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• Capacity constraints do not limit production output in any significant way, and
• Storage, retrieval, and forwarding the product is easy and inexpensive to do.


One consequence of these characteristics is that unauthorized use by purchasers of the
product (including the forwarding of the digital product to other parties who have not
paid for the product) can be difficult or impossible to control. A second consequence is
that sellers of such products must adopt different strategies from those used by sellers
of physical products to ensure that a revenue stream flows from the continuing use of
the digital product.
Many digital products are, in their essence, things that are experienced by customers.
They often have no meaningful physical existence separate from the experience.
Krishnamurthy (2003) discusses this characteristic of digital products as being either
experience or credence goods. Unlike an item of clothing, which can be examined before
purchase in a physical store, an experience good requires that the customer be exposed
to the product before determining its quality. An artwork or performance is an experience
good because the customer cannot judge its quality without experiencing it. A credence
product is even more complex. A customer often cannot judge the quality of a credence
good even after experiencing it. For example, the quality of a physician™s services could
be difficult for a person without medical training to judge even after the services have
been rendered. Purchasers rely on third-party reviews of experience and credence goods
for pre-purchase information.


Changing Technologies and Digital Products

Providers of digital products must maintain a current knowledge of underlying technolo-
gies that are used or could be used in the future for delivery of their products. One serious
case of vendors™ failure to keep up with delivery and transmission technologies is the
music recording industry, which grossly underestimated the impact of file-size compres-
sion technologies and increasingly inexpensive Internet bandwidth (Christman, 2002;
Dahl, 2003; Lee and Capell, 2003). The ability of customers to adapt and reformat digital
products is also an essential characteristic of digital products”a characteristic that can
be affected by changes in technologies, as well.




Pricing and Distribution of Digital
Products
Issues regarding pricing and distribution control of digital products arose before the
Internet and the World Wide Web (Web) became prevalent. However, the availability of
an inexpensive and near-immediate electronic transmission medium has added new
issues and complicated existing issues. These pricing and distribution issues affect the
nature, quantity, and quality of competition in markets for these products.


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Digital Products on the Web 157


Digital products require an approach to pricing that differs from that used for physical
products. Some digital products are made available at no charge, thus, an alternative
revenue stream that is somehow related to the product must be devised. Some digital
products are bundled with other products (digital or physical) to avoid some of the
problems inherent in the pricing of digital products alone. Another pricing strategy is to
create an artificial distinction within a subset of digital products and use differential
pricing to extract the highest revenue possible from each set of customers for the product.
Perhaps the most common pricing method is to use a licensing approach of one kind or
another.
On the Web, combinations of all these pricing methods are often seen. For example, Web
sites often make free content available and charge for other, related content. This is a
combination of the “no charge” approach with the differential pricing approach.
Although a number of studies (Bailey, 1998; Bakos, 1997; Brynjolfsson and Smith, 2000;
Lee, 1998) have been published regarding pricing on the Internet, these studies consider
the Internet as a part of the marketing and pricing mechanism in a general way for all types
of goods sold on the Internet. They do not address the specific issues that arise when
selling digital products on the Internet. Although these general analyses of the impact
of the Internet on marketing channels do conclude that in many cases the transaction
costs in the channel are reduced, the studies are less conclusive on the question of which
parties in the channel are able to reap the benefits of those transaction cost reductions
(Schneider, 2004). For most digital products, however, the real effect on pricing and
distribution strategy does not derive from the introduction of the Internet into the
marketing channel, but from the products™ very nature as digital products. In this section,
specific pricing and distribution strategies for digital products are outlined.


Low Price or Barter Strategies

Many digital products are offered on the Internet in a way that makes them appear to be
free. In almost all cases, however, there is a low price exacted. In general, this price is non-
monetary. In some cases, the site visitor obtains the digital product in exchange for
personal information, which the site is then able to use for marketing or other purposes.
In other cases, the site visitor agrees to have advertising appear in his or her Web browser
window. In effect, the customer is bartering personal information or time spent viewing
advertisements in exchange for the digital good.
Examples of these types of digital products and services include sites such as The New
York Times. The Times provides news stories in exchange for a site visitor™s registration,
which discloses a small amount of personal information, and for the visitor™s willingness
to view advertisements that are included on the Web pages that display the digital
product (the news stories). Many other newspapers, magazines, news services, and
other online information portals use this pricing and distribution strategy to sell their
digital products.
Another example of a low-price or barter strategy is the offering of “free” e-mail accounts.
Companies such as Yahoo! and Microsoft (through its Hotmail business) offer a limited
personal e-mail service. The companies do not charge for the service, but do collect



