Information Goods
What is Information?
As a first step, we need to get a clearer definition of the topic.
But what is this stuff, "information?" Before we can go very far, we need a definition of information goods and services, and that is a pretty controversial subject in itself.
Here are some examples of the trade in information goods and services:
1. A newly invented machine is patented, and the patent is licensed to a company that plans to build and sell the machine.
2. A new edition of a best-selling travel guide is published.
3. A public library buys 3 copies of the travel guide to lend (free) to its patrons.
4. A financial advisor offers his clients advice and opinions about profitable investments in return for a commission on their investment transactions.
5. An investor consults a World-Wide Web page for the values of "leading economic indicators" (key economic statistics) supplied by the U. S. Commerce Department.
There is no charge.
6. A collection of photographs of great paintings in world museums is put on CD-ROM and sold by a computer software company.
7. A record company publishes a boxed set of CD's with a digital recording of a recent performance of Mozart's "Marriage of Figaro," with Bryn Terfel singing the role of
Figaro. The set includes the libretto of the opera.
What these examples have in common is that information goods and services are being sold (or given away). For the purposes of our discussion, information goods and services share these properties: a) An information product is a collection of symbols.
b) Its utility depends on the arrangement of the symbols, not on the material form that they take.
Thus, for example, the plans for the newly invented machine are an information good. They are symbolic (perhaps pictorial as much as verbal) and their usefulness is the same whether they are on paper or some electronic form. Similarly, the utility of the travel guide is about the same whether it is from the original print run, a Xerox copy, or scanned and mounted on a computer disk. The utility of the travel guide may also be nearly as great when it is borrowed, and has to be taken back in a month, as when it is bought -- after all, by that time, the traveller is likely to have planned her trip and made her reservations. Yet again, the utility of the financial advice will be similar whether it is obtained orally or printed on a "market letter," -- assuming it is the same advice, that is, that the symbols are arranged in the same way. The photographs of the museum pictures are coded in a symbolic form -- one of the electronic picture standards, such as JPEG, TIFF or GIF -- and the utility of the coded photographs is pretty much the same

whether they are on CD, downloaded from a Web site, or broadcast on cable TV. Anyway, the coded photographs are worth much less than the originals because the originals are physically the paintings the great master painted. That is, the originals are not information goods because their utility comes from the material form they have, as much as from any arrangement of symbols. Similarly, the performance of "The Marriage of Figaro" was not itself an information product, since its utility depended on the material circumstances, including the vibration of air molecules set in motion by Terfel's extraordinary tenor voice. However, the score and libretto
(script) of the opera are information products. They can be performed again and again, and what gives them value is the arrangement of symbols to guide the future performances (and to aid in the enjoyment of the music by those who buy the CD set). Also, the CD's themselves are an information product, since the music is coded and the particular arrangement of digital codes is what produces music from the CD player, giving the CD's their value. Had the same digital codes been encoded on digital audio tape, they would have given the same utility (to those who have digital audio tape players, of course).
We may extend this definition of information products by observing that information services are services that provide or involve the manipulation of information products. In this article we use the terms information products and digital goods interchangeably.
Information, which is often loosely defined to include software and so-called 'edutainment' products as well as other knowledge-based products that can be digitized and delivered via networks, has received the most attention in the public press. However, information even in its broadest sense is far from the only product that can be digitized. Many physical products can be made "smart" by adding an electronic interface to monitor and control their functions—for example, smart cars and smart appliances, which become hybrid digital products. Other examples are electronic currencies and various forms of financial instruments and securities.
Even market processes are being digitized. For example, instead of driving to stores, consumers visit Web stores. Messages containing price quotes and orders sent over the Internet can indeed be considered to be digital products which perform the same functions as advertising and ordering in physical markets. In light of this far broader scope of possibilities, we define the properties and characteristics of digital products. We begin by discussing various types of digital products in terms of usage and valuation. We then examine three physical characteristics of digital products that distinguish them from their non-digital counterparts and that define the unique opportunities—and challenges—for commerce. Finally, we present a new taxonomy of digital product types based on user-product interactions.
Even a few random examples illustrate that virtually any product can be sold electronically using the Internet as an advanced communications medium for marketing and advertising, purchasing and payments. Large corporations to family-owned and neighborhood shops have set up online storefronts selling everything from flowers to salsa. In fact, a full range of easyto-use software has been available for some time through vendors that help businesses to set up an electronic shop. Electronic shopping can offer more than just convenient ordering. For example, when shopping groceries online through Peapod (http://www.peapod.com), you can search, compare, substitute, sort, and categorize your purchases using information on brands, prices, nutritional contents, and size. Peapod takes advantage of the computational power of the electronic marketplace to offer its customers convenience as well as personalized, planned,

