Blockbuster or Niche? Competitive Strategy under Network Effects

We provide a theory unifying the long tail and blockbuster phenomenon. Specifically, we analyze a three-stage game where the firms first make entry decisions, then decide on the investment in its product and lastly customers sequentially arrive to make purchase decisions based on product quality and historic sales under the network effect. We analytically show that a growing network effect always contributes to the demand concentration on a small number of products. However, product variety and quality investments, as an outcome of firms¡¯ ex-ante competitive decisions, may increase or decrease, as the network effect grows. When the network effect parameter is smaller than a threshold, the increasing network effect would shift more demand towards the products with higher qualities, preempting more products from entering the market ex ante and inducing firms to adopt the blockbuster equilibrium strategy by making larger quality investment. When the network effect is stronger than the threshold, the increasing network effect would make the market easily concentrated to a few products. Even some low quality ones may have chances to become a ¡°hit.¡± Interestingly, in this case, the ex-ante equilibrium product variety would be broader and firms adopt the niche equilibrium strategy by maker smaller quality investment. We empirically test the theory with the movie box office data and find strong supporting evidence.