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Consumer Search and Retailer Strategies in the Presence of Online Music Sharing

Author(s): Sudip Bhattacharjee, Ram D. Gopal, Kaveepan Lertwachara and James R. Marsden
Source: Journal of Management Information Systems, Vol. 23, No. 1 (Summer, 2006), pp. 129159
Published by: Taylor & Francis, Ltd.
Stable URL: http://www.jstor.org/stable/40398829
Accessed: 14-01-2016 12:34 UTC
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ConsumerSearch and Retailer


Strategiesin thePresenceof
OnlineMusic Sharing
RAM D. GOPAL,
SUDIP BHATTACHARJEE,
KAVEEPANLERTWACHARA,AND JAMESR. MARSDEN
in theDepartment
of Operations
Sudip Bhattacharjee is an AssociateProfessor
attheSchoolofBusiness,University
ofConnecticut.
andInformation
Management
lie in thedesignand analysisof distributed
Dr. Bhattacharjee's
researchinterests
economicsof information
His resystems,and supplychainintegration.
systems,
in variousjournalssuchas Journalof
searchhas beenpublishedor is forthcoming
onComputing,
Communications
INFORMSJournal
Business,
oftheACM,IEEE Transactions,DecisionSupportSystems,
EuropeanJournalofOperationalResearch,and
invariousmediaoutletssuchas Conhasbeenhighlighted
otheroutlets.His research
BusinessWeek,Washington
necticut
PublicTelevision,
Post,Der Spiegel,Christian
and
others.
ScienceMonitor,
slashdot.org,
ofBusinessintheDepartment
ofOperaRam D. Gopal is a GE EndowedProfessor
at
of
the
School
of Contionsand Information
Business,
Management
University
includeeconomicsof information
researchinterests
necticut.His current
systems
tointellectual
datasecurity,
economicandethicalissuesrelating
propmanagement,
His researchhas appearedin Management
markets.
Sciand electronic
ertyrights,
Journal
ence,JournalofManagement
Research,
Systems,
Operations
Information
of
ComResearch,INFORMSJournalon Computing,
Business,Information
Systems
on Knowledgeand Data Engineering,
munications
oftheACM,IEEE Transactions
andotherjournalsandconference
DecisionSupportSystems,
proceedings.
of Information
Kaveepan Lertwachara is an AssistantProfessor
Systemsat the
StateUniversity.
He receivedhis
OrfaleaCollegeofBusiness,California
Polytechnic
in 2004. His reof Connecticut
Ph.D. in Information
SystemsfromtheUniversity
onlinedataretrieval,
andeconomicsof
includeelectronic
searchinterests
commerce,
information
systems.
holdstheTreibick
JamesR. Marsden is a BoardofTrustees
Professor,
Distinguished
and Head of theDepartment
of
FamilyEndowedChair,and servesas a Professor
at theSchool of Business,University
of
and Information
Management
Operations
Dr.Marsdenalso servesas theExecutiveDirectorofboththeConnectiConnecticut.
Institute
andtheTreibickElectronicCommerceInitiacutInformation
Technology
withGE. Dr.
theUConn Directorof edgelab,a partnership
tiveand is currently
and analyses,ecorecordin marketinnovation
Marsdenhas a lengthy
publication
and production
His research
artificial
nomicsof information,
intelligence,
theory.
Journal
workhas appearedin Management
Science,
of ManagementInformation
IEEE Transactions
onSystems,
American
Economic
Man,and Cybernetics,
Systems,
Summer2006,Vol.23, No. 1,pp. 129-159.
JournalofManagement
Information
Systems/
2006 M.E. Sharpe,Inc.
0742-1222 /2006 $9.50 + 0.00.

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130

BHATTACHARJEE,GOPAL, LERTWACHARA, AND MARSDEN

InteJournalofEconomicTheory,
JournalofPoliticalEconomy,
Review,
Computer
otheracaandnumerous
DecisionSupportSystems,
gratedManufacturing
Systems,
demicjournals.
haveopened
andbandwidth
Abstract: Advancesinonlinetechnologies
availability
forconsumbenefits
newvistasforonlinedistribution
ofdigitalgoods,butpotential
one typeof
ersarejuxtaposedagainstchallengesforretailers.
Here,we investigate
includestheveryreal
environment
good- music- whosemarket
digitalexperience
aboundforandagainstonlinedistriarguments
presenceofonlinepiracy.Although
existsinthisarea.Wedevelopa modelof
butionofsuchdigitalgoods,littleresearch
market
consumersearchforsuchan experience
emerging
good,and studydifferent
forretailers,
whereconsumers
canpiratemusiconline.Retailercostto
environments
oflicensingschmas.Surveyresults,
is modeledusinga variety
together
publishers
are utilizedto validatea keyassumption.
withdatafromonlinesharingnetworks,
thatcannotbe obtained
analysisis used to developinsights
Finally,computational
Ourresultsindicatethatdecreasing
equivalent
piracyis notnecessarily
analytically.
fora
can provideadditionalprofits
to increasing
andonlinesellingstrategies
profit,
for
We showthatleadingstrategies
traditional
retailer
eveninthepresenceofpiracy.
search
businessin suchgoods shouldincludepricingoptions,provisionofefficient
tools,andnewlicensingstructures.
Key words and phrases: digitalexperience
goods,license,music,onlinechannels,
search.
piracy,sampling,

Emergingtechnologies often result in newopportunities,


choices,andpossibilities.Advancesin Internet
haveopenednewchannelsforonlineretechnologies
can be utilizedforunauthorized
tailingof digitalgoods. But thesame technology
a
and
dissemination.
The
online
retailer
of
copying
digitalgoodthusfacestwochalthe
and(2) analyzing
a businessmodelina newenvironment
lenges:(1) determining
on profit.
licensestructures
impactofpiracyanddifferent
of one digitalgood- music.The
Here,we presenta formalanalysisforretailers
as predicted
nature
of
music
offers
convenience
and portability,
by
digital
today's
Alexander[2],butalso raisesthespecterofpiracyandlostsales.In fact,theeconomics of music,themarketstructure,
and theimpactofpiracyhas beenthesubjectof
current
studies[1,3, 4, 11,16,17,27,28,45,47]. Musicis anexperience
good,a type
ofhedonicproductwhosevaluationis basedon theexperienceitprovidesto a consumer[18]. A musicitemmustbe experienced
valuedbya
(heard)to be accurately
consumer.
eachmusicitem,evenfrom
is potentially
thesameartist,
Moreover,
unique.
Whilephysicalpiracyof digitalmusic(through
in
be
common
certain
CDs) may
our
focus
is
on
those
markets
where
broadband
connections
markets,
increasing
providethemeansforlegalonlinemarkets
whileat thesametimeenablingonlinesharor P2P).
networks,
ingandpiracy(mainlythrough
peer-to-peer

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CONSUMER SEARCH AND RETAILER STRATEGIES IN ONLINE MUSIC SHARING

13 1

Retailerbusinessmodelsandpricing
good
optionsinsuchonlinedigitalexperience
hereis notintendedto
have notbeen widelystudied.The workreported
markets
- ourgoalis
theefficacy
ofonlinepiracy
addresslegalissuesorviewpoints
regarding
under
We examinetheconditions
markets.
to thedebateon electronic
to contribute
the
that
it
be
case
elecretailers.
Could
benefit
networks
whichonlinesharing
might
increased
consumers
foster
tronicmusicsharing/piracy
by
searching
optionsactually
theproductpriorto makingthepurchasedecision?Is itposseekingto experience
is linkedto increasedsales andthusincreasedbenefits
siblethatincreasedsearching
towardonlinesamplingas
In fact,thereis anecdotalevidencepointing
forretailers?
sales [13, 33, 38]. In addition,thereis some indicationthatthemusic
increasing
cannotbe closeddownbylegalmeansalone.
is realizingthatthesenetworks
industry
and
needsto developnewbusinessmodels,pricingstrategies,
theindustry
In short,
licensingschema[7, 30, 53].
We developa modelof consumersearchforsucha hedonicproductwhereeach
the
Wevalidatea keyassumption
itemmight
regarding
producea uniqueexperience.
froman illegallyobtainedsharedmusicitemveroveralllowerqualityofexperience
on a
on sharingactivity
sus a legallyobtainedoriginalusing(1) data we gathered
and(2) resultsofa surveywe conducted.
Utilizingthisconsumer
majorP2P network
retailerof
modelsfora monopolistic
searchprocess,we analyzea seriesof market
which
suchdigitalgoods,
environments,
pricingoptions,and lidiffering
represent
brick-and-mortar
Ourmodelsincludethetraditional
retailer,
censingarrangements.
an onlineretaileroffering
subscription
perunitpricing,an onlineretaileroffering
bothtypesofpricingoptions.Ourtheoretical
andan onlineretailer
offering
pricing,
a retailer
certain
resultssuggestthat,under
conditions,
mayactuallydo betterin an
use ofdownloadsas a meansof
withpiracy,largelydue to consumers'
environment
both
from
an onlinemodeloffering
that
revenues
find
We
sampling.
prepurchase
models
studied.
online
other
dominate
unit
and
However,
pricing
subscription per
solutionsundervariouslicensing
do nothaveclosed-form
profits
pricingandretailer
We conductcomputational
andpiracyenvironments.
structures
analysesto studythe
- in the
variables
and environment
factors
controllable
of theseretailer
interactions
absenceof publiclyavailableempiricaldata- to gaininsightsintotheseand other
someofwhicharenotyetavailabletoconsumers.
onlinemarket
scenarios,
emerging
foran existing
are: (1) onlinesellingstrategies
Keyresultsfromtheseexperiments
even underpiracyenvironments,
retailercan provideadditionalprofits
traditional
to legalonlinemarconsumers
areessentialto attract
searchtechniques
(2) efficient
and (4) lisolutionsdo notoccurin theabsenceofpiracy,
kets,(3) maximum
profit
have
a
with
music
retailers
online
of
cost
structures
significant
publishers
censing
impacton pricingandprofits.

