Social learning and optimal advertising in the motion picture industry

Social learning is thought to be a key determinant of the demand for movies, the decisions about whether and when to watch a movie. Through social learning, potential movie-goers learn about the quality of a movie from people who have watched the movie. For example, critics, word-of-mouth referrals and the box office performance may offer potential movie consumers some exposure to the quality of a movie prior to making their choices. This can be a double-edged sword for motion picture distributors: when a movie is good, social learning can enhance the effectiveness of movie advertising, but when a movie is bad, it can mitigate the effectiveness. This paper develops an equilibrium model of consumers' movie-going choices and movie distributors' advertising decisions. I develop a structural model for studios' optimal advertising strategies, taking into account the expected social learning process, and a model for consumers' movie demand, given an initial indicator of movie quality (critic ratings) and an initial level of advertising. Consumers are assumed to have uncertainty about movie quality that is resolved over time through Bayesian updating. That process depends on the number of previous viewers and their ratings reported over the Internet. I estimate the model parameters using data pertaining to 236 movies that were shown in theaters nationwide in the U.S. between January 1, 2002 and December 31, 2003. After estimating the model, I use it to explore how changes in advertising influence box office performance, dynamic social learning and movie-going patterns, and ultimately the revenue stream of each movie. The empirical results show that social learning has a positive multiplier effect on movie advertising, with the multiplier effect being strongest for good movies. The simulation of the effects of social learning relative to a world without learning shows that for good movies, producers spend substantially more on advertising when there is learning than they would if there were not learning. For bad movies, social learning makes much less difference to the level of advertising expenditure. Thus, the movie distributor's advertising expenditures are sensitive to both consumer uncertainty about movie quality and the speed with which potential movie-goers learn about movie quality.