Piracy and Competition

The effects of (private, small-scale) piracy on the pricing behavior of producers of information goods are studied within a unified model of vertical differentiation. Although information goods are assumed to be perfectly horizontally differentiated, demands are interdependent because the copying technology exhibits increasing returns to scale. We characterize the Bertrand-Nash equilibria in a duopoly. Comparing equilibrium prices to the prices set by a multiproduct monopolist, we show that competition drives prices up and reduces total surplus.information goods, piracy, copyright, pricing

Advertising and Price Signaling of Quality in a Duopoly with Endogenous Locations

We analyze a two-sender quality-signaling game in a duopoly model where goods are horizontally and vertically dierentiated. While locations are chosen under quality uncertainty, firms choose prices and advertising expenditures being privately informed about their types. We show that pure price separation is impossible, and that dissipative advertising is necessary to ensure existence of separating equilibria. Equilibrium refinements discard all pooling equilibria and select a unique separating equilibrium. When vertical differentiation is not too high, horizontal differentiation is maximum, the high-quality firm advertises, and both firms adopt prices that are distorted upwards (compared to the symmetric-information benchmark). When vertical differentiation is high, firms choose identical locations and ex post, only the high-quality firm obtains positive profits. Incomplete information and the subsequent signaling activity are shown to increase the set of parameters values for which maximum horizontal differentiation occurs.advertising; location choice; quality; incomplete information; multi-sender signaling game

Vertical Product Differentiation When Quality is Unobservable to Buyers

We analyze vertical product differentiation in a model where a good’s quality is unobservable to buyers before purchase, a continuum of quality levels is technologically feasible, and minimum quality is supplied under competitive conditions. After purchase the true quality of the good is revealed with positive probability. To provide firms with incentives to actually deliver promised quality, prices must exceed marginal cost. We derive sufficient conditions for these incentive constraints to determine equilibrium prices, and show that under certain conditions only one or both of the extreme levels of quality, minimum and maximum quality, are available in the market.experience goods, product differentiation, product quality, asymmetric information

Piracy and competition

The effects of (private, small-scale) piracy on the pricing behavior of producers of information goods are studied within a unified model of vertical differentiation. Although information goods are assumed to be perfectly differentiated, demands are interdependent because the copying technology exhibits increasing returns to scale. We characterize the Bertrand-Nash equiliria in a duopoly. Comparing equilibrium prices to the prices set by a multiproduct monopolist, we show that competition drives prices up and may lead to price dispersion. Competition reduces total surplus in the short run but provides higher incentives to create in the long run.Information goods; piracy; copyright; pricing

Nonlinear pricing of information goods

This paper analyzes optimal pricing for information goods under incomplete information, when both unlimited-usage (fixed-fee) pricing and usage-based pricing are feasible, and administering usage-based pricing may involve transaction costs. It is shown that offering fixed- fee pricing in addition to a non-linear usage-based pricing scheme is always profit-improving in the presence of any non-zero transaction costs, and there may be markets in which a pure fixed-fee is optimal. This implies that the optimal pricing strategy for information goods is almost never fully revealing. Moreover, it is proved that the optimal usage-based pricing schedule is independent of the value of the fixed- fee, a result that simplifies the simultaneous design of pricing schedules considerably, and provides a simple procedure for determining the optimal combination of fixed-fee and non-linear usage-based pricing. The introduction of fixed-fee pricing is shown to increase both consumer surplus and total surplus. The differential effects of setup costs, fixed transaction costs and variable transaction costs on pricing policy are described. These results suggests a number of managerial guidelines for designing pricing schedules. For instance, in nascent information markets, firms may profit from low fixed-fee penetration pricing, but as these markets mature, the optimal pricing mix should expand to include a wider range of usage-based pricing options. The extent of minimum fees, quantity discounts and adoption levels across the different pricing schemes are characterized, strategic pricing responses to changes in market characteristics are described, and the implications of the paper's results for bundling and vertical differentiation of information goods are discussed.nonlinear pricing, screening, digital goods, information goods, fixed-fee, usage-based pricing, transaction costs