Review
Literature
andconPrevious research on experiencegoods, sharedgoods,software
piracy,
sumersearchprocessesall helpedto shapeourmodelingand analysis,butthereare
similarities
we notelimited
thatsetourworkapart.Inthefollowing,
differences
critical

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132

BH ATTACHARJEE,GOPAL, LERTWACHARA, AND MARSDEN

differences
thatledustodevelop
critical
withthesebodiesofworkwhileemphasizing
music
markets.
newmodelsforanalyzing
digital

on Sharing
ofRestrictions
ExperienceGoodsandAssumption
focusesonmodelsrelatedtophysical
onexperience
research
goodsprimarily
Existing
is not
where
that
conditions
at
a
location
is,
sharingor redistribution
goods
given
Oi
ofentertainment
market
goods, [43]
experience
easy.Focusingon a monopolistic
locations
ofthegoodacrossdifferent
orredistribution
assumedthatsharing
implicitly
witha
dealt
but
on
a
focused
was difficult.
[50]
good,
personalexperience
Shapiro
Additional
oftheproduct.
to theresaleandredistribution
scenariowithimpediments
relatedstudiesincludeGale andRosenthal[19],HolbrookandSchindler
[31],Jedidi
et al. [32], Liebeskindand Rumelt[36], and Riordan[48]. Whilethedigitalmusic
andredisofbroadsharing
markets
we studyinvolveexperience
goods,thepossibility
in
those
from
different
market
makes
these
tribution
previousstudies.
quite
dynamics

EconomicModelswithSubscription
Pricing
Modelson economicsofsubscription
pricingandsharedgoodshaveusuallyfocused
In
occurs
whereprivate
onproducts
amongonlya smallgroupofconsumers.
sharing
GlazerandHassin[22] andOrdoverand
market,
analyzingthejournalsubscription
do notsharejournals.
or subscribers
individual
customers
assumed
that
[44]
Willig
a consumer's
and
examined
model
extended
the
and
subscription
Coyte
Ryan[15]
of
an
a
decisionto purchaseor renew subscription information
good a book.Borand
has a timelimitation,
book has low cost,butsuchborrowing
rowinga library
downloaded
a
the
other
in
limited
On
can
occur
a
hand,
digital
way.
sharing only
and
can be ownedpermanently
servicepotentially
musicfilefroma subscription
sharedwidely.

- IssuesofQualityand
Software
Piracy
Ease ofDissemination
decisionstopurWhileseveralstudieson software
piracyhaveexaminedconsumer
music
chaseorpiratetheproduct[14,21, 24, 25, 26],severalkeyfactors
distinguish
fromsoftware.
Musicfilesaretypically
muchsmaller(andthuseasiertocopy)than
in ourstudyis thequalityof the
software.
Another
difference
computer
important
sharedgood.Theacousticqualityoforiginalmusic(high-quality
media)is
recording
items
for
music
better
thanthatofa compressed
format
typical
digitalmusicfile,the
lossless
ontheotherhand,requires
sharedorpirated
online.Sharedcomputer
software,
of
volume
for
the
[8].
large
compression properfunctioning Finally,given extremely
of
market
musicfilesavailableonline,a searchprocessshouldbe an integral
part
inthisarena.As theliterature
indicates(see,e.g.,[8]),thisdoes
analysisandresearch
notappeartobe thecase foronlinesharingorpiracy.

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CONSUMER SEARCH AND RETAILER STRATEGIES IN ONLINE MUSIC SHARING

133

SearchProcessandCosts- WhyIs DigitalMusicDifferent?


Searchcostshavebeenwidelystudiedin theliterature
(see, e.g., [12, 20, 51, 52]).
different
Nelson[42] modeleda consumerwho searchesthrough
brandsof canned
brand.Once thecontunafish(a prototypic
experiencegood) to findherfavorite
forhernext
sumerfindsthebrandshe likes,she no longerneedsto searchfurther
be
to
have
the
since
the
same
brand
would
same
taste
overtime.
expected
purchase
inthemarketing
interest
ofhedonicproducts
Whiletherehasbeenincreasing
[34,46,
different
49], we suggestthatthesearchprocessfordigitalmusicis significantly
froma prototypical
searchprocess.Each piece of musicalperformance
containsits
Fora consumer,
and
a
music
itembya
ownuniquecharacteristics.
searching finding
likesis noguarantee
thatthenextmusicitembythe
artist
thattheconsumer
particular
likedby theconsumer(havethesame
sameartist(readbrand)wouldbe similarly
witha largevolumeofmusicitemsavailable,sug"value").Thisvariability,
together
to
additionalsearchesforadditionalprodare
geststhatconsumers likely perform
fromthatmodeledinearlierstudies.
ucts,a processquitedifferent
oftheproduct,
to
In sum,differences
potential
permanence
relating ease ofsharing,
and
differthatsetmusicfilesapartfromcomputer
characteristics
software, a rather
of new modelsspecifically
forthe
entsearchprocesslead us to thedevelopment
evolvingdigitalmusicmarket.

ModelingMusicMarketEnvironments
whosearchtoevaluateandobtainmusic.The
FACESCONSUMERS
A MUSICRETAILER
whomaydecidetopurchaseorpiratea number
of
searchprocessinvolvesconsumers
choicesoftheretailer.
theprofit-maximizing
affect
musicitems,whichcan directly

ModelsofConsumerSearchProcess
Consumerssearchto evaluateand obtainmusic.Each searchinvolvesa consumer
is not
a newmusicitem.Ourconsumer
andexperiencing
for,identifying,
searching
the
search
with
recommendations
but
start
search1
a
directed
process
may
pursuing
aboutmusicitemsthathe or she shouldconsider.A
or musicreviewers
by friends
and experience
a newmusic
consumerstartsthesearchprocessin orderto identify
n searches,
heorshewouldhave
ifa consumer
item.Inourrepresentation,
completes
fromthetypicalbestoption,singlemusicitems.Thisdiffers
n different
experienced
in
literature
the
itempurchaserepresented
set,resusingconceptsofa consideration
andan orderedsearch[41]. Followingbasiceconomictheory
ervation
utilities,
(e.g.,
is seekingto maximizeutility
bychoosinga set
[37]), we assumethattheconsumer
withina budgetconstraint
of musicitemswhileremaining
specificto thattypeof
good.
thereare(1) nontrivial
coststosearch,evaluate,andobtain
Ineachmodelwe study,
forconsumers
to piratemusic(exceptin thebase case
musicand (2) opportunities

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134

BHATTACHARJEE,GOPAL, LERTWACHARA, AND MARSDEN

hasa rangeofvaluestheywouldplaceonthe
model).Weassumethateachconsumer
musicitemsunderconsideration.
Notationally,
v= valuethatconsumer/placeson
andtakeson a discretesetof
E [0, V,max]
wherev/;afterexperiencing,
musicitem./
is individualfs maximumvalueforanymusicitem
valuesin theset[0, V/*].
V,max
seller.
offered
the
by
or
offers
We assumethatthemusicretailer
CD-qualitymusic,eitherelectronically
of a musicitemifitis obtained
on a physicalCD. We also allowdifferential
utility
we use
factor.
of
on
a
based
versus
Notationally,
experience"
"quality
illegally
legally
be
it
to
assume
and
ifthemusicitemis procured
as a multiplier
homogeillegally,
ofModelingAssumption
neousacrossconsumers
section,where
(see theValidation
/downForexample,ifconsumer
oftheseassumptions).
we offerinitialvalidation
valueof
heorshewouldreceivea utility
loadedsongj fromanonlineillegalchannel,
(1) loweracousticqualityof musicat
Vjj.The factor can be viewedas capturing
servicesthata retailer
(2) value-added
technologies,
illegalsitesduetocompression
an
atillegalsites,(3) thefactthata useris undertaking
thatarenotoffered
offer
might
files
from
or
(see,
e.g.,
downloading
polluted
illegalactivity, (4) possibledisutility
thediscussionin [35] aboutpossibleproducer-created
pollutedmusicfiles).Weconsidervaluesfor overtherange0 < < 1.
SearchCost
Because thegoodson whichwe
activities.
Searchesare,by theirnature,uncertain
valueonlyafter
individual
attach
can
a
consumer
focusareexperience
experigoods,
availablemuof
the
volume
commercially
to) an item.In addition,
encing(listening
releaseover27,000newalbumseveryyear
sic is vast.Themajorlabelsbythemselves
is awareofall musicitemsavailable.The
[23]. Hence,we assumethatno consumer
a setof music
knows(has identified)
individual
somehow
case
is
where
an
limiting
knows
the
itemsandhas sufficient
songandjust
already
knowledge(i.e., consumer
is zero.
wantsto obtainit)so thatuncertainty
a
a consumer
Each searchinvolvesprocessing
querywitha searchtool.Potentially,
channel
each
a
to
conduct
use
three
different
channels
consumer
search,
having
may
a different
searchcost.We considereach inturn:
Traditional:
thesearchin a typicalbrick-and-mortar
The consumerperforms
referred
to as BM). Consumerssearchandsamplein a tradi(hereafter
setting
Let thesearchcostforthis
tionalchanneland eitherpurchaseor do nothing.
traditional
channelbe ipBM.
Illegal: The consumerperforms
thesearchonlineat an illegalsource,where
consumers
can downloadandsamplea copyofthemusicitemforfree,without
can searchin an illegalchanneland
fromtheseller.A consumer
authorization
We hereafter
referto this
downloadandkeeptheillegalversionor do nothing.
onlineillegalchannelas ONI andthesearchcostas xpONI.
Legal: Thisonlinechannelis setup bya legitimate
referred
to
seller(hereafter
music
as ONLG).Thesellerallowsconsumers
tosample,evaluate,andpurchase
legally.Of course,a consumercannotdownloadand obtaina musicitemille-