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158 Schneider


personal information that they use for marketing purposes. The e-mail service is provided
on Web pages that include targeted advertising. The advertising is targeted based on
the personal information collected.
In most cases, the barter transaction is fully disclosed. In some cases, however,
companies offer “free” information or software services but include in the software a
feature that collects information from the customer™s computer and reports it back to the
seller for as long as the software is installed. This type of software is called stealthware
or spyware because it often installs the reporting feature in a way that makes it difficult
for the customer to detect its operation (Hagerty and Berman, 2003; Metz, 2003).
Sometimes, a digital product is given away so that customers can try it before purchasing
it. Sites that sell information by subscription often offer a 30-day free trial period.
Software is often sold this way. Called “shareware,” the software is provided for
download and can be used for a limited time. After the trail period expires, the software
will either disable itself or launch periodic reminders (called nag boxes) to register and
pay for the software. Some shareware does not include any type of disabling code or
programmed reminders. The vendors simply ask users who like the product to contribute
money. This has not been a terribly effective way to market digital products, but it was
widely used in the early days of the Internet and it does still continue today as a
distribution model for some software products (Liao-Troth and Griffith, 2002).


Subscription Strategies

In a subscription arrangement, the customer agrees to pay for access to content or the
use of a digital service over time. Companies that offer free e-mail services, such as
Yahoo!, often also offer additional services such as increased disk storage space or the
right to send and receive larger sized e-mail messages or attachments on a paid
subscription basis.
Some newspapers and magazines also offer paid subscriptions to Web site content. This
Web content is distinguished from the content that is offered at no charge by either being
additional content not available to non-subscriber site visitors, or it is content that is
offered free of the advertising messages that accompany free content on the site.
Subscriptions are attractive to sellers because they reduce the administrative costs
associated with tracking and billing individual consumption of digital products. Sub-
scriptions can also appeal to customers because they provide a simple pricing arrange-
ment that has a known and certain price (Fishburn and Odlyzko, 1999). In some cases,
such as AOL™s adoption of a fixed subscription price in 1996, the known and certain price
can lead customers to consume greater quantities of what they perceive to be free digital
goods. Once they have paid the subscription fee, their marginal cost of consuming
additional units of the goods is near zero (Roth, 1998).


Differential Price Strategies

Each person wanting to buy a product has a maximum price that he or she is willing to
pay for it. This price, often called a reservation price, is known to the buyer but not to

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Digital Products on the Web 159


the seller. Much of the seller™s pricing task is to estimate potential purchasers™ reserva-
tion prices and set the price of the product low enough to attract a large number of
purchases, but no lower than necessary (Edwards, 1942).
One way for a seller to extract the highest possible reservation prices from a diverse group
of potential purchasers is to segregate them into multiple categories and then charge a
different price to purchasers in each category (Bichler and Loebbecke, 2000; Forsyth,
Lavoie and McGuire, 2000). For example, some manufacturers sell their products primarily
to wholesalers and retail stores, but also sell direct to end-user customers from time to
time. These manufacturers typically charge a lower price to their wholesale customers
than to their end-user customers. If sellers can identify any reasonable basis for
discriminating in their pricing, they will optimize their profits if they can charge different
prices to different customers.
The ultimate in price discrimination is charging a different price to every single customer
(Peppers and Rogers, 1997). The Web, with its ability to identify site visitors and
customize the shopping experience, makes this not only feasible, but relatively easy to
accomplish (Godin and Peppers, 1999).
Some countries, such as the United States, have laws that prohibit certain types of price
discrimination (Purchasing Law Report, 2001). However, most price discrimination is
legal throughout the world. The ethics of price discrimination are open to debate
(Campbell, 1999) and companies such as Amazon.com have faced highly critical customer
reactions and press coverage when they have been identified as engaging in price
discrimination (Adamy, 2000; Cox, 2001).
One form of price discrimination that works very well with digital products is versioning
(Krishnamurthy, 2003). Information content on the Web can be versioned by:
• Offering a version of the product without advertising or with a smaller amount of
advertising or advertising in forms that are less obtrusive. The low-advertisement
content version is sold for a higher price or made available only to subscribers.
• More current information offered to customers who pay higher prices or who
subscribe. Those paying lower prices or not subscribing to the site receive
information after a time delay.
• A more complete feature set is offered at a higher price. For example, a news site
might include streaming video for subscribers.
• Varying the quality of the offering. Many sites that sell or lease graphics for use
on Web pages or in print applications offer a small, low-resolution picture on the
Web site at no cost or at a very low price. This graphic might also include a visible
mark that reduces the value of the image. For a higher price, customers can buy a
higher resolution version of the graphic.


These versioning strategies do not work well if the content can be converted readily. That
is, if a low-price version of the digital product can be converted to the high-price version
easily, customers will not see any reason for the price differential and will object to it
(Shapiro and Varian, 1998).