economic shopping. Once a customer's product choices are recorded and analyzed over a period of time, online shopping services can offer inventorying and automated refill recommendations as well as targeted advertisements and promotions. Such an integrated shopping experience is indeed a digital service made possible in the electronic marketplace.
Although selling physical products on the Internet is the main goal of Peapod and many online businesses, their process innovations are at the core of electronic commerce. For businesses selling physical products online, their focus has been on improving the efficiency of business transactions or on enhancing their services to improve market share, but innovative thinking can transform many physical products and processes into digital products.
Information is a primary example of a digital product, i.e. knowledge-based goods that can be digitized and transferred over a digital network. Information goods include a wide range of traditionally paper-based products such as books, magazines, newspapers, journals, photographs, and maps and other graphics. Most of these products are first produced in digital format and then printed on paper. Some information products such as databases, computer software, and computer games are distributed and used in digital format. Since video and audio signals can now be digitized, multimedia products such as movies, television programs, and sound recordings can be combined with information products or sold separately as entertainment products. Clearly, these are all transparent examples of products that exist as physical products but that can easily be digitized for the electronic marketplace.
We can, however, take this process one step further. Anything that one can send and receive over the Internet has the potential to be a digital product. Just think of all the things you can send in an email message—letters and postcards, news, instructions, credit card information, product inquiries, etc. Paper-based products of all kinds can become digital products by scanning or by changing conceptually the way we use those products. For example, airline, concert or baseball tickets need not be printed on paper. Instead, a ticket—or the authorization for entry—can be assigned, transferred, and stored digitally in a person's ID card. To make a reservation, one can log on to a Web site, and make payments digitally. The ticket is then downloaded into the customer's storing device, which is scanned when boarding an airplane or entering a sporting venue. Similarly, business and government forms that we fill out every day can be digitized in their entirety. Instead of simply viewing information about a government service on Web pages, you could easily fill out a request form for public assistance and receive, for example, welfare payments deposited digitally on your electronic card or hard drive. Tax returns may be disbursed electronically, completely digitizing the whole process— maintaining expense records, calculating tax liabilities, submitting electronic filing, and paying taxes or getting refunds. Some non-paper objects can also be digitized. Museums routinely collect, describe, and catalog their collection using databases, photographs, and sounds. Virtual museums could digitize these materials and offer them on the Internet, reaching a far larger population. When art objects themselves are digital pictures and photographs, museums may be more virtual than physical, and the commerce of such objects includes the right to digitize them—and thus the ability to control the content of the Internet—for which Microsoft and other companies are prepared to pay a large sum of money.
Some products or services do not have a corresponding physical form but exist as a knowledge base or a process. This does not mean they cannot be turned into digital products. Take, for

example, a salesperson in a clothing store who has considerable expertise and knowledge of fabrics, sizes, and fashion acquired through years of training and experience. This valuable knowledge base could be digitized into a file or a program and made available to customers.
Similarly, any process involving multiple human interactions and communications can be organized as a digital process or an electronic market. For example, a news clipping service searches newspapers and magazines every day to locate and collect articles for a client based on specified preferences. A computer program could do the same information filtering of digitized news articles. Auctions for virtually all products could be organized as electronic markets where auction items are viewed online, and bids and payments are taken electronically.
Christie's publishes its auction catalog online, but it may well have to adapt its auctioning process itself to respond to its electronic competitors in the future. The government and corporations may also use electronic markets to send out requests for proposals. They may also receive and evaluate them in digital form, not only improving efficiency but expanding the number of participants. If a TV or radio station conducts a viewer response session using phone, fax or letter, a few hundred responses may strain its human and material resources.
Conducted on a Web page, it can easily accommodate tens of thousand responses, analyze them and respond in real-time. Innovative digitizing may also change the way we woo.
Although some occasions may demand real flowers, a virtual flower—a graphic file of a flower—is an example of digitizing a physical product whose main purpose is symbolic. A flower sent over the network could embody the gesture of greeting, consolation, affection or any other emotion.
The list of information-goods/digital-products is bounded only by human imagination. Still, they share a number of common traits. Besides the apparent physical quality of being a stream of bits, they have no physical bounds in production and use. They can, however, be grouped in the three broad categories shown in the Table below: information and entertainment products; symbols, tokens and concepts; and processes and services. As concert tickets demonstrate, many products are simply a token or a symbol whose physical form is not an essential requirement. Paper money is another example of a product that needs not necessarily be printed on paper. It is merely a symbol—in fact a concept of value that they can be digitized.
Table 2.1: Examples of information/digital products
(1) Information and entertainment products:
• Paper-based information products: newspapers, magazines, journals, books
• Product information: product specifications, user manuals, sales training manuals
• Graphics: photographs, postcards, calendars, maps, posters
• Audio: music recordings, speeches
• Video: movies, television programs
(2) Symbols, tokens and concepts:
• Tickets and reservations: airline, hotels, concerts, sport events
• Financial instruments: checks, electronic currencies, credit cards, securities
(3) Processes and services:
• Government services: forms, welfare payments
• Electronic messaging: letters, faxes, telephone calls