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CONSUMER SEARCH AND RETAILER STRATEGIES IN ONLINE MUSIC SHARING

135

gailyfromthischannel.A consumercan searchin a legal channeland either


Let thesearchcostbe xpONLG.
purchaseordo nothing.
can piratemusiconlyfromONI, butcan purchasemusic
Noticethata consumer
BM
fromeither orONLGchannels.Giventhelimitedtimeavailableata
legitimately
storeand theeffort
brick-and-mortar
requiredto access it (visitand searchat the
> ip0NI.
we assumeipBM
online
to
Also,givena greater
channels,
store),compared illegal
fromlegal onlinesellersto providebettersearchtoolsthatreturnmore
incentive
> xp0NLG.
Violationsofthis
< xpom.
Hence'')m> xpom
we assumeip0NLG
relevant
results,
theComputain
our
later
are
(see
analyses
computational
investigated
assumption
tionalResultssection).
a searchon one channeland thenswitchto
Of course,a consumercan perform
ofsuch
ourrepresentation
themusicitem.We summarize
channeltoprocure
another
BM
consumer
at
the
a
1
.
For
in
searches
channel,
instance,
starting
Figure
two-stage
He or she
a costofipBM.
thenthsearchandevaluatesthemusic,incurring
performs
searchanddownloadsan illegalversionof
a directed
thengoestoONI andperforms
searchwould
The costforthistwo-stage
a costofipBM~*ONI.
thesamesong,incurring
and
incursa cost
searches
the
consumer
at
+ xpBM^0Nl.
be 'pBM
ONI,
starting
Similarly,
to terminate
choose
the
consumer
consumer
Givenhisorher
ofip0Nl.
might
surplus,
an additionalcostof
thesearchhere,or switchto BM and buytheitem,incurring
1? Notethata
in
costs
are
related
and
other
Thg
depicted
Figure
options
yjONi^BM^
theinformation
whoswitcheschannelsis assumedtodo so aftergathering
consumer
tomakea specificnthitemprocurement
(legalorillegal).Whenmovingto
necessary
as
to moveas directly
has theinformation
thenewchannel,theconsumer
necessary
the
we
make
More
a
transaction.
to
finalize
following
assumptions
formally,
possible
aboutsearchcosts:
= 0; thatis,oncea consumer
= 0 andyjONi^ONLG
a pieceof
hasidentified
1. xpONi^BM
whenswitchmusicusingtheillegalchannel,a directedsearchis performed
oflegal
features
cataloging
ingtoandusingBM andONLG.Weassumebetter
reducedirectedsearchcosts.
channelsdrastically
< ip0NI;
inthe
thatis, a customer
2. 0 < ipBM-*0NI
gathered
havingtheinformation
than
when
to
ONI
when
nthsearchat BM is moreefficient
making
switching
at ONI.
thenthsearchinitially
< ip0NI;
thatis, a customer
3. 0 < xpONLG^ONI
gatheredin
havingtheinformation
to ONI thanwhen
whenswitching
thenthsearchat ONLG is moreefficient
at ONI.
makingthenthsearchinitially
SearchEfficiency
A searchcan be viewedas a drawovera set of finitemusicitems.The qualityor
of a searchtool(e.g.,a musicrecommender
system)willaffecttheprobefficiency
If there
a high-orlow-valuemusicitemfora givenconsumer.
abilityofidentifying
to a
areN musicitemsavailableto search,thena "randomsearchtool"is equivalent
search
ofbeingselected.A "better"
drawwitheachoutcomehaving1/Nprobability

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136

BHATTACHARJEE,GOPAL, LERTWACHARA, AND MARSDEN

Consumer
at
starting
thebrick-and-mortar
(BM)channel
StapelSearch'

at
Consumer
starting
theonline
illegal{ONI)
channel

at
Consumer
starting
theonline
legal
(ONLG)channel

/CMtfChanneN
yfON'
(SearchCost:

/ONLGChanneK
Search
Cost:

fBM channel'
y,)
(SearchCost:

/BM ChannN
f Switch
Cost: )

XS^/ChanneN
Stage2:
Cost: )
Procure ( Switch

TotalCost: + j/bm->oni
TotalCost:(/ow+ ^ow^w

/6^GChanneK
Cost: )
( Switch

/ONI ChaneN
Cost: )
( Switch

+ oni*onlg TotalCost:^onlg+ ij/onlg^on


TotalCost:y/ONi

Possible
Channel
SearchProcess:
Switching
Options
FigureI. Consumer

musicitemis identified
toolwillmakeitmorelikelythata high-value
bythesearch.3
toprovide
incentive
hasa monetary
a retailer
Wearguethat,forlegalonlinechannels,
no
has
channel
the
whereas
search
a more"helpful"
tool,
comparableincenillegal
searchtool,searchesineachofthechannelsaremore
tives.Evenwitha rudimentary
/is
we knowthatconsumer
efficient
thana randomsearch.Frompreviousdiscussion,
it.Fortheni'' search,
able to place a valueon a musicitemonlyafterexperiencing
toeach
i's valueassignments
acrossconsumer
distribution
thereis a trueprobability
of values,not
distribution
of thefinitesetof songsto be searched.Thisprobability
is modeledas
knowna priori(beforeexperiencing
items)bytheconsumer,

v/7e[o,irx]
search
foreachL, whereL denotesthechannel(BM,ONLG,orONI) inwhichthercth
have
Withina givenchannel,searches
is beingconducted.
expectedvaldecreasing
ues as n increases,or

v^-(vj,)>

vv/e[o.v/nax]

v,,4-+l(v,;/).

v-:/e[o^max]

ofthepreviousmusic
In musicitemsearch,newsearchesoccurwithout
replacement
a musicitemwhosevaluetothe
item.Thus,thenthsearchina channelmayidentify
consumer
wouldbe abovethemeanvalueforall musicitemsinthechannel'ssearch
evaluation
andremovalofthatitemwillresultina lowerexpected
space.Subsequent
searches
itemsforthen + 1thsearch.We arguethatelectronic
valueofall remaining
hasshown
tendtobe moreefficient
searches.Previousresearch
thanmanual/physical
onlinesearchandactivity
tobe lesscostlyandmoreefficient
[5,6, 10,17,28,29]. In
serto developand enhancecustomer
addition,legalonlinesellershaveincentives
the
final
we
whereas
online
such
incentives.
sites
have
no
Hence, posit
vice,
illegal
(on theexpectedvalueof searchfromeachchannel):
assumption

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CONSUMER SEARCH AND RETAILER STRATEGIES IN ONLINE MUSIC SHARING

v..ONLG'n(v)>
y
jLt
yijrij
'vij]

v(/e[o,v;-max]

137

vONIn(v)
vjYij
Vu)

v(/E[o,v^max]

> s Mr M
Vije[o,vrK]