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160 Schneider


Product Bundling Strategies

Some products can be offered in combinations, or bundles. For example, a music CD is
a bundle of individual song recordings. A newspaper is a bundle of stories and
advertisements. A software suite is a bundle of individual programs. Research (Venkatesh
and Mahajan, 1993) has shown that if customer preferences are not homogeneous, the
prices of the individual items in the bundle are not close to each other, and a significant
proportion of customers are indifferent to a large number of the products in the bundle,
a mandatory bundling of products can yield greater profits than offering the products
separately (Estalami, 1999).
If the individual products function better as a bundle, as might occur with software
programs offered as a suite, the seller can even charge a premium for the bundle (Estelami,
1999). Companies offering digital products on the Web can easily bundle products and
services (Sieber and Sabatier, 2003) and can charge premiums for complementary
products in different amounts to different customers, thus combining the product-
bundling strategy with the price discrimination strategy described above (Venkatesh and
Kamakura, 2003).




Revenue Models for Digital Products
Companies have combined the basic pricing and distribution strategies described in the
preceding section into a number of different revenue models that they are currently using
to sell digital products on the Internet. These include subscription-based models,
advertising-supported models, per-item sales models, and a variety of mixed models
(Schneider, 2003). This section discusses specific industries that sell digital products
and provides a brief description of how each industry is using various revenue models.
According to Cohan (2001), Internet business models must be based on selling one or
more of four digital product elements to customers. These four elements include:
charging for access to content, charging for copies of content, charging to transmit
messages to current or potential customers, and charging for transactions that result
from exposure to or consumption of content.


Newspaper and Magazine Sites

Many newspapers and an increasing number of magazines publish all or part of their print
content on the Web. It is unclear whether a newspaper™s presence on the Web helps or
hurts the newspaper™s business as a whole. Choi (2003) argues that the reputation of an
old product (the print newspaper, in this case) can carry over to a new product (the news
Web site, in this case) if the products are bundled. However, other researchers, such as
Cripps and Schmidt (1996) have argued that the reputation transfer is unpredictable.




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Digital Products on the Web 161


Advertising Revenue Model

Although news Web sites can provide greater exposure for newspapers™ names and can
provide larger audiences for the advertising that the newspapers carry, they can also
cannibalize sales from print editions. Like retailers or distributors whose online sales lead
to cannibalization of their brick-and-mortar sales, publishers also can experience sales
losses as a result of online distribution. Newspapers and other publishers worry about
these sales losses, because they are very difficult to measure. Some publishers have
conducted surveys in which they ask people whether they have stopped buying the
newspaper because the content they want to see is available online. In addition to the
concern about lost sales of print editions, most newspaper publishers have found that
the cost of operating their Web sites cannot be covered by the revenue they can generate
from selling advertising on the site. Thus, many newspaper publishers have experi-
mented with various other ways of generating revenue from their Web sites.
The advertising revenue model is used by network television in the United States.
Broadcasters provide free programming to an audience along with advertising messages.
The advertising revenue is sufficient to support the operations of the network and the
creation or purchase of the programs. Many observers of the Web in its early growth
period believed that the potential for Internet advertising was tremendous. Web adver-
tising had grown from essentially zero in 1994 to $2 billion in 1998 (Sharples, 1999).
However, Web advertising has been flat or declining from 2000 until quite recently. In
2002, Web advertising revenues began to increase again, but at a fraction of their former
growth rate (Tynan and Gilbert, 2003). After some years of experience in trying to develop
profitable advertising revenue models without the growth rates of the early years of the
Web, many companies are less optimistic about the potential for advertising as the sole
basis for revenue generation.
The success of Web advertising has been hampered by two major problems. First, no
consensus has emerged on how to measure and charge for site-visitor views. Since the
Web allows multiple measurements, such as number of visitors, number of unique
visitors, number of click-throughs, and other attributes of visitor behavior, it has been
difficult for Web advertisers to develop a standard for advertising charges. In addition
to the number of visitors or page views, stickiness is a critical element to creating a
presence that will attract advertisers. The stickiness of a Web site is its ability to keep
visitors at the site and to attract repeat visitors. People spend more time at a sticky Web
site and are thus exposed to more advertising.
The second problem is that very few Web sites have sufficient numbers of visitors to
interest large advertisers. Most successful advertising on the Web is targeted to very
specific groups. The characteristics that marketers use to group visitors is called
demographic information, and includes such things as address, age, gender, income
level, type of job held, hobbies, and religion. It can be difficult to determine whether a
given Web site is attracting a specific market segment unless that site collects demo-
graphic information from its visitors, which is information that visitors are increasingly
reluctant to provide because of privacy concerns.




