Secondhand Deadweight Pirates

Today's news brings us the story of a company trying to build a marketplace for second-hand sales of digital games. There are all sorts of technical challenges regarding tracking those digital games (like the invasive system-scanning software they propose) and issues with disentangling specific games from accounts (see: Steam). But I think these are small issues compared to the fundamental issue of re-selling "goods."

Just what are "goods" anyways? When I think of second-hand sales of books, I think of the value of trading the physical object rather than the content. A specific edition, for example, is valuable for being a rare physical object and is owned for being a thing, not for being read. The reason collectors buy more than one copy of a book isn't to re-read it, but to collect those editions. If someone simply wants to read a book, they don't spend gobs of cash on an exclusive and rare original.

In contrast, when I think of games, I think of the act of reading a book. It doesn't matter where you get that book: from a store, from a library, from a friend. You may not even keep the book after you read it, but you still want to read it, to experience it.

When most people pay for games, they're paying for the experience, not the object. This is especially so with digital games.

Arguably, when games were delivered on physical media there was a similar value to second-hand sales as there was for books: games would go out of print, the disks or boxes or manuals would become valuable for themselves. But digital games don't share this property. In theory, they never go out of print, continually available from digital distribution stores. There is no need for a second-hand market for collectors.

The only reason people would want to buy a second-hand digitally distributed game is to pay less. At that point, it makes a hell of a lot more sense to pirate the game rather than buy it second-hand. Furthermore, in either case, the developer is getting no money. Why should it be any more legal for a second-hand seller to get your money than no one at all?

Economics of Game Markets

The real source of the problem is price inflexibility in the current digital marketplace. In economics terms, a games company has a monopoly: they alone can sell their game, thus they alone set the price of the game. while it could be argued that similar games are in competition with one another and are substitute goods, most gamers recognize that the differences between games make them non-interchangeable.

This puts games in "weak" competition with each other. Buying one game does not obviate the desire to buy another. A gamer may go into a game store and buy multiple similar games. The price of a game is usually a secondary concern when buying a game and often does not greatly impact the choice between games (eg: people probably don't turn away from Diablo 3 in favour of Torchlight 2, despite the significant price difference).

In other words, the price people are willing to pay for your game is rarely influenced by the price of its competitors, but rather their quality. So, to continue the example, people are willing to pay less for Torchlight 2 not because of Diablo 3's price, but because of Diablo 3's quality.

[note: I use the term "quality" here very broadly to encompass everything from aesthetics to brand recognition]

This means each game's price is weakly linked to the price of other games. This is why we see so many different games today at so many different prices, from "AAA" games ranging from $40 to $80 down to 99cent titles or free to play games.

But it wasn't always that way. Wide price ranges are bad for sellers because they're inconsistent. And consistency builds complacency: when people see the same price everywhere on everything, they stop thinking about the price and just pay it. This is one of the reasons for price fixing in markets and why the $60 blockbuster reigned for so long: if everyone plays along and sells their game at the same price, all the consumers will internalize that price as the "normal" price to pay.

Death of the Blockbuster

Of course, the $60 blockbuster wouldn’t work in every market. Some markets would pay less, some more, and to maximize profits in each market you’ll want a different price in each. This leads to price discrimination: trying to find the best price to sell in each market. Of course, then people try to circumvent price discrimination by importing goods between regional markets, leading to all sorts of lawsuits.

The other problem with price discrimination is that it leads to deadweight loss. Deadweight loss is the loss of money from crude discrimination. If you over-generalize a market, you undercharge people who might be willing to pay more and completely lose out on people only willing to pay less. The opposite ideal is unit-discrimination: charge each and every customer a different price in the hopes of maximizing that price for that customer.

Unit-discrimination is the principle behind negotiating, bargaining, and haggling: the idea that each transaction was unique and based on the conditions of that transaction. It’s a practice that’s been lost in modern economies of scale, but one that’s potentially revivable with intelligent computing.
 
Steam has gone a long way to combating price inflexibility with regular sales and deals. But take it a step further: imagine if Steam introduced a negotiation system, where users can state how much they'd pay for a game and a window in which they'd be willing to pay that price. Publishers can either accept or refuse the offer, or make a counter-offer. This would, in a sense, restore the negotiating power to both consumers and publishers.

Second-hand sales are another way to restore consumer negotiating power: if you have an inflexible initial purchase price but a flexible re-sale price, you can navigate the difference as an ultimate cost for the good. It makes a lot of sense that, in the absence of flexible prices from publishers, people would seek alternative means of regaining that negotiation space. The problem here is that publishers are losing out on any of the revenue from secondary sales. Which makes the fact that they’re not engaging in unit-price-discrimination all the more confusing. Who would buy a secondhand game when they could buy a brand new one for less?

Digital Marketplace Confusion

All this could only reasonably happen in the digital marketplace, where marginal costs are zero. Broad price discrimination and secondhand sales make sense in physical markets, where you’re limited by estimates for the production of goods and the grace of storefronts that will shelve those goods.

The simple fact is that traditional publishers just don’t seem to understand the nuances of a non-traditional supply market.

That they still spend money fighting piracy instead of selling games to pirates is a major indicator of this ignorance.

No one likes being told "my way or the highway." No one likes having their voice taken away. What piracy and secondhand sales both have in common is that they are ways gamers have to retaking their voice, of reasserting their worth and their power.

Of course, there are no real examples to point to in terms of massive economic success stories with empowered customers, aside from the limited successes of "pay what you want" bundles. Successful, to be sure, but not in the market ranges the big publishers normally deal with. Off by two or three orders of magnitude.

Maybe companies just have to try something new. Change the digital marketplace around to a different model. Instead of selling games, sell "admit one" tickets to play a game as much as you want. Instead of fixed prices, negotiate with customers (or, rather, build computer systems that negotiate for you). The company that does so will eliminate deadweight loss, secondhand sales, and piracy, all in one masterful stroke.

In theory.