Are Digital Rights Valuable? Theory and Evidence from the eBook Industry

Abstract

The effective management of digital rights is a crucial challenge in many industries making the transition from physical to digital products. We present an economic model that characterizes the value of digital rights when products are sold both embedded in tangible physical artifacts and as pure digital goods, and when granting digital rights may also 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 their 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 their effect on the differential quality of legal and pirated digital goods. When the latter effect is negative, granting digital rights may 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 a significant impact on ebook prices, and establishing that those two that are most strongly associated with digital piracy have a negative impact on seller value. We also show, both analytically and empirically, that sellers should increase the prices of digital goods as the prices of their physical counterparts increase, but decrease them as the technological sophistication of their potential customers increases. Our results represent new evidence of the importance of an informed and judicious choice of the different digital rights permitted by one’s DRM platform, and provide a framework for guiding managers in industries that are progressively being “digitized.”