(l)

thansearchon
( 1) indicates
(1) theonlinelegalsearchis moreefficient
Assumption
thansearchin a
and(2) searchon an illegalsiteis moreefficient
an illegalnetwork,
brick-and-mortar
store,whichrequiresbotha physicalvisitand a physicalsearch.
a searchon an onlinelegalsiteis morelikelyto resultin a musicitem
Specifically,
Notethata searchin different
chanconsumer.
witha highervalueto theindividual
thesamemusicitem.After
somenumber
resultinobtaining
nelsdoesnotnecessarily
ofthelegalonlinesearchchannelcan be expectedto lead
ofsearches,theefficiency
ofsearches
musicitems.The samenumber
ofmostly
totheidentification
high-value
andremovalofrelaintheotherchannelswouldbe expectedtoleadtoidentification
to
valuedmusicitems.Atsomepoint,thesetofmusicitemsremaining
tivelylowerof
lowvalued
items.
Our
will
consist
be searchedinthelegalonlinechannel
mostly
and certainly
sometime
witha budgetconstraint
is thattheconsumer,
assumption
beforeviolationsofassumption
willstopsearching
limitations,
( 1) occur.
whodiffer
intheirV/max
Ouranalysisfocuseson a retailer
facinga setofconsumers
facesa distriwherea retailer
values.Eachofthestepsthatfollowcanbe generalized
we
on a reprecenter
forms.
withvarying
butionofconsumers
Notationally,
0,7A"(v(/)
/
to
music
item
the
value
consumer
to
indicate
consumer
sentative
/,utilizing
assigns
v,7
We
the
subor
maintain
in
ONI.
channel
search
from
a
BM, ONLG,
given
j resulting
willdiffer thatis,wedo notmakethe
consumers
thatindividual
/toemphasize
script
distributed
andidentically
commonsimplifying
(i.i.d.)assumption.
independently
a
of
that
seller
cases
five
2
illustrates
digitalmusicmayface:(1) a
possible
Figure
in a "worldwithoutpiretailer
with
brick-and-mortar
a
base case
(BM) operating
havea piracyoption,andmayswitchbewhereconsumers
racy";(2) BM operating
a perunitpricingandwhere
tweenchannels;(3) an onlineretailer
(ONLG) offering
havea piracyoption,andmayswitchbetweenchannels;(4) sameas (3)
consumers
whereconsumers
wouldnotswitch
offers
pricing,
onlysubscription
excepttheretailer
channels(explainedin case 4 discussionbelow); and (5) same as (3) butretailer
offers
bothperunitpricingandsubscription
pricing(a mixedpricingmodel),which
and ONI. The lastthree
between
the
also permits switching
perunitoffering
option
onlinemarket
involvediffering
settings.
pricingoptionsforemerging
knowsthesearchcostand
we assumethattheconsumer
Inourmodeldevelopment,
theconsumer's
ofeachchannel,andthefunction
thesearchefficiency
(pthatcaptures
choiceson the
rational
makes
the
consumer
With
this
music.
in
interest
information,
numberof searchesto initiate(a consumerwouldcontinueto searchuntiltheexofthenextsearch),channelsto search,and
pectedcostexceedstheexpectedbenefit
to obtaina songlegallyor illegally.In ourmodeldevelopment
whether
below,we
facedbytheconsumer.
explainindetailthechoiceenvironments

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138

BHATTACHARJEE,GOPAL, LERTWACHARA, AND MARSDEN

Base Model:
Consumer
Choices |
^-

f
'.

^^-n.

Take
no^'
action

briccN
/^Z- i "o ^^
^-"^"^
""~-'
/""mcgal onlincN /""fraditional
f
/-Traditional
brickN
^ - - J
^ ^ - acuo;
J^)
""^ (1^ -^^~- -""^
- -^
._

J 'and-mortarstore/

Case I : ConsumerChoicesin Base


Model (Base)

Model(BM)
Case 2: ConsumerChoicesin Brick-and-Mortar

Per UnitPriceModel: I
ConsumerChoices 1

V^aaion/

Brick-and-Mortar
Model:
Consumer
Choices

V^jicm'orks^y

I Subscription
Model:
I ConsumerChoices

unitprice^/ V^ation^y

'jrer

V^gtworls^

V^^umon^x

Case 4: ConsumerChoicesin OnlineSubscription


Case 3: ConsumerChoicesin OnlinePer UnitPrice
Model(iftf)
Model (Unit)
MixedModel:
Choices
Consumer

Case 5: ConsumerChoicesin OnlineMixedPricingModel (Mixed)

2. Consumer
Different
RetailModels
ChoicesUnder
Figure
Case 1: Base Model- No PiracyOption
a piracyoptionforconsumHere,we considera BM whooperatesina worldwithout
ers(Figure2, case 1). Pricingis perunitwitheach musicitemavailableata priceof
pu,and each consumerhavinga budgetconstraint
specificto thistypeof good (as
indicatedearlier).In thissituation,
hereas cona rationalconsumer(represented
sumer/)wouldinitiatea first
searchonlyif
v-elz?
I
'
IJ L Mvmax
J
LetAfte(v.ma*)
denotethenumber
ofsearchesconducted
/inthisbase
byconsumer
case. Fromutility
itfollowsthat
maximization,
RM 'rbase(vmax'

and

v-E 'd

*v

vmaxl

'

(vijhj-pu)<v>BM-

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CONSUMER SEARCH AND RETAILER STRATEGIES IN ONLINE MUSIC SHARING

139

Notethatthenumber
ofsearchesis monotonically
inthevalueof V,max
nondecreasing
so thatconsumers
withhigherV,max
valuesareexpectedtoconductmoresearches.
Case 2: BM ModelwithPiracyOption
an onlineillegalchannel.The
Our secondcase stillinvolvesa BM butintroduces
consumer
whowishesto searchmusicitemscan startthesearchprocessfromeither
BM or ONI. Again,ifthesearchcostsexceedtheexpectedvalueof searching,
no
searchwouldoccur(Figure2, case 2).
is sufficient
tojustifyat leastone search,be at the
Let a consumer,
whose V,max
of
the
nth
and
start
this
searchprocessat theillegalchannel,
search,
starting
point
The consumer'ssubsequent
a searchcostofipONI.
behaviordependson the
incurring
attheendofthenthsearch.The threeconofthemusicitemexperienced
value,v(/,
=
are:(1) switchtoBM andbuy:viy
sumerchoicesandthenetbenefits
-pu-ipONl^BM
or(3) do nothing:
0.
(2) pirate:v,y;
Vij-pum,
wouldswitchtoBM. Ifnot,theconsumer
IfVjj-pu> viptheconsumer
wouldpirate
neta prioriexpectedbenefit
froman nthsearch
themusicitem.Thus,theconsumer's
thatstartswiththeillegalchannelis

*+A))

(2)

Aw^i

whostarts
thenthsearchatBM andincursa search
consumer
another
Now,consider
are:( 1) buyfromBM: vtj-pu;
Theconsumer
choicesandthenetbenefits
costof'pBM.
0.
or (3) <jonothing:
(2) pirate:v^- i/>bm+oni;
willbuyfromBM ifv(j-pu> vtj- 'pBM^ONI.
a
The consumer
Thus,theconsumer's
starts
with
BM
is
froman nthsearchthat
prioriexpectedbenefit

2 v^-(v(,)+ y /r(v,)(v,-P)

Vij^b)

V(/e[,iiaxj

_ y - yBM+ONl

v(,-e[0)

0. ^y

(3)

1- ). Thefirst
termis theexpectedvalue
andb = (pu-ipBM^0NI)/(
wherea = ipBM-*0NI/
themusicitemis optimal.The secondtermis theexovertherangewherepirating
pectedvalueovertherangewherebuyingthemusicitemfromBM is optimal.The
termis theswitching
cost(BM
third
termis thesearchcostinBM. Finally,thefourth
fromBM to ONI to obtain
of theconsumerswitching
to ONI) timestheprobability
thecostsand
in thenthsearchat BM. Table 1 summarizes
themusicitemidentified
In additiontotheuse ofa andb,definedabove,forbrevity,
theexpectedbenefits.
we
denotec = pj( 1 -).

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140

1 #
I wl

g_

Io 1
g
? =
g
<u
5

en
t/3
O

1
TD
C
cd
C/3

(D
G
<D

<+*

(
-O

S.
X

'HT'

ai

4-

$
^

wl

"

%
^

H# >

<D

Oh

"8

IO

Cd

t
o
I
G
cd
i
^d

^O
'C
PQ

i
s

JQ

<u

e2

'fi
S

vi

TB
C

.2

gco
=

.
c

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CONSUMER SEARCH AND RETAILER STRATEGIES IN ONLINE MUSIC SHARING

141

in
of searchesin case 2 be NBM(V"VdX).
Let thenumber
UsingtheRomannumerals
to thetermsdirectly
abovethemin thetable,we can specify
Table 1 to correspond
Forn = NBM{Vrx),
(I + II) > (III + IV) or (V + VI) > VII,

(4)