Entry and Innovation in Vertically Differentiated Markets

This paper analyzes the optimal entry into experience goods markets with vertically differentiated buyers. We consider the case where the value of the new product is imperfectly known, but common to all buyers (common values) as well as the case where the quality is different across buyers (private values). We distinguish between new products that are improvements to existing products and new products that are substitutes. Different types of products have qualitatively distinct diffusion paths. Improvements are introduced slowly relative to the full information case, while substitutes are introduced more aggressively. The slow entry strategy is associated with increasing supply and decreasing prices over time. The reverse pattern holds for an aggressive entry strategy The incentives to innovate display a similar distinction. A firm with a currently inferior product opts for a large but risky innovation, whereas a currently superior producer chooses a smaller but certain innovation.Experience goods, vertical differentiation, entry, innovation

Entry and Vertical Differentiation

This paper analyzes the entry of new products into vertically differentiated markets where an entrant and an incumbent compete in quantities. The value of the new product is initially uncertain and new information is generated through purchases in the market. We derive the (unique) Markov perfect equilibrium of the infinite horizon game under the strong long run average payoff criterion. The qualitative features of the optimal entry strategy are shown to depend exclusively on the relative ranking of established and new products based on current beliefs. Superior products are launched relatively slowly and at high initial prices whereas substitutes for existing products are launched aggressively at low initial prices. The robustness of these results with respect to different model specifications is discussed.Entry, Duopoly, Quantity Competition, Vertical Differentiation, Bayesian Learning, Markov Perfect Equilibrium, Experimentation, Experience Goods

Entry and Vertical Differentiation

This paper analyzes the entry of new products into vertically differentiated markets where an entrant and an incumbent compete in quantities. The value of the new product is initially uncertain and new information is generated through purchases in the market. We derive the (unique) Markov perfect equilibrium of the infinite horizon game under the strong long run average payoff criterion. The qualitative features of the optimal entry strategy are shown to depend exclusively on the relative ranking of established and new products based on current beliefs. Superior products are launched relatively slowly and at high initial prices whereas substitutes for existing products are launched aggressively at low initial prices. The robustness of these results with respect to different model specifications is discussed. Classification-JEL: C72, C73, D43, D83 Keywords: Entry, Duopoly, Quantity Competition, Vertical Differentiation, Bayesian Learning,Markov Perfect Equilibrium, Experimentation, Experience Goods

Market Segmentation for Information Goods with Network Externalities

Positive externalities characterize the consumption of a majority of information goods such as software, various Internet services, and online communities. In a simple model of vertical differentiation, we show that network externality is a critical factor for the versioning of such information goods. In particular, a multi-product monopolist offers two versions of distinct qualities. The underlying rationale is that offering the low-end version expands the network size and thus enhances the (network) value of the high-end version, allowing the firm to charge a higher price for the high-end version. In addition, we show that the low-quality version may be offered for free under very general conditions. Competition between firms producing compatible products reduces their incentive to version their products due to the spillover effects in a shared product network.Information Systems Working Papers Serie

Differentiated Networks: Equilibrium and Efficiency

We consider a model of price competition in a duopoly with product differentiation and network effects. The value of a good for a consumer is the sum of a common and an idiosyncratic component. The first captures the vertical dimension of quality, the second captures horizontal differentiation. Each consumer privately observes his own value for each good, but cannot separate the common and the idiosyncratic component. Therefore, he has incomplete information about the value of the goods for the other consumers. After firms announce prices, consumers choose simultaneously which network to join, facing a coordination problem. In the efficient allocation, both networks are active and the firm with the highest expected quality has the largest market share. To characterize the equilibrium allocation, we derive necessary and sufficient conditions for uniqueness of the equilibrium of the coordination game played by consumers for given prices. The equilibrium allocation differs from the efficient one for two reasons. First, the equilibrium allocation of consumers to the networks is too balanced, since consumers fail to internalize network externalities. Second, if access to the networks is priced by strategic firms, then the product with the highest expected quality is also the most expensive. This further reduces the asymmetry between market shares and therefore social welfare.