Pricing and resale market strategy for durable goods : a dynamic equilibrium model of video games
I study the impact of the used goods market on pricing and profits in the video game industry and the implications of resale restrictions. I develop a modeling framework that incorporates (a) heterogeneous consumers who are forward looking in their buying an selling behaviors, (b) a strategic game producer who prices its products considering both inter-temporal price discrimination and price competition with used goods, (c) rational expectations on future prices by both consumers and the firm, and (d) market equilibria for both new and used-goods markets. Without observing sales data, I use equilibrium pricing solutions in my model and the varying rate of price decrease after a game's release to identify the sales volume of a game in every period as a percentage of its total demand. I develop a computationally tractable utility specification to solve the computational challenge comes with modeling the supply side equilibrium. I construct the demand function for a game from heterogeneous consumers whose valuations distribute on an interval, and partially characterize the consumers' decisions and reduce the dimensionality of the state space. Applying the model to a unique dataset of game prices collected from the Internet, I estimate the game-specific demand for multiple games released in the U.S. market. The results show significant variation across games in terms of shapes of valuation distributions, expected play time, degrees of consumers' preference for new over used games, and price sensitivities. Policy simulations show that the effects of prohibiting resale largely depend on the shape of a game's demand distribution, because most of the profits are gained from higher-valuation consumers who purchase the game when the price is high. Prohibiting resale does not dampen their willingness to pay for the game because their high utility from playing it. Moreover, higher expected future prices in the absence of the used-game market further reduces their incentives to wait. I find the predicted profit increase is significant for most games when reselling is prohibited. However, games with demand consisting mostly of low valuation consumers benefit less from this structural change, because (a) early sales increase only slightly given a much smaller proportion of high valuation consumers and (b) losing the option to resell significantly decreases the willingness to pay for low valuation consumers, forcing the firm to slash its prices dramatically over time. I find empirical evidence that a firm can be better off with the used game market. This suggests that though eliminating the resale market is generally optimal for popular games, retaining it can be more profitable for some games.