Digital distribution and the prohibition of resale markets for information goods


An existing theoretical literature finds that frictionless resale markets cannot reduce profits of monopolist producers of perfectly durable goods. This paper starts by presenting logical arguments suggesting this finding does not hold for goods consumers tire of with use, implying the impact of resale is an empirical question. The empirical impact is then estimated in the market for video games, one of many markets in which producers may soon legally prevent resale by distributing their products digitally as downloads or streamed rentals. Estimation proceeds in two steps. First, demand parameters are estimated using a dynamic discrete choice model in a market with allowed resale, using data on new sales and used trade-ins. Then, using these parameter estimates, prices, profits, and consumer welfare are simulated under counterfactual environments. When resale is allowed, firms are unable to prevent their goods from selling for low prices in later periods. The ability to do so by restricting resale outright yields significant profit increases. Renting, however, does not raise profits as much due to a revenue extraction problem.

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  1. 1.

    See Hurt (2009), Rich (2009), Digital Entertainment Group’s “Digital Entertainment Group Year-End 2008 Home Entertainment Sales Figures,” and the International Federation of the Phonographic Industry’s “Recorded Music Sales 2008” report.

  2. 2.

    The first-sale doctrine dates back to an 1854 Supreme Court case, Stevens v. Royal Gladding, which ruled that a cartographer’s right to sole distribution ended at first sale. It was subsequently codified in 1909, and updated in 1976. It has been unclear whether the first-sale doctrine applies to licensed goods. A District Court judge decided in Vernor v. Autodesk in 2008 that permanent licenses constituted sales, and as a result were covered by the first-sale doctrine. In September 2010, the Ninth Circuit Court of Appeals reversed this ruling, determining that firms can legally prohibit resale in their licensing agreement even if they never intended for the good to be returned to them. In 2011, the ninth circuit took the opposite view in Universal Group v. Augusto. Capital records v. ReDigi, currently ongoing, considers whether licensed digital songs can be resold.

  3. 3.

    To resell a downloaded good, one would need to sell the hard drive that contains it. In many cases, this would mean selling the entire device, along with all other information goods downloaded to it. See (Graham 2002; Hinkes 2006; Long 2007; Seringhaus 2009).

  4. 4.

    Firms can enforce prohibited resale with access control software, and following the Digital Millennium Copyright Act (1998) can prosecute creators of software designed to circumvent copyright protection software.

  5. 5.

    In the Balance Act of 2003, Congress considered instituting a digital first-sale doctrine, allowing resale of digital goods via the ”forward and delete” resale method. However, the bill did not pass.

  6. 6.

    For oligopolist producers, Chen et al. (2011) find resale lowers profits.

  7. 7.

    In Japan new game prices do not fall over time. In the U.S. prices fall by roughly half in the first year following release.

  8. 8.

    Leslie and Sorensen (2011) also investigate impact of ticket resale on consumer welfare.

  9. 9.

    The firm can extract full surplus from a single individual by renting if it can condition the rental price on the consumer’s past rental history.

  10. 10.

    Bulow (1982), Hendel and Lizzeri (1999), Rust (1986) show that imperfect durability on its own may lower profits, because owners have the option of keeping a good they purchased earlier rather than returning to the market to buy a new product.

  11. 11.

    Resale can lower producer profits if resale transaction costs exceed primary market transaction costs, or demand fluctuates substantially. See the hide/steers analogy in Benjamin and Kormendi (1974)

  12. 12.

    Papers finding resale lowers firm profits (Anderson and Ginsburgh 1994; Miller 1974) still find resale weakly raises monopoly profits for producers of perfectly durable goods.

  13. 13.

    GameCrazy shared retail space with Hollywood Video. It closed when its parent company, Movie Gallery, declared bankruptcy in 2010.

  14. 14.

    NPD observes over 80 % of point of sales transactions of video games and scales them up to the market.

  15. 15.

    Consumers had several outlets for reselling games, suggesting a competitive market price received for resold (traded-in) games

  16. 16.

    The standard deviation of trade-in prices around the average in the first year following release was $5.67, omitting outliers priced above $100 (\(0.25~\%\) of observations). Differences in trade-in prices across copies of the same game in the same month can have many causes, including market price changing over the month, differences in the perceived quality of auction sellers and the condition of the item (e.g. whether it includes instruction manual), and randomness in number of bidders participating in the auction.

  17. 17.

    Rental revenues in 2011 in the U.S. were approximately $330 million ( Total industry revenues from the U.S. were $16.6 billion (\(_{1}\)20116/).

  18. 18.

    See Nair (2007).

  19. 19.

    These assumptions imply that the firm can condition on the current value of the component of demand not observed by the econometrician, \(\xi _{t}\), but not future ones, when setting prices.

  20. 20.

    When \(\varepsilon_{1}\) and \(\varepsilon_{2}\) follow the type 1 extreme value distribution with location parameter equal to the negative of Euler’s constant, and scale parameter equal to one: \(E\left [\max \left (A+\varepsilon _{1},B+\varepsilon _{2}\right )\right ] =\ln \left (e^{A}+e^{B}\right )\). See Rust (1987), equation 4.12.

  21. 21.