Forn = NBM{
, (I + II) < (III + IV) and(V + VI) < VII.
V,max)+1

(5)

and
thesearchat theillegalchannelis higherthanat
ofbeginning
The expectedbenefit
a rationalconsumerstartsat theillegalnetwork,
channel.Therefore,
thetraditional
is
of
the
music
if
the
value
and,
buythemusiclegally.
highenough,willsubsequently
observation:
Thisleadstothefollowing
a greaternumber
/.Rationalconsumers
ofsearchesformusicintheBM
perform
modelwithpiracythaninthebase model(without
piracy).(Proofprovidedinthe
Appendix.)
is thattheexistenceofan illegalonlinechannelleadstoconsumA directimplication
moremusicitems.
forandexperiencing
erssearching
Unit,Subs,andMixedModelswithPiracyOption
whooffers
one ofthree
In thenextthreecases,we consideran onlinemusicretailer
perunitpricingwithpricepu(unitmodel)(Figure2, case
typesofpricingstrategies:
with
3), subscription
priceps(subsmodel)(Figure2, case 4), ora
pricing an up-front
offered
mixwithbothperunitandsubscription
(mixedmodel)(Figure2,case
pricing
the
same
follows
stepsutilizedin cases 1 and 2
5). Modelingof cases 3, 4, and 5
we do notrepeatdetails,choosinginsteadtoprovidethesummary
above.Forbrevity,
j _)
inTable2. We denoted = ^m(WW7ande = (pu- ipoNLc^omy^
information
each search,theconsumermusttakeinto
In theunitmodel,beforeconducting
fromsearcheson thelegalandon theillegalchanaccounttheexpectednetbenefit
decides
nelsindecidinghisorhercourseofaction.In thesubsmodel,theconsumer
to pay thesubscription
whether
fee,ps,and gain access to all musicitemson the
to
siteorpirateall musicitemshe or shewantsto obtain.Once subscribed
retailer's
items
if
wouldchooseto searchforadditionalmusic
theretailer's
site,theconsumer
fromthesearchexceedsthesearchcost.Notethatoncethecontheexpectedbenefit
to
willno longerhaveincentives
totheretailer's
sumersubscribes
site,theconsumer
in
the
all
music
items.
to
access
she
Finally,
alreadygainslegal
pirate,becausehe or
to subscribetotheretailer's
wouldchoosewhether
mixedmodel,theconsumer
site,
net
to
the
the
music
or
items
music
expected
according
pirate
individually,
purchase
fromeachofthethreeoptions.
benefit
UnderProposedModels
RevenueImplications
on thesearchcostand thesearcheffihas information
We assumethattheretailer
ciencyof each channel,licensingcostsforthemusic,and theoveralldemandfor

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142

T*

31 i

s-

- -^

s.

"

l
%.

| I
I
l

a.
s.
i

- i

1
I

1
I
I
C/5

T'
S
^C
^

jr

c.

c.

T"

T'
5"
^
o

.- s

T
+

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^T

T
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i

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co

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CONSUMER SEARCH AND RETAILER STRATEGIES IN ONLINE MUSIC SHARING

143

musicacrossconsumers.
Withthisinformation,
theretailer
makesrational
choiceson
or
thepricingstrategy
mixed
and
(units,subs,
pricing) corresponding
pricelevelsto
maximizetheprofits.
The resultsderivedfromtheBM modelwithpiracy(case 2) suggestthat,since
consumers
searchforandexperience
moremusicitemscomparedtoa no-piracy
sce1
it
nario(case ), is arguablethatconsumers
maypurchasemoreundercase 2 ifthey
findmusicofsufficient
value.
a unitmodel(case 3) providesat leastas muchrevenueas case
Moreinterestingly,
1
to
Result
2, leading
(proofprovidedintheAppendix):
Result1: RetailerrevenueswiththeunitmodelweaklydominatetheBM model
withpiracy.
botha subscription
In themixedmodel,theretailer
offers
serviceandan la carte
whooptstosubscribe
obtainsall ofhisorhermusicvia
purchase
option.A consumer
whiletheone who does notsubscriberesortsto somecombination
theretailer,
of
la
and
Since
the
for
the

carte
mixed
model
subsumes
purchase
strategy
piracy.
space
thatoftheunitandsubsmodels,thenaturalimpacton retailer
revenuesis formalized
as follows:
Result2: Retailerrevenues
withthemixedmodelweaklydominatetheunitand
subsmodels.

andRetailerProfits
LicensingCostStructures
ofdigitalmusicis nearzero.Butthereare
costo physicalreproduction
Themarginal
that
incurred
the
retailer
affectoverallprofit.
costs
maysignificantly
by
licensing
to
cent
that
65
79
and Smith[54] reported Applepays
licensingfeesfor
Wingfield
inonlinemusicretailing,
iTunes.In addition,
each99 centdownloaditsellsthrough
flexible
With
thisinmind,ouranalysis
arebecoming
licensestructures
54].
[40,
quite
a
sum
cost structures:
considersthreedistinct
(1) lump
payment(c) by retailerto
based on thenumberof songsoffered
musicpublisher
(N), (2) a paymentsetas a
and
a
of
revenue
overall
retailer
(/?),
(3)
perdownloadfee(cd)fora
percentage
(cp)
structure
musicitem(mostcommonmarket
currently).
costs:Nc under(1) above;Rcpunder(2); and a
The retailer
incursthefollowing
costperdownloadofcdunder(3) everytimea consumer
downloadsa
fixedmarginal
musicitem(in unit,subs,or mixedmodels).However,under(2), ifa musicitemis
facesa fixedmarginal
costperdownloadofpucp.
soldon a perunitbasis,theretailer
with(2), theretailer
incursa fixedmarginal
cost
serviceis offered
If a subscription
Notethatthelicensefeeswith(2) areindepenofpscppersubscriber.
persubscriber
Thefollowing
resultshighlight
the
ofdownloadsbya subscriber.
dentofthenumber
in
are
the
structures
of
license
(proofs
Appendix):
implications
profit
Result3: Retailerprofitswiththemixedmodelweaklydominatetheunitand
subsmodelswhenthelicensestructure
is basedon either(a) lumpsumpayment
or (b) percentage
ofretailerrevenue.

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144

BH ATTACHARJEE,GOPAL, LERTWACHARA, AND MARSDEN

Table3. BitRateDistribution
on WinMX
Bitratedistribution
(in bitspersecond,bps)
96
128
160
192
256
320

Percentage
0.85
20.61
5.66
62.60
2.62
^65

Quality
(fromwww.slyck.com)
Tolerable
Good
Good
Verygood
High
Near CD

withthemixedmodelweaklydominatethesubsmodel
Result4: Retailerprofits
is based on a perdownloadfeeper musicitem.
whenthelicensestructure
is
tothemusicpublisher
toholdifthelicensestructure
NotethatResult3 continues
of
retailer
a
and
of a lumpsumpayment
based on some combination
percentage
on therestructures
ofcontract
proceeds.The aboveresultsindicatetheimportance
whenthefeesarebased on theperdownload
In particular,
tailerpricingstrategies.
structure
optionbecomeslessviable,becausea disgruntled
(cd),thepuresubscription
theretailer
couldbankrupt
ormalevolent
consumer
byrepeateddownloads.Here,the
Resultssection,we
retailer
wouldonlyoffera perunitoption.In theComputational
oflicensingimplidetails
additional
to
useextensive
analyses provide
computational
ofthevariousonlinemodelsstudied.
cationson thepricingandprofits

Validation
ofModelingAssumption
In OURanalytical model (see theModelsof ConsumerSearchProcesssubsecin is theloweracousticqualityofmusicatillegalsitesdue
reflected
tion),onefactor
that is homogeInaddition,
we suggested
tolossesfromcompression
technologies.
forouruse of.
neousacrossconsumers.
Here,we providevalidation
A number
offactors
influence
theacousticqualityofcompressed
music,including
andtheuser's
bitrateofthecompressed
and
file,compression
equipment algorithms,
how
to
discern
bit
which
indicates
various
audio
ability
outputs.
Amongthese, rate,
manybitsare used to captureone secondof music,is a widelyutilizedproxyfor
acousticquality.
We monitored
bitratesofmusicfilesavailableonWinMX,a popularP2P network
for17 weeks,fromOctober28, 2002, to February20, 2003. This includeddaily
searchesforsongsthatwereinthetop100 albumson theweeklyBillboard200 chart.
From4.3 millionmusicfilesobserved,
we foundthatlessthan10percent
wereofthe
levelconsidered
or
in
"near
CD"
the
(Table3). There
"high"
www.slyck.com
ratings
about75 percent
thathadbitratesinthe"verygood"orabovecategowere,however,
ries.Thus,although
wouldbe viewedas roughly
onlya smallpercentage
equivalent
toCD quality,
a substantial
could
be
viewed
as
close,
percentage
certainly
relatively
at leastfroma technicalbitrateperspective.