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Subscription Revenue Model

One alternative to a pure advertising revenue model is to add the sale of subscriptions
to the information content of the Web site. Few newspaper or magazine publishers use
a pure subscription model. Most of these businesses that sell subscription access to their
sites use a combination of advertising and subscription revenues, much as print
newspapers and magazines do. Consumers Union, the publisher of the monthly product
evaluations and ratings magazine Consumer Reports, is an exception to this rule. It does
operate a Web site that relies heavily on subscriptions. Consumers Union is a not-for-
profit organization that does not accept advertising as a matter of policy (because it might
appear to influence its testing and research results for the products of its advertisers or
their advertisers™ competitors). Therefore, the site is supported by a combination of
subscription revenue and some donations. The Web site does offer some free information
as a way to attract subscribers and to fulfill its organizational mission of encouraging
improvements in product safety, but this is not a revenue generator for the organization.


Advertising-Subscription Combination Model

In the advertising-subscription combined revenue model used by most online newspa-
pers and magazines, subscribers pay a fee and accept some level of advertising. On Web
sites that use the advertising-subscription revenue model, subscribers are typically
subjected to much less advertising than they are on advertising-supported sites. Firms
have had varying levels of success in applying this model and a number of companies
have moved to or from this model over their lifetimes.
Two leading newspapers, The New York Times and The Wall Street Journal, use a
combined advertising-subscription model. The New York Times version is mostly
advertising-supported with a small subscription fee for visitors who want full access to
enhanced online versions of the newspaper™s crossword puzzles. The New York Times
also provides a searchable archive of past articles and charges a small fee for access to
non-current articles. The Wall Street Journal™s combination model is weighted more
heavily to subscription revenue. The site allows non-subscriber visitors to view the
classified ads and certain stories from the newspaper, but most of the content is reserved
for subscribers who pay an annual fee for access to the site. Visitors who already
subscribe to the print edition are offered a reduced rate on subscriptions to the online
edition.
Note that both of these newspapers use one version of this revenue model for their print
edition and another version for their online editions. Increasingly, newspapers and
magazines are finding that they need to use different revenue models for their print and
online editions. Other newspapers, including The Washington Post and the Los Angeles
Times, use another variation of the combination revenue model. These newspapers do
not charge any subscription fees for access to their Web sites. Instead, they offer current
stories free of charge on their Web sites, but require payment for older articles.
Business Week offers yet another combination revenue variation. It offers some free
content at its Business Week online site, but requires the purchase of a subscription to


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Digital Products on the Web 163


the Business Week print magazine if visitors want to gain access the entire site.
Subscribers who want to read archived articles that are more than five years old are levied
an additional charge per article. Business Week does place content in the subscriber
section of its Web site before the magazine appears on the newsstands or is delivered
to subscribers.
Sports fans visit the ESPN site for all types of sports-related information. Leveraging its
brand name from its cable television businesses, ESPN is one of the most visited sites
on the Web. It sells advertising and offers a vast amount of free information, but serious
sports fans can subscribe to its Insider service to obtain access to even more sports
information. Thus, ESPN uses a revenue model that includes advertising and subscrip-
tion revenue, but it only collects the subscription revenue from Insider subscribers, who
are a small percentage of site visitors.


Classified Advertising Sites: An Advertising Revenue
Model

Although attempts to create general-interest Web sites that generate sufficient adver-
tising revenue to be profitable have met with mixed results, sites that target niche markets
have been more successful. For newspapers, classified advertising is very profitable.
Thus, Web sites that specialize in providing only classified advertising do have profit
potential. This is especially true if they can reach a narrow target market and charge higher
rates because the advertising reaches the right audience.
One implementation of the advertising-supported revenue model that does appear to be
successful is Web employment advertising. As the number of people using the Web
increases, these businesses will be able to move out of their current focus on technology
and higher-level jobs and include advertising for all kinds of positions. These sites can
use the same approach that search-engine sites use to offer advertisers target markets.
When a visitor specifies an interest in, for example, engineering jobs in Dallas, the results
page can include a targeted banner ad for which an advertiser will pay more, because it
is directed at a specific segment of the audience.
Employment ad sites can also target specific categories of job seekers by including short
articles on topics of interest. These articles increase the site™s stickiness and it helps draw
people to the site who are not necessarily looking for a job. This is a good tactic because
people who are not looking for a job are often the candidates most highly sought by
employers. Classified employment advertising site Monster.com includes links to ar-
ticles, reports, a message board, and chat sessions that might interest employees at
various levels. It also offers a variety of newsletters tailored to employees at various
levels in their current positions.
Another type of classified advertising Web site that can generate sufficient revenue to
be profitable is the “used vehicle” site. Trader Publishing has printed advertising
newspapers for many years and now operates a number of vehicle classified advertising

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