Digital distribution and the prohibition of resale markets for information goods

Abstract

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.

Appendix

1.1 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:

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

(23)

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