Multi-Channel Sequential Search with Application to Piracy

This paper presents a multi-channel search model, where each channel consists of multiple firms that are ex ante homogeneous to consumers. Consumers, nevertheless, ex ante can tell channels apart in the following aspects: search costs, product quality, product availability and price distributions. We first analyze the channel selection problem, i.e. which channel a consumer searches first. We show that a consumer’s optimal channel selection at any stage of the search is independent of found prices – in other words, history independent. We further show that the optimal channel choice can be determined using each channel’s reservation price and consumer valuation. One implication is that interleaved search never takes place. We then apply this model to study the competition between legitimate and piracy products. One immediate result is that reducing the number of piracy services has no impact on consumers’ decision of whether to pirate unless all piracy services are shutdown. When piracy products pose a threat, legitimate firms may respond by giving up low search cost consumers. This leads to the surprising result that piracy threat may induce firms to increase, rather than to decrease, their product prices. At the same time price distribution among legitimate firms can be more polarized in that the variance in prices increases.