• Business value creation processes: ordering, bookkeeping, inventorying, contracting
• Auctions and electronic markets
• Remote education, telemedicine, and other interactive services
• Cybercafes and interactive entertainment

Economic Properties of Information Products
This definition and these examples of information products point toward some of the distinctive economic and organizational characteristics of information products:
1.
2.
3.
4.
5.

Media of Transmission
Uniqueness
High Fixed Costs
The Incentive Problem
Intellectual Property

1.

Media of Transmission

Information products cannot be bought or sold alone. While it is the arrangement of symbols that gives utility, the symbols have to be recorded or expressed in some material form. In the examples above, we have symbols recorded on paper blueprints and plans, on paper in a bound book, expressed in oral speech, in computer code on a hard disk, and on compact disks. Each of these is a "medium" for the preservation and transmission of the symbols, and the plural of
"medium" is "media." Information products cannot be bought, sold, given away or even preserved except in conjunction with some medium.
2.

Uniqueness

In the ideal competitive markets discussed in economics textbooks, the goods traded are assumed to be "homogenous." Since it is the specific arrangement of symbols in an information product that gives utility, information products cannot be "homogenous." For example, even if computer spreadsheets differ only a little in "look and feel," computer spreadsheets are not a
"homogenous product.” This means that there always is an element of monopoly in markets for information products.
3.

High Fixed Costs

Since the information product is not sold alone, but in conjunction with some medium, the costs of the information product itself are largely independent of the number of copies sold in the various appropriate media. That is, from the viewpoint of the seller, the costs of the information product itself are fixed costs, and the only variable costs are those of the media.
Information producers have this cost structure in common with public utilities and "natural monopolies" of all kinds, and as the phrase indicates, high fixed costs have some tendency to give rise to monopoly (though the term "natural monopoly" is probably usually an exaggeration). Of course, this reinforces the tendency toward monopoly created by uniqueness.

4.

Incentive Problem

Since it is the arrangement of the symbols that gives utility, it may be very easy and cheap to duplicate the information product. For example, once an inventor has worked out plans for a valuable invention, others can use the plans to produce the machine without sharing the cost of developing the invention. In general, a valuable arrangement of symbols can be imitated. That is, imitators can arrange symbols in the same way in the same or another suitable medium. In general imitation is less costly than original work, and thus the imitators can undersell the originator. In effect, the imitators need not bear any of the fixed cost of the original information product, but only the variable cost of the media. Other examples are those who
"pirate" software and recordings by making unauthorized copies. This may make it very difficult for originators of information products to recover the cost of their work, let alone profit by it. If this is so, then there will be little incentive to originate information products, and this would be inefficient. This is the "incentive problem."
5.

Intellectual Property

As a means of remedying the incentive problem, the law may give the originator of an information product some exclusive right to control use, or sell the information product, regardless of the media in which it is expressed. Rights of this kind are called rights of
"intellectual property." Patents for new inventions and copyright on new written or artistic work are examples of intellectual property.

