firms may hurt consumers when they choose which recommender systems to use. We use data from a large scale field experiment ran using the video-on-demand system of a large telecommunications provider to measure the price elasticity of demand for movies placed in salient and non-salient slots on the TV screen. During this experiment, the firm randomized the slots in which movies were recommended to consumers as well as their prices. This setting readily allows for identifying the effects of price and slot on demand and thus compute consumer surplus. We find empirical evidence that consumers are less price elastic towards movies placed in salient slots. Using the outcomes of this experiment we simulate how consumer surplus and welfare change when the firm implements several recommender system, namely one that maximizes profit. We show that this system hurts both consumer surplus and welfare relative to the systems designed to maximize the latter. We also show that, at least in our setting, the system that maximizes profit does not generate less consumer surplus than some recommender systems often used in practice, such as content-based, lists of most sold, most rated and highest rated products. Yet, how much extra rent the firm can extract from strategically placing movies in salient slots is still a function of the popularity and quality of movies used to do so. Ultimately, our results question whether recommender systems embed mechanisms that extract excessive surplus from consumers, which may call for better scrutiny.