Where are you going for dinner tonight?

It has happened countless times to everyone with a smartphone. You are out with your friends, suddenly you decide you want to go to eat and, as utility maximizers that we are, we look to make a "good", well-informed decision, i.e., we go to Yelp and see what others have to say about nearby places. As a restaurant owner, the next natural question follows: How much ($) is a Yelp star worth?

Michael Luca, an Assistant Professor at the Harvard Business School, just published a paper that analyzes what the impact of restaurants' Yelp ratings are on their revenue. Here is the abstract or summary of the paper:

"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." 

The idea that I liked the most is that people are going back to traditional ways of reputation/recommendation mechanisms. Chain restaurants used to be a safe bet, but now that you have Yelp to offer you good, local options, it's easier to be willing to try other options. One more benefit of having so much information, so handy. Awesome. Also, pretty cool that somebody could actually quantify the results with a formal model.

If you want to know more, but don't want to read the paper itself, there is an article about it here.


(via Prof. Al Roth's Market Design blog)