Do online consumer reviews affect restaurant demand?

One of the more difficult questions in social media is the degree to which online reviews impact upon the bottom line of businesses; and whether bad online reviews cause declining patronage. Harvard Business School’s Michael Luca says yes, and very much so [PDF]. There is not only an impact, but that impact is causal:

Do online consumer reviews affect restaurant demand? I investigate this question using a novel dataset combining reviews from the website Yelp.com and restaurant data from the Washington State Department of Revenue. Because Yelp prominently displays a restaurant’s rounded average rating, I can identify the causal impact of Yelp ratings on demand with a regression discontinuity framework that exploits Yelp’s rounding thresholds. I present three findings about the impact of consumer reviews on the restaurant industry: (1) a one-star increase in Yelp rating leads to a 5-9 percent increase in revenue, (2) this effect is driven by independent restaurants; ratings do not affect restaurants with chain affiliation, and (3) chain restaurants have declined in market share as Yelp penetration has increased. This suggests that online consumer reviews substitute for more traditional forms of reputation. I then test whether consumers use these reviews in a way that is consistent with standard learning models. I present two additional findings: (4) consumers do not use all available information and are more responsive to quality changes that are more visible and (5) consumers respond more strongly when a rating contains more information. Consumer response to a restaurant’s average rating is affected by the number of reviews and whether the reviewers are certified as “elite” by Yelp, but is unaffected by the size of the reviewers’ Yelp friends network.

It is pretty grim news, if you’ve spent the last hundred or so years building up the strength of a chain restaurant’s brand, only to find that increased reviewing is replacing your hard-earned equity. The recognition that certified reviewers actually do have a greater impact in systems like Yelp raises further questions whether these “elite” users follow the crowd or lead it. Duncan Watts and Matthew J. Salganik have done some great research into this, in which perceived success of cultural products online translates into actual success regardless of content, so it is altogether possible that people who contribute online reviews continually reinforce each others reviews for the good or ill of businesses.

Hat tip to Adam Ozimek from Modeled Behavior for the article.

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