Your PS3 is an all-in one entertainment system. It's not only a Blu-ray player, but a handy AVI player as well. It's not straightforward though. My experimenting revealed a few things:

1. The thumb drive’s file system must be FAT32. If it's exFAT, NTFS, your PS3 won't recognize it.
2. The ideal format is AVI-XVID. (To determine format, install the program "Any Video Converter" from CNET and drag your movie into the main panel.)
3. MPG will also play fine, however full-length MPG movies tend to be huge and FAT32 can only support a max of 4GB.
4. Some files in AVI-DX50 do play properly, while some do not.
5. MP4 will play, but the audio may be out of sync.
6. To view your movies, go to Videos. You should see your drive there. If you press O and it says "There are no titles", press X, then the triangle button. A side bar will open. Choose "Display All".

Enjoy watching movies with your PS3!

PS. If you intend to watch videos with subtitles, there's some work involved. Check here.