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CONSUMER SEARCH AND RETAILER STRATEGIES IN ONLINE MUSIC SHARING

145

Table4. SurveyResult
Choicesavailable
Almostthe same
Verygood, but not the same
Halfas good
Does not even compare

Response
frequency
48.30
42.38
8.52
0.80

ofqualityofmusicatillegalsites,we conducted
To analyzeconsumer
a
perception
the
current
sales
environment
with
(BM
piracyoption).This setsurveycomparing
thepredominant
modelforretailers
andis theonewithwhich
existing
tingrepresents
areveryfamiliar.
wereaskedfortheirperception
consumers
ofthequalRespondents
online
of
an
MP3
file
relative
to
that
of
an
(thetypical
format)
sharing
ity
originalCD
forthesamemusicitem.Table4 showsthechoicesavailableto therespondents
and
A majority
thecorresponding
number
ofresponsesin eachcategory.
ofrespondents
as either
"almostthesame"(48.3 percent)
or"verygood"
thequalityperception
report
of
the
Since
thesean(42.38 percent),
suggesting homogeneity qualityperception.
theresultsto meanthatmostconsumers
swersareon an ordinalscale,we interpret
as "verygood"but
perceivetheacousticqualityofmusicfilesfromillegalnetworks
notthesameas thequalityofaudioCDs.
siteandthesurvey
In sum,theobserved
do not
qualityat a majorsharing
responses
. We mightarguethatthereis some
withourassumptions
conflict
regarding
directly
in individual
viewsofpiratedfilequality.Together,
these
ofhomogeneity
indication
withtheexistence
ofa technical
difference
thatindividuals
resultsarealso consistent
the"qualityofexperience"
factor,
maynotbe able to discern.Notethat represents
thisqualityof experience
andthereremainotherforcesthatwouldtendto diminish
ofundertaking
musicfiles[35]anddisutility
Refined
illegalactivity.
including
polluted
directions
of
future

are
research.
of
our
regarding important
testing
assumptions

Results
Computational
INSIGHT
INTOTHETHREE
onlinemarket
models(unit,
To GAINADDITIONAL
emerging
extensive
simulaundera piracyscenario,we conducted
subs,andmixed)operating
How
do
retailer
tionsto addresseach of thefollowing
questions:
pricingstrategies
affect
undereachofthethreemodels?How do licensingstructures
differ
pricingand
associatedwithmaximum
solutions?EmWhatis thepiracyactivity
profit
profits?
variablesarenotpubliclyavailable,andsimulation
piricaldatafortheseinteracting
the
oftheconsumer
searchprocess,
bed
to
a
rich
test
study combinedeffects
provides
to maxiofillegalchannels,andretailer
pricingandlicensingstrategies
availability
mizeprofit.
We simulated100 consumers
withV,max
drawnoverf/[l,100].The retailer
offers
250 songs.An onlineillegalchannelexistsand offers"pirated"copiesof thesame

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146

BHATTACHARJEE,GOPAL, LERTWACHARA, AND MARSDEN

Table5. Simulation
Parameter
Settings
Parameter

Notation

= 1)
Ratioofsearch costs (ip0NI
Cost ofswitching
channel

ipNLGp0NI
^onlg^oni
^pONI-^ONLG

Qualityofexperiencemeasure
ofpiratedmusic
Per unitprice
Subscription
price

pu
p^

Values
0.1, 0.2, .... 1.0, and 1.2
q.2
Q

0.1, 0.2, . . ., 0.9, and 0.95


1, 2, . . ., 20
100, 105, 110, .. ., 1,500

and xp0NI),
setupinvolveda rangeof searchcosts(ip0NLG
songs.The experimental
Table 5.
in
shown
as
values
and
of
costs,quality experience()
prices
switching
decision
retailer
and
These providea wide arrayof possiblechoicesforconsumer
designpoint,one setofvaluesforprices(puand/?,),
making.Foreachexperimental
searchcosts,channel-switching
costs,and is chosen.Wethencalculatethenumber
thenumberof songseach consumer
of searchesconductedbyeach consumer,
purrevenueunder
andtheretailer's
chases,thenumberofsongseachconsumer
pirates,
forthatdesign.As indicatedinTable5, we also simueach ofthepricingstrategies
was violated(i.e.,
on searchcostordering
latedtwoscenarioswhereourassumption
>
three
g^^
yjONLGxpONi}^ designpointrequiredapproximately daysto completeon
fora totalof 61,820,000observations.
dedicatedracksof IntelPentiumIII servers,
We thenperformed
an exhaustive
searchamongall designpoints(bruteforcesoluforthefollowinginformation:
tionby considering
(1) maximum
everypossibility)
foreach
and
foreach ofthethreemodels;(2) /?M,
ps,
profit
puandps (as appropriate)
solution;and (3) piracyactivityassociatedwitheach profitprofit-maximizing
solution.
maximizing
As discussedintheModelingMusicMarketEnvironments
section,usingthemore
witha highervalue
efficient
legalonlinesearchservicewouldprovidetheconsumer
fortheoutcome(music)ofa search.We formalize
thisbyassumingthata consumer
on
the
online
servicewouldobtaina songwith
more
efficient
search
searching
legal
a valuefromthetophalfofavailablesongs,whereasa searchon theillegalchannel
wouldyielda songfromtheconsumer'stoptwo-thirds
ofvaluesofavailablesongs.
in subseOnce a songis chosen,thatparticular
songis removedfromconsideration
of
in
a
return
from
both
searches,
quent
types searches
resulting diminishing
expected
as thenumber
ofsearchesincreases.
Fortheunitmodel,eachconsumer
a searcheitherthrough
a legalorillegal
canstart
channelor notinitiatea search.If theconsumereventually
choosesto acquirethe
songfromthelegal channel,therevenueto theretailerwouldbe pu.For thesubs
and piracy(acfromsubscription
model,we calculateeach consumer'snetbenefit
iftheexpectedbenefit
wouldsubscribe
fromsubcordingtoTable2). The consumer
exceedsthatfrompirating
otherwise
he or she
(withretailerrevenue/?y);
scription
wouldpirate.Forthemixedmodel,we compareeachconsumer's
fromsubbenefits
andperunitpurchase.Theconsumer
ifthebenefit
is posiwouldsubscribe
scription

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CONSUMER SEARCH AND RETAILER STRATEGIES IN ONLINE MUSIC SHARING

147

individualsongs;otherwise
he or shecan eitiveandexceedsthatfrompurchasing
therpurchaseor pirateindividualsongs.In thiscase, theconsumer'sdecisionbecan also choosenottoacquire
comessimilartothatintheunitmodel.Theconsumer
in all cases arenegative.
anysongat all iftheexpectedbenefits
we willonlyrefertothepercentlicensingcoststructure
In subsequent
discussion,
underthepercent
canalways
Sincea payment
fortheretailer.
licensingcoststructure
theresultspresented
in thenext
intoan equivalent
be converted
lumpsumpayment,
Notethatboththelumpsumand
sectionwillholdequallyforthelumpsumstructure.
as a fraction
oftheretailer's
can be represented
revenueand
coststructures
percent
ofdownloadsfromtheretailer's
on theactualnumber
service.We
arenotdependent
whichis depenthesewiththeperdownloadfeecoststructure,
willmainlycontrast
denton thenumberof downloadsand noton theretailer'stotalrevenue.Next,we
forretailers.
The completesetof rediscussthemainresultsandtheirimplications
theresults,
are availsultsforeach designpoint,and additionalchartshighlighting
etal. [9].
able at Bhattacharjee

Profit
Implications
thanunitandsubsinmostcases
Result3 showsthemixedmodelyieldshigherprofit
and
resultssuggestthat
cost
sum
and
structures),
(underpercent lump
computational
from
of
theillegalchannel.
the
affected
thisis considerably
()
by quality experience
->
frommixedand subsmodels
betweenthemaximum
As 1, thedifference
profit
nolongerfinditbeneficial
topurchase
as consumers
decreasesandthetwoconverge,
individualsongsand thosewho can stillbenefitfrommakingthepurchasewould
frommixed
Similartrendsareobservedforprofits
subscription.
onlydo so through
andunitmodelswithrespectto. On theotherhand,as thevalueoflegalsearchcost
are
andconsumers
thesubscription
increases,
optionbecomesless attractive
(ipONLG)
the
from
morelikelyto purchaseonlyindividual
Hence,
songs.
high-valued
profits
at a highvalueoflegalsearchcost(xpONLG).
themixedandunitmodelsconverge
increasefromthemixedmodelis derivedfromtheretailer's
The profit
abilityto
thevalueoftheperunit(pu)andsubscription
fine-tune
(ps)prices.In manycases,the
whilelowering
revenuefromsubscribers
additional
canincreasepstoextract
retailer
individual
to purchase
songs(Figures3 and4). This
puto encouragenonsubscribers
fromunitand subspricing,
difference
especiallyat lower
policyshowssignificant
et al. [9].
can be foundin Bhattacharjee
valuesof. Completecomparisons

ofLicenseStructures
Implications
has a significant
witha publisher
ofan onlinemusicretailer
The licensingstructure
onlinemodels,in termsofpriceschargedto conofdifferent
on theviability
effect
theratioofpufortheunit
As Figure5 illustrates,
sumersandoverallprofits
generated.
is alwaysless than1. This
model,withpercentand perdownloadcost structures,
tothemusicpublisher
thatforthesamenetlicensefeesoffered
demonstrates
(costto
the
is
lower
than
download
fee
the
under
structure,
retailer), optimalprice
per
percent

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148

BHATTACHARJEE,GOPAL, LERTWACHARA, AND MARSDEN

y/ONLGlyjONI =0.5

8-,
v

_6

Unit
-

N.