    Note that this is a nontraditional specification of the value function. It (1) does not include the current flow utility, and (2) is specified as the expected maximum utility from next period’s options. Neither difference, however, precludes contraction—one can verify that this function satisfies the monotonicity and discounting sufficient conditions in Blackwell’s Theorem. While one could specify the value function in the traditional way for this problem, doing so would slow estimation considerably because it requires \(\xi _{t}\) be included as a state variable in order to account for its correlation with \(\eta _{t}\). This is because \(\xi _{t}\) cannot be integrated out without knowledge of \(\eta _{t}\), which requires knowledge of \(P_{t-1}\) as well as \(P_{t}\). Hence lagged price, or the price shock, would need to be included as a state variable too in order to integrate out \(\xi _{t}\).

  22. 22.

    When \(\xi \) follows Rust’s conditional independence assumption, the value function is independent of \(\xi \), and the contraction mapping still holds.

  23. 23.

    Nair notes that the the equilibrium is not guaranteed to be unique. However, we both found that multiple starting values converged to the same equilibrium.

  24. 24.

    The sum of marginal costs equals about $140 million, however 87 % of these costs are licensing fees.

  25. 25.

    The result for highly acclaimed games may not generalize to other games. Such games had higher sales and smaller price declines, compared to less highly acclaimed games. However, since highly acclaimed games had a disproportionate share of sales, they might better reflect the overall impact.

  26. 26.

    Average development costs for XBOX360/PS3/PC-based games for one major producer, Ubisoft, average between $18.8 million and $28.2 million. (, accessed Nov 28, 2011).

  27. 27.

    For the 17 games released in the first two months of the dataset, 92 % of profits (in the first 3 years) occur in the first year, on average. Assuming that this holds for all games, then profits from resellable goods are underestimated by about 8 %, not enough to explain the difference in profits when resale is shut down.

  28. 28.

    There are multiple possible definitions for implied rental prices. If it is defined by the cost of buying minus the amount received from selling the product one period later, rental prices decline by about 80 % over the first year.

  29. 29.

    The welfare calculation does not include a third group, used video game retailers, whose profits would increase welfare when resale is allowed. Their profits cannot be estimated because their cost functions are not known.

  30. 30.

    A greater share of revenues are obtained later under the rental pricing strategy, compared with other strategies. Hence, profits under renting decline faster as the discount factor is reduced.


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Corresponding author

Correspondence to Benjamin Reed Shiller.

Additional information

I owe much gratitude to Joel Waldfogel, Katja Seim, and Alon Eizenberg for numerous discussions, suggestions, advice, and generosity with their time. I also thank Ulrich Doraszelski and Lorin Hitt for their helpful input, and the editor and two anonymous referees for insightful comments and suggestions. I also would like to thank Tim Derdenger, Shane Greenstein, Adam Isen, Phil Leslie, Andrew Paciorek, John Riley, David Rothschild, Kent Smetters, Rahul Telang, and Jeremy Tobacman for their suggestions, and Hamilton Chu, David Edery, and Marc Mondhaschen for imparting to me some of their wisdom on the video game industry. I am also grateful for support received from the NBER program on digitization which is kindly funded by the Sloan Foundation.



Evidence that games are not substitutes

Nair (2007) argued that because “each game is fairly unique, having its own distinct features, characters and idiosyncrasies,” they are likely not substitutes for one another. Empirical results showed (1) that there are no statistically significant cross-price effects within genre, (2) neither sales nor prices are significantly impacted by hit game releases in the same genre, and (3) that concentration in a genre does not significantly impact the rate at which prices decline. However, Derdenger (2011) yielded opposing results when investigating other 6th generation consoles.

To test whether XBOX 360 video games in the data are substitutes, I employ a static nested logit regression similar to previous papers (Nair 2007; Derdenger 2011), where genre determines the nest. Following their specification, I regress:

$$ \ln( s_{jt}/s_{0t}) =\alpha_{j}+\omega_{t}+\lambda( t-r_{j}) +\beta P_{jt}+\sigma\ln( s_{jt|g}) +\varphi_{jt} $$

where \(s_{jt}\) and \(s_{0t}\) are the shares of game j and the outside good in period t, respectively, \(\alpha _{j}\) and \(\omega _{t}\) are game and month fixed effects, \(r_{j}\) is the release date of game j, \(P_{jt}\) is the price, \(s_{jt|g}\) is game j’s share of genre g sales, and \(\varphi _{j,t}\) is an error term. Following earlier papers (Derdenger 2011; Nair 2007), I set the market size to the cumulative installed base of XBOX 360 console owners. The value of the parameter \(\sigma \) determines the extent to which games are substitutes for one another. A value close to zero, rather than a higher positive number close to 1, denotes that the nests are largely irrelevant and hence games are not substitutes for one another.

Two right-hand size variables in Eq. 23 above, price (\(P_{jt}\)) and the within-genre share of sales (\(s_{jt|g}\)), are likely endogenous. To address this concern, I instrument for them using the lagged price and the number of games in the genre.

The results are shown in Table 7. The sample is restricted to games with the highest quintile of critic scores. The first three columns in Table 7 employ OLS, and the second three employ 2SLS. Note that once the instruments are included, the estimated values of \(\sigma \) are negative and insignificant, strongly suggesting that games are not substitutable for one another.

Table 7 Nested logit estimation of substitutability

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Shiller, B.R. Digital distribution and the prohibition of resale markets for information goods. Quant Mark Econ 11, 403–435 (2013).

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  • Resale
  • Secondary market
  • Digital
  • Downloads
  • Renting
  • Streaming

JEL Classifications

  • M30
  • L00
  • K19