Blockbuster or niche? : competitive strategy under network effects

We provide a theory that unifies the long tail and blockbuster phenomena. Specifically, we analyze a three-stage game where, first, a large number of potential firms make entry decisions, then those who stay in the market decide on the investment in its product, and lastly customers with heterogeneous preferences arrive sequentially to make purchase decisions based on product quality and historic sales under the network effect. We show analytically that a growing network effect always contributes to more sales concentration on a small number of products, supporting the blockbuster phenomenon. However, product variety and investments in quality, as an outcome of firms' ex ante competitive decisions, may increase or decrease, as the network effect grows. When a parameter that determines the strength of the network effect is below a particular threshold, an increasing network effect would shift more sales towards the products with higher quality, preventing more products from entering the market ex ante and inducing firms to adopt the blockbuster equilibrium strategy by making high-budget products. When the parameter is above the threshold, the network effect will easily cause the market to be concentrated to a few products; even some low-quality products may have a chance to become a "hit." Interestingly, in this case, when the network effect is growing, the ex-ante equilibrium product variety will be broader and firms adopt the niche equilibrium strategy by making low-budget products, a finding which supports the long tail theory. We test the theory with the movie box office data and find strong supporting evidence