Strategic Analysis of the Agency Model for Digital Goods

Abstract

The introduction of digital goods in the media industry has gained a considerable amount of positive press due to superior features such as increased accessibility and portability. However, the distribution of these digital goods in conjunction with their physical analogs (i.e., printed books) has been operationally problematic for media supply chains. Specifically, the types of contracts utilized to distribute these goods such as agency models have come under fire in the press. A high profile case brought by the Department of Justice (DOJ) against Apple exemplifies this debate as the DOJ claims that the agency model utilized by Apple caused higher prices and decreased consumer surplus. We create and analyze a model of vertically differentiated goods to compare and contrast the agency model with the wholesale model. We ascertain that both (a) the revenue‐sharing structure and (b) the upstream publisher's control over the price contribute to the benefits of the agency model. We consider a variation of this model which shows that if the retailer utilizes a “fixed price” model, then he suffers from a short‐term loss in profit, possibly to garner additional market share. We also investigate an incentive alignment condition for the agency model which assures that the retailer and the publisher will together commit to selling digital goods alongside physical goods in the supply chain. Finally, we analyze an extension of the original model which incorporates horizontal differentiation in addition to vertical differentiation and shows that in most cases, the horizontal differentiation does not alter our original results that the agency model outperforms the wholesale model.

How Add‐on Pricing Interacts with Distribution Contracts

“…Under the agency contract, the platform yields the retail pricing power regarding or to the firm. Therefore, a key distinction between the wholesale contract and the agency contract is whether the firm or the online platform has the control to set the retail price (Tan and Carrillo ). Similar to Hao and Fan (), for each bundle (under bundling) or core product (under add‐on pricing) sold under the agency contract, the platform takes proportion of the revenue while the upstream firm gets the remaining proportion.…”

When Old Meets New: Wholesale and Agency Models in the Market for Printed and Electronic Books

“…Intuitively, the publisher ought to always desire a lower α while the retailer should prefer the exact opposite [19]. The question then arises, does that simple intuition extend to my setup?…”

“…This finding is in clear contradiction not only to the common intuition but also to the suggestions from prior literature. For instance, [19] demonstrates that the retailer with a higher negotiating power would always opt for a higher α. In contrast, the above proposition implies that even when the retailer's bargaining power is great enough to command a large α, it may be in the retailer's best interest not to; it might be a better strategic move to yield more to the publisher.…”

“…The setup used in [19] is similar to the one used in this paper in the sense that it also captures a case where the retailer sells traditional goods through wholesaling and digital goods through an agency setup. While the model details differ, the authors also find that the agency model might be preferred to the traditional wholesaling setup by both the publisher and the retailer.…”

“…However, they find that the retailer can only do better with a higher agency fee, which is in stark contrast with one of the main messages of this work. The key reason for this discrepancy is in the timing; in [19], the authors assume that the e-book's retail price is determined before that of the printed version. However, since the publisher has full control over the e-book's retail price-and the retailer over the printed-book's retail price-it is more reasonable to assume that the retail prices are best response functions of each other.…”