Characteristics of Information Products
In the electronic marketplace of today digital goods consist primarily of information products.
An information or knowledge good is a peculiar kind of commodity. It needs no physical presence and the same idea or information can be expressed and conveyed in many ways. As the virtual cyberspace exists in the minds of the users, the idea or information—as the product of the mind—is said to be the native dweller of the cyberspace. Its economic significance, however, should be analyzed as a consumable commodity for which a market is organized and a price is determined based on its usefulness. In this section, we highlight some economic aspects of information products in terms of their usage by consumers. These aspects apply to both digital and non-digital information products.

1. Information as experience good
You can only tell if you want to buy some information once you know what it is--but by then it is too late. How can one transact in goods that you have to give away in order to show people what they are? There are several social and economic institutions that are used to overcome this problem.
Previewing and browsing
Information producers typically offer opportunities for browsing their products: Hollywood offers previews, the music industry offers radio broadcasts, and the publishing industry offers bookstores, nowadays complete with easy chairs and cappucinos. One of the great difficulties

faced by sellers of information on the Internet is figuring out ways to browse the products.
Video and previews work well, but it appears that previewing textual information would be quite difficult.
However, things are not quite as bad as they seem. The National Academy of Sciences Press found that when they posted the full text of book on the Web, the sales of those books went up by a factor of three. Posting the material on the Web allowed potential customers to preview the material, but anyone who really wanted to read the book would download it. MIT Press had a similar experience with monographs and online journals.
Reviews
Another way to overcome the experience good problem is for some economic agents to specialize in reviewing products and providing these evaluations to other potential consumers.
This is especially common in the entertainment industry: film reviews, book reviews, and music reviewers are ubiquitous.
But reviews are also found in the purer sort of information goods. The most academic popular papers (as measured by citation) are typically surveys since the specialization required for frontier work in the sciences has created a demand for such overviews.
Peer review is the standard technique used in the sciences for evaluating the merit of papers submitted for publication, while most humanities use academic presses to provide a similar function. This institution survives because it meets an important need: evaluating information.
Reputation
The third way that producers of information goods overcome the experience good problem is via reputation. I am willing to purchase the Wall Street Journal today because I have read it in the past and found it worthwhile. The Journal invests heavily to establish and maintain its brand identity. For example, when it started an online edition, it went to great lengths to create the same ``look and feel'' as the print edition. The intent was to carry over the reputation from the off-line edition to the online version.
Investing in brand and reputation is standard practice in the information biz, from the MGM
Lion to the Time magazine logo. This investment is warranted because of the experience good problem of information.
2. Dependence on Individual Preference
As conceptual embodiments of human ideas, knowledge, and intelligence, information products do not have physical form or structure that can be physically consumed. So information products are not 'consumable' goods in a conventional sense. What is being
"consumed" is the idea represented by the information and the use to which the information is put—something that varies greatly among consumers. Although the demand for any good varies according to the heterogeneity inherent in consumer tastes, the demand for information is likely to be more variable than that for other products. The main reason for the difference is that knowledge or information has many uses that often cross the boundary of established product categories. Consequently, information product sellers need to rely more on the signals

consumers send in order to group consumers according to preferences. As a result, product customization and discriminatory pricing based on consumer types or other identifiable information become essential for digital products because their uses and values are relatively heterogeneous. With differentiated products, pricing strategies will be based on consumers' valuations or their marginal willingness to pay rather than on marginal cost of production.
3. Transitory or Cumulative Utility
Many information products are time dependent. For example, weather information is used to forecast an output level of crops. For this year's crops, last year's weather information has no relevancy as long as we assume that the weather conditions in each year are determined by a random process (that is we discount the possibility to forecast this year's weather based on last year's). In this sense, some information, e.g. time-dependent, outdated, or outmoded information, may be transitory and perishable. Yesterday's weather information or news is no longer needed except for archiving and referencing purposes. But, archiving and referencing of transitory information has value in its own right. This means that the utility of information is really cumulative. A portion of any information file can be recycled and reused to produce different products. In contrast to most other types of products, even "consumed" goods can have value for information products. Interestingly enough, not only the consumption but the creation of information is also a cumulative, and often collaborative, process. John Perry
Barlow (1993) has argued "information is conveyed by propagation, not distribution." His point is to emphasize that information propagates like a plant and that both transferor and transferee have the same information. Often, information evolves as it is transferred through accumulation, modification, addition, and improvement. The process of schooling and learning begins with reading texts of accumulated knowledge and continues with improvements made by successive generations. In an age of digital products, changes can be made at an exponential rate. Due to this continuous, cumulative process of creation, given an information product, delineating and protecting an author's rights is no simple matter. Whether a work is copyrightable will depend on a close examination of all legal requirements. It suffices to say that cumulative consumption and production of digital products significantly complicates product pricing strategies.
4. Externalities of Information Products
Externalities are economic consequences that are not fully accounted for by the price or market system. These could be either unaccounted benefits or harmful effects. Automobiles pollute the air but its cost on environment is not reflected in the price of the automobile—an example of a negative externality. If your neighbor's tree gives you shade, it is a positive externality for you.
A new agricultural technique, e.g. the use of fallows in the Middle Ages, developed by one, has benefited all other farmers. The use of the new technique by others does not prevent the inventor from using it on his land. Therefore, the technique has a positive externality.
Many products have network externalities, which means that the value of a product increases as more people use it. Network externality is one example of a positive externality. The benefit of network externality may come directly from the increasing number of users, as in the case of the telephone. The value of the telephone is low if few people have a telephone, but much higher if you can reach almost anyone. Another example of a network externality is the software industry, where more companies develop programs for users of a popular operating

