Blockbuster or Long Tail? Competitive Strategy Under Network Effects

Abstract

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 choose to stay in the market decide on the number of products to offer and the investment level in each product, and lastly customers with heterogeneous preferences arrive sequentially to make purchase decisions based on product quality and historical 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 quality investment, as an equilibrium outcome of firms' ex ante competitive decisions, may increase or decrease, as the network effect grows. When the strength of the network effect is below a threshold, an increasing network effect would shift more sales towards those products with higher quality, preventing more products from entering the market ex ante and inducing firms to adopt the blockbuster equilibrium strategy by making a small number of high-budget products. When the strength of the network effect 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 long tail equilibrium strategy by making a (relatively) large number of low-budget products, a finding which supports the long tail theory.

Keywords: long tail, blockbuster, product variety, network effect, competitive strategy

JEL Classification: C72, D43, L11, L25, M21