Pricing strategies for tied digital contents and devices

a r t i c l e i n f o Media companies are increasingly offering digital content to consumers. Many of these companies are tying digital content with their proprietary digital devices. In this study, we develop a consumer demand model for digital device and digital content based on a constant elasticity demand function. In modeling consumer valuation of the digital device, we take consumer surplus on digital content into account. We further derive equilibrium prices for digital devices based on an oligopoly competition model with horizontal product differentiation. We analyze the equilibrium prices and how prices affect firm profits. We find product differentiation and the level of product substitutability affect prices. We also find that content price plays a significant role in affecting the price of the digital device. Content price can either increase or decrease the tied digital device price depending on the profit margin and demand elasticity of the digital content. We further analyze how content and device prices affect their respective profits and the overall profit of the firm. We extend our model to vertical product differentiation and find vertical product differentiation and the level of product quality affect prices. Media companies are increasingly offering digital content online. Apple Computer is one of the pioneers in selling digital music at its iTunes store. Consumers can buy digital songs and videos starting at just 99 cents a piece [25]. With the high speed Internet, Apple, Netflix, TiVo and some other companies are providing videos directly to televisions at home [15,22]. As " the last bastion of analog " , according to Amazon's founder Jeff Bezos, books will be digitized as well [11]. The competition in digital books market has been heated. About 2 years after Amazon introduced its popular e-book reader Kindle in 2007. Barnes and Noble announced its digital book reader in 2009 [27]. In 2010, Apple introduced its competing iPad device, aiming to break Amazon's lead in the digital book market [14]. There are different ways to sell digital contents. While some companies provide " free " content with advertising on the Internet, many of the media companies are selling digital content with their proprietary formats and digital devices. For example, Apple sells digital songs in iTunes format using Advanced Audio Coding that can only be played with iPod. If consumers want to stream videos to their TVs from iTunes store, then they have …