system, e.g. Windows, than for less popular operating systems. Many digital products have network externalities. For example, some computer games are more enjoyable when there are more people to play with. A communications network such as email or newsgroup messaging clearly enjoys network externality similar to the telephone. Because of this, sharing of information, computer software, and other digital products is often encouraged by the fact that the gains from sharing are substantial due to network externalities and often exceed the potential cost of sharing if caught and levied copyright infringement fines. When information products have network externalities, the control over reproduction and sharing has been the primary objective of copyright protection. Copyright control has been effective as long as infringers are easy to locate. Copies of books and audiotapes, for example, are usually pirated by those who have access to mass production facilities. As the number of potential pirates is limited and the investment necessary for such an operation is relatively high, most serious copyright infringement by pirates has been by overseas publishers operating beyond the reach of territorial copyright enforcement. However, digital products are highly vulnerable to copying by consumers who have the very same technology as the producers. The stake is raised even higher when we consider the possibility of pirate copies of digital currencies and electronic financial instruments.
Appropriate technologies and effective legal means must clearly be established to adapt to this new environment. A more proactive strategy, however, can be found in the very nature of digital products. Some information is inherently more valuable if fewer people have it. In these cases, the information has a harmful, or negative, externality if someone else has the same information. Although a basic tenet of economics observation holds that the value of a good is higher if it is more scarce, in the case of information, the opposite is often true due to network externality. Nevertheless, there are numerous instances where exclusive information is more valuable because its exclusivity renders the owner benefits. A primary example would be market information that can be used for investment or speculative purposes. The profitability of insider trading, although illegal, depends on the exclusivity of the information. For digital products with negative externalities, it is not easy to guarantee maximum value to a buyer.
Value assurance is comparatively easy in the case of physical products. If one owns an item, it is physically impossible for others to own the same object at the same time—and the fewer similar items that exist the higher the value of each. In a digital world, however, products can be reproduced and redistributed at will and the exclusivity of information products is not due to physical impossibility. Rather, exclusivity is artificially imposed through control of ownership.
Hoarding a physical product to create an artificial scarcity and to corner a market may be illegal, but there is no such constraint placed on hoarding an idea. Preferably, if sellers want to guarantee the value of information to their customers, information should be hoarded, or its access be limited. In terms of copyright protection, information sharing by consumers is never a problem for a seller when there is negative externality since sharing would mean lowering its value. However, sellers of information products need to provide stronger evidence of their guarantee or trustworthiness to customers than do sellers of non-digital products.
5. Intrinsic Values of Digital Products
Exclusivity in production can be just as valuable as exclusivity in consumption. This is akin to the reputation built by high-quality good producers of physical goods. When many versions of information, software, news analysis, or commentary are available, exclusivity depends on the originality and creativity of producers. An exclusive news coverage or a carriage of syndicated

column distinguishes one newspaper from another. In the world market for digital products, it will be the individuality or point of view of the authors, and the relevancy to the customers' needs that give one producer an edge over the other. By producing unique and customized products—exclusive products—sellers will be able to compete successfully regardless of size.
As an intermediary distributing products of many producers, the exclusivity or uniqueness also applies to the selection or bundling of these products. For example, retail outlets in physical markets offer a distinctive selection that attracts targeted customers, just as a magazine or a newspaper distinguishes itself from the rest through the selection of particular articles and features. Implementing such a unique selection or a "point of view" becomes easier because of the physical nature of digital products—especially their transmutability—which we discuss in the next section.