S5

0 -I
0.1

0.2

Mixed

1
1
.
.
,
,
.
0.3 0.4 0.5 0.6 0.7 0.8 0.9 0.95
Qualityof Experience(5)

PerUnitPrices(pu)
Figure3. Revenue-Maximizing

pONLGlpONI =0.5

1600 -i

1400

'V^

I 1200- -^XXV.
8
1000

'^

I 800

>v
^V

>v

60
I 400
%

n'

^^^^

^"^^^^

,
0.1

SubS'

Mixed1

X^^

200

0 '

0.2

,
,
,
,
0.5 0.6 0.7 0.8 0.9 0.95
Qualityof Experience()

0.3

0.4

Prices(pv)
4. Revenue-Maximizing
Figure
Subscription

to the
withthedifference
as increases.Thisimpliesthatthenetbenefit
increasing
consumer
is higherunderthepercent
structure
(forthesamemusicitem),especially
at high values.We also notethatat highvaluesof and q, themaximum
profit
achievableby theretailerunderperdownloadstructure
is 0. This leads to thetrunoffunder
is better
catedgraphat highvaluesof andcd.Thisimpliesthata retailer
from
evenwhenthequalityofexperience
percentthanperdownloadfeestructures,
theillegalchannelapproachesthatofthelegalchannel.

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CONSUMER SEARCH AND RETAILER STRATEGIES IN ONLINE MUSIC SHARING

149

09

J 0.7

^'

8 0.6

* %*
%
t 05 L" *
-

03

Cd=5

CC(=11

0.1

^^^_

0 -I

'

0.2

0.3

XX

0.8
0.5 0.6
0.7
0.4
Quality of Experience ()

,
0.9

0.95

VersusPerDownloadLicenseFee (UnitModel,
Figure5. PerUnitPriceswithPercent
=
Q.')
ipoLC>/ipONI
100 -r

1
Cd=11

1
Cf=5

i 50

0.1

0.2

0.3

0.4 0.5 0.6 0.7 0.8


Qualityof Experience (S)

0.9

0.95

withPercentVersusPerDownloadLicenseFee
Figure6. UnitModelProfits
=
tyONLC./yjONI 0. 1 )

theperdownloadcoststruccostweaklydominates
underthepercent
Wefindprofit
we notethatas cdincreases,
ture.Figure6 depictsresultsfortheunitmodel.Further,
-
in themaximum
difference
the

As
download.
dominates
1,
per
percentstrictly
distinct.
more
becomesconsiderably
Hence,profinthetwocostenvironments
profit
This
thanwitha perdownloadstructure.
licensestructure
witha percent
itsarehigher
is
a
more
of
or
sum
structure
cost
revenue)
a
bounded
that
percentage
(lump
suggests
andmusicpublishers,
as wellas retailers
viableoptionforconsumers
comparedtoan
itis
underpercent,
Also,givenhigherprofit
unbounded
perdownloadfeestructure.
to sharethegrowingpie witha musicpublisher a win-win
possiblefora retailer
evidenceofonlineservicesdoes notyetsuggest
for
all.
situation
However,
reported
orlumpsumlicensingstructures.
use ofpercent
widespread

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150

BHATTACHARJEE,GOPAL, LERTWACHARA, AND MARSDEN

200 T

Ccf=11

#Cof=5

150-

loo
O

/ '
'

'J -f-- ^

0.1

- -- - - -

0.2

0.3

0.5
0.7
0.8
0.6
Quality of Experience ()
0.4

0.9

0.95

UnderMixedModelwithPercentVersusUnitModelwithPerDownload
Figure7. Profit
= 0. i )
LicenseFee {x^onlg^oni

themixedmodel(perunit
Retailerprofits
can be increasedfurther
byintroducing
modelunderpercent
mixed
in
the
7
as wellas subscriptions).
Figure comparesprofits
withFigure6, we notethe
withunitmodelunderperdownloadstructure.
Comparing
The result
environments.
the
two
ratios
between
in
the
difference
profit
significant
cangenerate
theretailer
tothepublisher,
showsthatwiththesamenetpayment
higher
andperunit
bothsubscription
whileoffering
coststructure
profit
byusinga percent
pricingoptions.

PiracyImplications
We findthatatthemaximum
profit
prices,piracylevelsarelower(orsimilar)witha
thanperdownloadfee fortheunitmodel(Figure8). The piracy
percentstructure
defordifferent
ratioshowssimilarpatterns
cdvalues,andthelowerpiracybenefit
flowsfromthepreviousdiscussionofpriceschargedto
creaseswith. Thisdirectly
to purchasethanto pirateunderthe
consumers.
Lowerpriceslead moreconsumers
percentstructure.
Another
resultis thattheretailer's
positionoccursin
significant
profit-maximizing
levels(Table6). In general,the
an environment
withpiracyactivity
aboveminimum
the
retailer
obtainshigherprofit
underthemixedmodelthanothermodels.However,
piracylevelinthemixedmodelis higherthaninthesubsmodelinmostcases,while
thepiracylevelinthemixedmodelrangesfrom8 percent
to45 percent
ofthepiracy
that
levelundertheunitpricingmodel(exceptwhen = 0.95). This demonstrates
retailer
thatlowerpiracydo notnecessarily
increaseprofits.
As notedbestrategies
etal. [9].
results
areavailableatBhattacharjee
fore,thecompletesetofcomputational
To testwhether
in
thereexistconditions
underwhichtheretailer
profit
reapshigher
thecompleteabsenceofpiracy,
we considered
thebase case scenario(case 1) where
themusicretailer
a musicpiracyoptionforconsumers.
operatesin a worldwithout
retailer
is assumedto offera searchchannelwhoseeffiHere,thebrick-and-mortar

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CONSUMER SEARCH AND RETAILER STRATEGIES IN ONLINE MUSIC SHARING

1 -,

151

_
Cd=1

0.9

K 0.5

Cd=11

0.3J
0.1

*^^^>

,
0.2

,
0.3

0.4
0.5
0.6
0.7
Quality of Experience (S)

^^

,
0.8

,
0.9

0.95

8. Piracy
RatiowithPercent
Versus
PerDownload
LicenseFee(UnitModel,
Figure

= Ql^
yjONLC/yjONI

ciencyis identicaltotheonlinelegalmusicchannel,and'j)BM
rangesfrom0.1 to 1.2,
in increments
of0. 1. Atthecompletion
ofeach searchintheno-piracy
scenario,the
consumer
eitherpurchasesthemusicitemat a priceofpuordecidesto notpurchase
theitem.Figure9 presents
a comparison
ofprofits
intheno-piracy
basecase withthe
mixedmodelwithpiracyoption.For lowervaluesof a, presenceof piracyyields
evenwhensearchefficiency
and searchcostsare identical.Interesthigherprofits,
the
cutoff
for
below
which
the
increasesas
,
ingly,
point
piracyoptiondominates,
thesearchcostdecreases.
In summary,
thecomputational
resultsinvestigate
thecomplexinteraction
of the
consumer
searchprocess,theretailer's
controllable
ofpricingandlicensparameters
thepresenceofillegalchannels,
andconsumers'
ingstructures,
qualityofexperience
on thesechannels.We showthat
1. themixedonlinedistribution
modelfordigitalmusicgenerally
dominates
the
unitandsubsmodelsinthepresenceofpiracy;
2. retailer
aresignificantly
affected
searchcosts,
profits
byqualityofexperience,
andlicensestructures
withpublishers;
and
3. lowerpiracylevelsdo notnecessarily
translate
intohigherprofits
forretailers
forvarioustraditional
andonlinemodels.
fromboththetheoretical
are
Keyinsights
analysisandcomputational
investigations
inTable7.
consolidated

Remarks
Concluding
New opportunitiesand potential benefitsofInternet
arejuxtaposed
connectivity
for
retailers
of
we
modeled
the
consumer
search
digitalgoods.Here,
againstchallenges
market
channelsforone typeof digitalexperience
processand analyzedalternative
searchmodelincorporates
good- music.Ourconsumer
channel-switching
strategies

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152

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CONSUMER SEARCH AND RETAILER STRATEGIES IN ONLINE MUSIC SHARING

80000 i

.^

70000

^v.
*

">*

^'.

60000

'**^

50000
|

153

Base:;;::S:;

L^^^A^VTrJ^i^^.j^^rJAV'^^^A^^T

40000

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'*'*">,>* %V.

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*"**OnT* /^V.

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20000

N.

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= 0.1
Mxed:v|CmG

"--.,"

0 J

0.1

0.2

0.3

0.4

0.5

0.6

0.7

0.8

x>0NLG=M

0.9

0.95

Quality of Experience (<?)

BetweenBase andMixedModels
Figure9. Profit
Comparison

Table7. BriefRecapofKeyResultsUnderVariousPricingModelsandLicense
Structures
Modeling

Keyresultsandinsights

Theoretical
analysis

1. Mixedmodelweaklydominatestheunitand subs modelswhen


is lumpsum or percent.
licensingstructure
2. Mixedmodelweaklydominatessubs whenlicensingstructure
is
perdownload.
betweenprofits
3. As -*>1, thedifference
frommixedand subs
decreases and thetwoconverge.Similartrendsare seen for
ofmixedand unitmodels.
profits
4. As cost oflegal search increases,profits
fromsubs decrease,
frommixedand unitconverge.
and profits
withpercentlicensingcost weakly
5. Underunitmodel,profit
dominatesperdownload.As perdownloadcost (cd)increases,
dominatesperdownload.Hence,
percentlicensingcost strictly
is a moreviableoptionforall
a boundedcost structure
involved.
participants
Withthe
6. Undermixedmodel,profits
can be increasedfurther.
theretailer
can generatehigher
same netpaymentto publisher,
profit
usingpercentcost structure.
7. Retailerstrategiesthatminimize
piracydo notnecessarily
maximizeprofit.
Retailer'sprofit-maximizing
positionoccursin
withpiracyactivity
above minimum
an environment
levels.
8. Profit
is usuallyhighestunderthemixedmodel.Piracylevelin
mixedis higherthansubs inmostcases, and rangesfrom8 to
45 percentofpiracyundertheunitmodel.
withpiracyyieldshigherprofits
than
9. Forlower, an environment
even withidenticalsearch efficiency
and
a scenariowithout,
search cost.As search cost decreases, needs to increase
beforepiracybecomes a viablealternative.

