Strategic Analysis of the Agency Model for Digital Goods

The introduction of digital goods in the media industry has gained a considerable amount of positive press due to superior features such as increased accessibility and portability. However, the distribution of these digital goods in conjunction with their physical analogs (i.e., printed books) has been operationally problematic for media supply chains. Specifically, the types of contracts utilized to distribute these goods such as agency models have come under fire in the press. A high profile case brought by the Department of Justice (DOJ) against Apple exemplifies this debate as the DOJ claims that the agency model utilized by Apple caused higher prices and decreased consumer surplus. We create and analyze a model of vertically differentiated goods to compare and contrast the agency model with the wholesale model. We ascertain that both (a) the revenue‐sharing structure and (b) the upstream publisher's control over the price contribute to the benefits of the agency model. We consider a variation of this model which shows that if the retailer utilizes a ‘fixed price’ model, then he suffers from a short‐term loss in profit, possibly to garner additional market share. We also investigate an incentive alignment condition for the agency model which assures that the retailer and the publisher will together commit to selling digital goods alongside physical goods in the supply chain. Finally, we analyze an extension of the original model which incorporates horizontal differentiation in addition to vertical differentiation and shows that in most cases, the horizontal differentiation does not alter our original results that the agency model outperforms the wholesale model.