The Physical Nature of Digital Products (Information Goods)
Whereas the nature and use of information discussed above applies to both digital and nondigital forms of knowledge-based products, there are some characteristics of digital products that are fundamental or unique to the medium. Since we are concerned with commercial aspects of delivery and transmission over digital networks, we identify three such fundamental and unique features: indestructibility, transmutability (i.e. easy to modify), and reproducibility.
Some non-digital products share these characteristics, but only to a limited degree. For example, pictures can last for many decades with proper care; parts of a song can be copied and changed; and whole books can be photocopied. Despite these similarities, a digital file is the first medium of expression that takes all these characteristics to an infinite degree of perfection. 6. Indestructibility
Once created, a digital product maintains its form and quality ad infinitum because of the lack of normal wear and tear. While some durable goods such as automobiles or buildings may have a long life, they still suffer from usage, and initial quality differences are further accentuated by consumer usage behaviors. But the quality of a digital product does not degrade no matter how long or how often it is used. Therefore, no distinction can be made between durable and nondurable goods in the case of digital products. In other words, for most purposes, a product sold by a producer is equivalent to one offered in the secondhand market. This alone has significant ramifications on the market.
Like any durable good, a producer of a digital product competes with its own past sales since consumers purchase a digital product at most once during the product's life. As a result, the producer is often forced to charge a very competitive price—the lowest possible price—for its product even when it has no competitor. Suppose that Alice sells a complete database of
Medieval English names. As the list is complete and no new names can be added, the database is most durable. Suppose that those with English heritage are willing to pay $100 for such database, while non-English persons will pay only $10. On the first market day, Alice can maximize her profit by selling only to English descendants at $100 each. After all sales are made and if Alice wants to sell more, she must lower the price since all remaining buyers' willingness to pay for the product is only $10. However, if Alice lowers the price to $10 on the second day, such behavior could be predicted by all consumers who know the market demand.
Knowing that price will be lowered on the second day, no buyers will pay the initial high price.

Therefore, Alice can only price its product at $10 at any time. This peculiar market behavior is due to the shrinking market size as the durable good producer makes sales. Several measures are available to avoid lowering prices. For example, Alice may announce that she will not lower her price below $100 on the first day, or issue a buy-back guarantee if the price is lowered, but their effectiveness depends on her credibility. Alternatively, she may sell to the same number of customers in each market period with different, or 'updated' products. That is, a supposedly 'complete' database is continuously updated based on 'newly found' data—a strategy of planned obsolescence. Frequent updating and licensing are two popular strategies of durable good sellers having a significant impact on digital product marketing and pricing.
Frequent updates make old versions of software obsolete, thereby enabling the seller to continue to sell durable goods to the same buyers. While updated versions may be used to introduce new and more efficient features, the underlying profit motive in updates often increases inefficiency. Software manufacturers often make changes in the user interface—to differentiate new products sufficiently from old ones—so that users need to re-learn the software, resulting in waste. And in some cases, it is not clear whether new versions are of superior quality to old ones. After many years of updates, some computer programs have become exaggerated in size and complicated with unnecessary and useless features.
Licensing is another way to continue to sell. By renting instead of selling a durable good, consumers are charged for the usage in each period, whereby the market for the seller continues to exist. When renting, consumers are not affected by their expectations about the future sales and prices, and the firm has no incentive to produce any additional units or to lower prices in the future. Thus, licensing software will achieve the same goal in maximizing profit as the practice of frequent updating.
The indestructibility of digital products is another factor why digital product sellers would prefer licensing or leasing to direct sales. The life of a digital product is not only comparably longer than that of most durable goods it also has to compete with 'used' products that are indistinguishable from new products. When products in second-hand markets resemble the products in new product markets in every aspect, revenue protection for producers will depend on how successfully they can discourage second-hand sales, especially when the life of a product is longer than the product's usefulness to each consumer. Consequently, certain products like books and musical CDs may need special protection against reselling. Despite the obvious rationale from the producers' perspective, it is still uncertain whether second-hand markets can be legally prohibited.
7. Transmutability
A paradox to the above claim is that the content of digital products can be changed instantly.
They are extremely customizable and, indeed, seem to be changing constantly. Changes, whether accidental, intended, or fraudulent, can be irreversible. Hence, by the nature of digital products, producers lose some control over the integrity of their products. Although most free documents on the Internet state that they allow distribution only for unmodified copies, in a world composed of ones and zeros, this is a stipulation that is virtually impossible to enforce.
This does not prevent producers from employing a wide variety of mechanisms in their attempt.
Certain technologies, for example, prevent easy modification. For example, a document such as a PDF file can be viewed or printed with Adobe's Acrobat Reader, but users cannot save the