Additional
computational
insights
Impactof
licensing
structures

Piracy
implications

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154

BHATTACHARJEE,GOPAL, LERTWACHARA, AND MARSDEN

in
betweenillegaland legaloptions.We studiedfivedifferent
market
environments
the
for
whicha retailer
a
of
choose
to
We
derived
variety implications
may
operate.
environments
andprovidedvalidation
for"qualityofexperience"
(a), a key
differing
resultsfromextensive
forpiratedmusicitems.Finally,
computamodelingconstruct
markets.
tionsarepresented
for
music
tooffer
insights emerging
Our resultsindicatethatdecreasingpiracydoes notnecessarily
implyincreasing
maximumprofit
outcomesoccurin thepresenceof piracy.Seeking
Rather,
profits.
Partof the
meansto stoppiracyis likelyto be a self-harming
strategy.
regulatory
well
be
music
access to unauthorized
networks
prepurchase
sharingmay
enabling
an activity
to makebetterpurchases.Ouranalysisalso
sampling,
aidingconsumers
forretailers.
strategy
suggeststhatonlinemusicsales is a dominant
can eithersubOurresultsalso indicatethatthemixedmodel,wherea consumer
Interestretailer.
for
the
scribeorpurchasemusic la carte,is thedominant
strategy
thisdominance
continues
toholdevenwhenthesearchcostinthelegalchannel
ingly,
is a
withmusicpublishers
exceedsthatin theillegalchannel.Licensefeestructures
or
sum
show
that
a
We
and
overall
factor
lump
profits.
significant
affecting
pricing
cost
download
ofrevenuepayment
a per
modeldominates
structure,
suggestpercent
inga needfornewlicensingmodelsforonlinemusicsales.
Variouscompanies,includingApple,Roxio,Musicmatch,
Wal-Mart,Sony,and
that
or
services
Our
have
are
online
music
Microsoft,
[39].
analysissuggests
planning
As
conwe
the
mixed
someofthemmaybe missinga dominant
strategy.
strategy
tinueto studyonlinedigitalmarkets
thelong-term
andtheimpactofpiracy,
viability
a
interest
as
andpopularity
ofsuchmarket
will
be
of
compleofferings always
great
Our
mentofourtheoretical
is a challenging
results.
Onlinemusicretailing
enterprise.
goal herehas beento initiatea formalanalysisof alternative
pricingand licensing
structures.
has forever
sampleandprocure
Technology
changedthewayconsumers
thenewlandmusicitems,andthepotof goldawaitsretailers
whocan understand
and
scape
adaptappropriately.
The authorsgratefully
theTreibickFamilyEndowedChair,
Acknowledgments:
acknowledge
theTreibickElectronic
CommerceInitiative,
theXEROX CITI Endowment
Fund,theGE EndowedProfessor
Data andResearchIntelligence
Services(CIDRIS),
Fund,CenterforInternet
andtheGladsteinEndowedMIS ResearchLab forsupport
thatmadethisworkpossible.The
authorsare indebtedto threeanonymous
comreferees
fornumerous
helpfuland insightful
mentsandsuggestions.

Notes
1. A directed
searchincludessearching
fora knownmusicitemthattheconsumer
hasbeen
hasalreadyexperienced
radio,MTV,andso on. In thiscase,theconsumer
exposedtothrough
themusicitemandis awareofitsvalue.Undersucha scenario,
thecostofthemusicpromotion
anddiscovery
bornebytheretailer
andis
andpublisher,
nottheconsumer,
processis primarily
a criticaldifferentiator
inourmodelingcontext.
2. We showlaterthatBM -* ONLG andONLG -> BM optionswouldnotbe feasiblegiven
thesearchcoststructure.

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CONSUMER SEARCH AND RETAILER STRATEGIES IN ONLINE MUSIC SHARING

155

an individual'stasteand deliversa high-value


3. We assumethesearchtoolincorporates
We can drawparallelsto urnmodelsas follows.Consideran urnthat
itemto a consumer.
containsballsof variouscolorssuchas white,blue,green,orange,red,and so on. Suppose
a mappingthatis basedon
eachcolorcan be mappedintoa measurewe termcolorintensity,
a searchusingkey
coloris lightordark.In theurnscenario,a userinitiates
whether
a particular
a setofballsthatmatchthekeywords.
Thesearchenginethenreturns
wordsoncolorintensity.
fromtheresulting
setandreturned
totheuser.
A ball is thendrawnrandomly

References
firmsin themusic
releasebehavior,and multiproduct
1. Alexander,
P.J.Entrybarriers,
ReviewofIndustrial
9, 1 (1994), 85-98.
Organization,
industry.
recording
structure:
Evidencefromthemusicrecordandmarket
2. Alexander,
P.J.Newtechnology
JournalofCulturalEconomics,18, 2 (1994), 113-123.
ingindustry.
structure:
A newmeasureanda simpletest.
andmarket
P.J.Productvariety
3. Alexander,
JournalofEconomicBehaviorand Organization,
32, 2 (February1997),207-214.
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Proofs
Appendix.
1
ProofofObservation
Note that the cost incurred for performinga searchin theBM modelwith
below.Conpiracyis lowerthaninthebase model.Thisfollowsfromtheinequality
fromthen'hsearchatBM, we have:
theexpectedbenefit
sidering

= 2 vrb)+
VijG[a,h)

2 C'"(v,)(v,-,,()

vj[h,c)

+ 2 ^'hlh-^

< c, thenov, < v-p. Therefore,


When b < v,;/

v,/e[o,vT"<]

C''"h)max{v,,v,y-4

r,;/G[(),V,max]

fromeach searchoutcomeis higherin BM withpiracy


theexpectedbenefit
Further,
base
(without
piracy)as
comparedto

.e[o.v,-]

i-j,e[o.vr"J

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158

BHATTACHARJEE,GOPAL, LERTWACHARA, AND MARSDEN

ProofofResult1
eachsearchatthe
initiate
NotethatintheBM modelwithpiracy(case 2), consumers
each searchat the
initiate
illegalchannel.Considertheunitmodel.Ifall consumers
toBM (Tables
identical
costs
are
and
search
benefits
then
the
channel,
illegal
expected
areidenticalinthiscase. Nowconsider
1 and2). Thus,theseller'sexpectedrevenues
a searchat thelegalchannel.This
theconditions
underwhicha consumerinitiates
occurswhen

_xpONLG_ipONLG^ON,

0LG'" (v/y
)

The above can be recastas follows:

v^-Glo^)

v(,.e[o,vjmax]

_ipONLG_l/jONLG-ONI

^ONLCn ^

> 2 WM^Kyu-p.}-*VijG[0,c]

Rearranging,we have:

Vye[o.K.max]

0f/'"(v,)maX{ov,,v,-/,,,}

> 2 v,cG'"h)+ 2 vu^-M


VyE[/,-)

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CONSUMER SEARCH AND RETAILER STRATEGIES IN ONLINE MUSIC SHARING

159

side is
is strictly
side in theaboveinequality
The left-hand
positive.The right-hand
with
that
a
consumer
such
exists
a
V*
there
in
Thus,
decreasing V,ma'
monotonically
max
>
thata
at leastone searchon thelegalchannel.The probability
y* wju initiate
y
thesearchon thelegalchannelwouldsubsequently
whoinitiates
consumer
purchase

thesearchat theillegalchannel
initiates
is higherthanwhentheconsumer

2 *r*MQED.

ProofofResult3
In thelumpsum
revenuesandprofit,
Let R and FI denotetheretailer's
respectively.
II =
we haveIT = R Nc,.In thepercentage
structure,
payment
structure,
payment
thatmaximizesrevenuesalso
Forgivenvaluesof N, ch and c,,,strategy
#(1_ Cp)m
theunit
model
mixed
the
that
Result2 shows
maximizesprofits.
weaklydominates
andsubsmodelsforsellerrevenues.QED.

ProofofResult4
serviceat a
a subscription
offers
Considertheanalysisof Result2 whentheretailer
a per unitoption,let[p,ps]denotethepricerangefor
offers
Iftheretailer
priceof/?,.
Ifthereexistsa valueofpu
continueto subscribe.
subscribers
current
all
in
which
pu
<
<
whoonlypiratesmusicin
individual
least
one
if
at
>
and
suchthatpu cd
p pu ps
arestrictly
theretailer
somemusiclegallyat/?H,
thesubsmodelnowpurchases
profits
is no worseoff.QED.
theretailer
Otherwise,
higher.

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