Are Digital Rights Valuable? Theory and Evidence from Ebook Pricing

Abstract

The effective management of digital rights is the central challenge in many industries making the transition from physical to digital products. We present a new model that characterizes the value of these digital rights when products are sold both embedded in tangible physical artifacts, and as pure digital goods, and when granting rights permitted by one's digital rights management (DRM) platform may affect the extent of digital piracy. Our model indicates that in the absence of piracy, digital rights should be unrestricted, since a seller can use its pricing strategy to optimally balance sales between physical and digital goods. However, the threat of piracy limits the extent to which digital rights should be granted: the value of digital rights is determined not only by their direct effect on the quality of legal digital goods, but by a differential piracy effect that can lower a seller's pricing power. When the latter effect is sufficiently high, granting digital rights can have a detrimental effect on value - our model indicates that this kind of effect is more likely to be observed for digital rights that aim to replicate the consumption experience of physical goods, rather than enhancing a customer's digital experience. We test the predictions of our analytical model using data from the ebook industry. Our empirical evidence supports our theoretical results, showing that four separate digital rights each have an economically significant impact on ebook prices, and establishing that the digital rights which aim to replicate physical consumption while increasing the threat of piracy are the ones that have negative impact on seller value. We also show that if the pricing of a digital good is keyed off that of an existing tangible good, optimal pricing changes for the former should be more nuanced, rather than simply mirroring changes in the price of the latter, and we discuss the effect of the technological sophistication of potential customers on optimal pricing and rights management. Our results represent new evidence of the importance of an informed and judicious choice of the different digital rights granted by a DRM platform, and provide a new framework for guiding managers in industries that are progressively being digitized.