file in digital format. Therefore, any casual digital modification will be prevented although unlimited printing is allowed.
Acrobat Reader is platform independent and used to disseminate technical papers that contain graphics and equations. Despite these advantages, the program is extremely large for its limited function and has spread very slowly. While it is difficult to control content integrity at the user level once a digital file is downloaded, there are mechanisms that can verify whether a document has been modified. Encryption technologies (Data Encryption Standard and RSA— public key encryption scheme patented by RSA Data Security, Inc. (http://www.rsa.com)) provide privacy and protection against modification, but only in transmission. Other authentication technologies have been developed primarily for checking authenticity or whether a document's content has been altered. These technologies are useful if buyers are concerned about corrupted copies but will not provide sellers with effective control against unauthorized modifications or copies.
The strategic implication of transmutability is that rather than trying to protect content integrity, producers need to differentiate their products by customizing and updating, and by selling them as interactive services, not as standard shrink-wrapped products. This product differentiation is not only a possibility but should be the overall business strategy adopted by companies producing digital products. Component texts, graphics, audios and videos, or an overall look and format cannot be adequately protected. On the other hand, consumer updates can be a natural process in the evolution of information and digital products increasing the value of unmodified new products. This is underscored by the third and final attribute of digital products—reproducibility. 8. Reproducibility
The beauty—and the bone—of all digital products is that they can be reproduced, stored, and transferred at ease. This means, quite simply, that after the initial fixed investment cost, the marginal cost of production is almost zero. However, if the producer cannot appropriate even the fixed cost from the market, product quality may be lowered or the product may disappear altogether. Given a set market price, the level of fixed costs determines the minimum number of sales or market share needed to break even.
Consequently, advocates for intellectual property rights have centered on preventing improper duplication and reselling of digital products. Whether reproduction can be prevented via technology remains to be seen, but there is great skepticism that this can be achieved. Rather, producers must strive to make reproduction less valuable or irrelevant by continuously changing and improving their products. For an obvious reason, the marginal cost of a digital product is assumed to be zero. In terms of production—or reproduction—costs, this assertion would be reasonable enough. However, the copyright payment would be applied to each copy or reproduction, and a non-zero per-unit cost is added. Once we include such variable costs in the total production costs, digital products no longer have zero marginal costs. Here, we emphasize that, although digital products may be reproduced at a minimum or no additional cost, this in no way implies that their marginal costs will be zero.
Physical Nature and Economic Issues

The unique characteristics of digital products are all related in different ways to the key issues in electronic commerce. The indestructibility raises the concern regarding the effects of durability on market shares as well as the product choices that producers of durable products must employ to counter these effects. The first sale doctrine—allowing buyers to resell or lend purchased products—may destroy the market completely unless an information seller, for example, can restrict its customers from reselling.
On the other hand, the transmutability of digital products lends itself to product differentiation and customization, perhaps to a much heightened degree than any other physical products. Due to more flexible production technologies, consumers are increasingly enjoying products that match their tastes far better than mass-produced products that cater to average tastes. In electronic commerce, each consumer would be able to purchase a product based on his or her individual preference. The transmutability raises the whole issues of customized products, individualized pricing, and the proper use of consumer-revealed information.
Among the three characteristics, the reproducibility has been widely recognized as the most problematic aspect of digital commerce. Participants in the international copyright convention held in Geneva in December 1996 spent an extraordinary amount of time debating whether the temporary copies made by computers when browsing, backing-up, and displaying on screen—being reproductions, technically—violate the copyrights.
When copyright laws apply to paper-based products, a simple act of photocopying is undoubtedly an area of concern. For digital products, however, transmitting and reading a document on a computer involve a different set of user behaviors. Transmitting a file, for example, is based on the reproducibility of the file—a file transfer program always sends a copy rather than the file itself. Such routines are embedded in all aspects of computer file operations, but only now became a serious issue.
How digital copyrights should evolve—through re-defining copyright terms or through adapting to the new usage pattern of digital products. But the three characteristics of digital products discussed earlier clarify many aspects of digital copyright. Resale prohibition, for example, stems from the producer's concern about the infinite life span of the product— indestructibility. Content control is necessary because of the product's transmutability, and duplication prohibition is motivated by the easy reproducibility. Of these three, only transmutability can be countered by producers through business strategies—via such strategies as frequent updating and customization. Correspondingly, product differentiation and price discrimination based on consumer tastes will be the main economic concerns in the electronic commerce. The other two characteristics of digital products appear to work in the consumers' favor, and producers have high incentives to prevent reproduction and resale.

