Informing consumers and restricting bad apples: that’s the dual role that occupational licensing is supposed to play. If a plumber, painting contractor, or HVAC repairer has a license it should matter to consumers wanting their services, right?
As it turns out, even when consumers know that a home service provider has a license, their hiring decision is still more driven by price and online reviews than the quality assurance that comes with licensing. New research shows that tougher licensing requirements reduce the pool of providers available to any given consumer and increase the prices he or she will pay.
The study, Consumer Protection In An Online World: An Analysis Of Occupational Licensing, is the first to look together at what consumers care about and the effects on demand and metrics of customer satisfaction. It is coauthored by Harvard Business School Assistant Professor Chiara Farronato, Andrey Fradkin, Boston University; Bradley Larsen, Stanford University; and Erik Brynjolfsson, MIT Sloan School of Management.
We asked Farronato, whose interests include economics, innovation, electronic commerce, and electronic markets, to share the potential impact of these findings on consumers, platform managers, and policymakers.
Martha Lagace: What piqued your interest in this research?
Chiara Farronato: I study market design choices of online platforms from eBay to Airbnb. Online platforms help match many fragmented buyers and sellers of goods and services. But how do you ensure that buyers and sellers who don’t know each other trust that the transactions will be safe and of high quality? This is the fundamental role of online platforms: aggregating information that is useful for buyers and sellers who want to meet, transact, and make exchanges. Online platforms aggregate this information through various forms of screening, certifications, and online reviews.
“Fundamentally, occupational licensing exists to increase consumer trust in service providers.”
Government regulation also exists to ensure trust between buyers and sellers of services. Occupational licensing, for example, is one such regulation that covers over 30 percent of the US workforce. It exists to correct informational asymmetries between buyers and sellers. Occupational licensing regulation requires service providers, such as plumbers and carpenters to attend classes, pass exams, and spend some time in training before they can legally sell their services. These requirements are meant to screen out low quality providers. So fundamentally, occupational licensing exists to increase consumer trust in service providers, just like online reputation mechanisms are designed by online platforms to help consumers make informed choices.
So, I wanted to know how online platforms could complement government regulation in informing consumers about the quality of different providers, specifically home service professionals, and how much occupational licensing mattered when buyers hired home improvement professionals.
That’s how I started studying the role of occupational licensing in an online world, and together with my co-authors we found the perfect setting: an online platform for the exchange of home improvement services, such as plumbing, air conditioning, and painting. If a consumer needs help from an electrician, they can post their request on this platform, and receive bids from available electricians. The consumer can then choose to hire one of these professionals.
This online platform is an ideal setting because we can observe how consumers make hiring decisions as a function of professionals’ prices, online ratings, and occupational licensing credentials. It is also an ideal setting because each US state has its own occupational licensing regulation of home improvement professionals, with some states imposing stringent licensing requirements—more exams, more years of training—while others having laxer or no regulation.
The setting allows us to answer two questions. First, we can evaluate whether consumers care about occupational licensing requirements, in the absolute and compared to other quality signals contained in online reviews. Second, by exploiting variation in licensing stringency across states and occupations, we can evaluate the aggregate costs and benefits of licensing regulation.
In our study we take government regulation as a given and test the fact that some states regulate the same occupation much more stringently than other states, requiring more exams and more years of training. Occupational licensing is oftentimes at the state level, so if you are licensed in Massachusetts it’s not obvious if you can work in Nevada. And there are a lot of costs attached to occupational licensing regulation such as training, exams, fees, and so on.
Lagace: What did you find?
Farronato For consumer choices, we find the knowing that a professional is licensed does not affect the decision of whom to hire. Instead, we find that consumers are very price sensitive and care a lot about online reviews of the professionals they want to hire. This is what we find using data from the online platform we study, but we also confirmed this result in a nationally representative survey of consumers.
At the market level, we find that more stringent occupational licensing regulation actually reduces the number of professionals available to any given consumer and increases the prices that consumers are going to pay. This is not surprising. When you are required to attend more years of education, pass more exams, and pay higher licensing fees, fewer home improvement providers are going to enter the profession. What is perhaps more surprising is that the higher scrutiny that comes from stringent regulation does not translate to better quality, at least as measured by customer satisfaction metrics.
Lagace: What does this mean for consumers?
Farronato: It seems that consumers do not consider licensing credentials as an important signal of quality. And this is not because they don’t care about quality. In fact, consumers put a lot of weight on online reviews when hiring service professionals. Our independent consumer survey offers some insights into why consumers may not care about licensing signals.
“For consumer choices, we find that knowing that a professional is licensed does not affect the decision of whom to hire.”
It turns out that consumers know very little about occupational licensing requirements for the services they need. In a sense, consumers hope that the government is doing a good job screening high and low quality professionals. If that were the case, however, we would expect that consumers experience higher quality service in states and occupations with more stringent licensing requirements. But that’s not what we find. If consumers live in a state with stringent regulation, they do not end up more satisfied with their professionals, and instead have to face fewer providers to choose from and higher prices.
Does this mean licensing regulation is useless for consumers? We cannot say for sure, but at least that data we have does not show immediate benefits to consumers, and instead highlight clear costs. I should clarify though, that our analysis cannot be extended to other occupations like lawyers or doctors. I would never want to select my doctor on the basis of online reviews rather than their training and education. I think there is a big distinction.
Lagace: How about for digital platform managers?
Farronato: You want to find the optimal mix of online reputation and government regulation to ensure that people trust each other. A platform has every interest in guaranteeing safe, trustworthy transactions because if buyers and sellers don’t trust each other, they are not going to show up on your website. If consumers don’t trust the service providers who are active on the platform, they won’t go there and the platform won’t get any revenues. So, a platform’s interests are very aligned with the government goals of protecting consumers from risky transactions. I think there is scope for regulators and platform companies to get together and discuss how best to coordinate the information that each of these parties has about service providers.
Lagace: What does this mean for policymakers?
Farronato: I think governments should reconsider occupational licensing regulation. Even if occupational licensing laws were optimally designed decades ago when they were first implemented, it is not obvious to me that the world we live in now—a world where providers’ reputation is more widely available on and offline—requires the same level of licensing stringency. With this study, we can’t say for sure whether governments should reduce the licensing requirements on education, exams, training, or licensing fees. But there is scope for governments to experiment with gradual reductions in licensing requirements, because when we compare customer satisfaction metrics for service quality in states with more stringent and less stringent regulation, we do not see much of a difference.
A big caveat is that we’re looking at consumer satisfaction metrics. We are not measuring adverse events that may happen far down the line in which, say, a roof is installed and ten years later it starts leaking because the professional was not licensed. We also don’t have data to measure risks that do not directly affect the consumer making the hiring decision, but may adversely affect their neighbors.
Lagace: What are you working on next?
Farronato: This is one of two papers I’m currently working on that looks at these complementarities between online reviews and regulation. The other paper looks more at health and safety inspections that health departments conduct of restaurants. That paper highlights the complementarities between reviews and health inspections, and shows how we can combine information that’s available on the online review platforms and information that’s obtained through government regulation to gather more informative signals of restaurant hygiene. I’m also working on other research estimating network effects in online platforms, which will help us understand whether two competing platforms are better for consumers than a single aggregate platform.
About the Author
Martha Lagace is a writer based in Boston.
[Image: nimis69]
Related Reading
- Is Business Management a Profession?
- LEED-ing by Example
- Why Entrepreneurs Must Focus on Building Trust