A new working paper by Michael Luca estimates the effect of Yelp reviews on Seattle restaurant revenues. Disentangling causality here is difficult, as even if reviews have no effect on revenues we would expect to observe reviews and revenues both moving with changes in underlying relative quality. Luca exploits a quirk in the way Yelp presents information: average scores are reported rounded in 0.5 star bins on a 5 star scale. For example, underlying average scores of 2.76 and 3.24 are both reported as “3 stars,” but a good review which bumps the average up to 3.25 bumps the reported score up to 3.5 stars. The estimates show that Yelp reviews do have a substantial effect on revenues.
An increase in average rating of one star increases revenues by about 9% ( p < 0.05 ).
However, the point estimate for chains is neither economically nor statistically distinguishable from zero, which makes sense since the purpose of chains is to reduce quality uncertainty. The paper shows higher Yelp penetration is associated with a decrease in chain market share, that is, Yelp is appears to harm chains and help independent restaurants. Hurray for Yelp!