its, in that order. In 1999 and 2000, Internet start-ups were the beneficiaries of
enormous capital infusions by investors and spectacular market valuations,
sometimes before a trace of revenue had been earned. These early Internet
ventures were properly regarded as investments, and risky ones at that. Early
losses were expected to be balanced by significant future revenues. For
instance, strong revenue growth was the pattern for such information goods as
videotapes, CDs, DVDs, MP3 players, and music downloads (once a critical mass
of consumers had adopted the new technologies).
In many respects, however, information providers face special revenue
issues. First, revenues can be earned in numerous ways. The most familiar
means is simply setting a price per unit, as in the sale of a music CD, a movie
DVD, a piece of software, or content to a Web site. Maximizing total revenue
from sales means identifying the unit price such that EP1. However, there
are myriad other pricing options. When a movie producer sells a DVD to a
video store for rental, it receives a modest price of $8 per unit, but receives
roughly 40 percent of rental revenues from the store. Alternatively, software
may be sold via site license, allowing group users to enjoy a kind of quantity dis-
count. Internet services are sold by monthly subscription, by pay per use (or per
download), or in some combination. Many information services, particularly
search engines such as Google and high-traffic Web portals, earn the bulk of
their cash flows from advertising revenues. Internet advertising includes spon-
sored search links, banner ads, pop-up ads, e-mail advertisements, and even
Web-page sponsorships to promote brand names. Finally, there are all kinds of
indirect revenues. For instance, some information suppliers sell their customer
lists to third parties. It is also important to recognize the numerous trade-offs
between these different revenue sources. Outright DVD sales compete with
DVD rentals. Raising subscription prices lowers traffic and therefore reduces
the effectiveness of Web advertising. Obviously, these trade-offs complicate the
task of maximizing total revenue. In effect, the information supplier faces mul-
tiple, interdependent, and imprecise demand curves.
Second, most information goods exhibit positive network externalities.
This means that customers of a given information good obtain greater value
with a larger network of other connected customers. For instance, wireless tele-
phone customers benefit from the most fully developed nationwide (or world-
wide) network, and air travelers benefit from airlines with integrated national
and international routes offering multiple daily flights. Teenagers intensively
utilize American Online’s instant message service. The network need not be
physical. For example, the global network of Microsoft’s Windows-based oper-
ating system and Office applications allows easy file and software transfers
among users. By contrast, the separate network of Apple Mac users is much
more limited. eBay, the highly successful online auction company, has attracted
thousands of sellers and millions of buyers. This enormous network is valuable,
not only for sellers who seek the greatest number of potential buyers (and vice
versa), but also for eBay, which earns a percentage fee on all auction listings.104 Chapter 3 Demand Analysis and Optimal Pricingc03DemandAnalysisAndOptimalPricing.qxd 8/18/11 6:48 PM Page 104