Types of Digital Products and Services: a Taxonomy
Digitized products can be composed of text, data, graphics, video, and /or audio.
Technologies are also making it possible to convey "feeling" in addition to sights and sounds. For example, when a cursor passes over a surface described as "rough" on the computer screen, a joystick or a mouse shakes and jolts. Because of the ease and speed with which these components can be reorganized, digital products are innately heterogeneous, making it difficult to derive marketing or pricing strategies that can be

used for a wide variety of products. In this section, we develop a taxonomy by which digital products can be grouped into a few major categories around common features and that is meaningful in analyzing economic issues and developing business strategies.
A number of alternative schemes have been used to categorize digital products. For example, file components have been used to characterize a product as either a text file, a graphic or a data file. With the increasing use of multi-media formats, however, this distinction is no longer useful. Categorizing digital products into databases, information products, entertainment, software, etc., is both descriptive and subjective. Although useful, this practice is inadequate and gives the false impression that electronic commerce simply mirrors other product markets. Furthermore, it is loosely based on the usage of a product which, as we discussed, may differ among consumers. In light of this, we propose to categorize digital products based on user-product interactions. Once converted into digital format, all products are essentially the same. What determines the type of product is how it is acquired and how it is used by consumers.
Transfer Mode: Delivered vs. Interactive Digital Products
The first criterion we can use to classify digital products is the transfer mode. Products that are downloaded at once or in piecemeal fashion such as through daily updates can be called 'delivered products.' 'Interactive products,' on the other hand, are products or services such as remote-diagnosis, interactive games, and tele-education. A simple communication between a server and a client, such as a request for search that is accomplished by sending information and receiving a reply, is usually defined as interactive. In this definition, however, all two-way communications are interactive.
Video-on-demand is regarded as an interactive service; a movie that allows viewers to select different plots and endings is called an interactive movie. But they simply operate under an automated process of delivered transfer mode.
To characterize a transfer as interactive requires (1) the use of a real time application and
(2) the need to interact in successive requests and responses. For example, a requested search information may be delivered in seconds or in hours depending on the status of network congestion. But once delivered, there is no more need to interact. Sending another request will be a different service. An interactive product or service, on the other hand, consists of a stream of requests and responses in a session that defines an objective such as a search, a game or a consultation with a doctor. A live or real-time communication requires an orderly transfer of data—i.e. you would not want to hear words backward.
At present, the vast majority of digital products on the Internet are delivered, not interactive. Information products such as databases and electronic versions of all printed media including books, journals, newspapers and magazines dominate the commercial offerings in today's Internet commerce and most are delivered. Even Web browsing is a delivered product—it depends on a sequential transfer of files which does not require a continuous connection or a real time coordination with other users or processes.
Similarly, a subscription service to a database is not an interactive product even though it involves periodic deliveries. Piecemeal access or delivery is the common mode of transferring files when periodic updates are needed, or if the whole database is not needed at once or too expensive to buy. In any case, these updates do not require real time

interaction between sellers and subscribers, and despite that such products are called
'interactive editions,' they are delivered products.
A conventional definition of interactivity often includes search activities. For example, forms and queries submitted to and processed by World Wide Web servers are often considered to be interactive. However, search, catalog, and directory services can be considered to be equivalent to a subscription service with a large database (indexes), a portion of which is accessed by a buyer. Thus, searches are delivered, not interactive, products. What does seem to be an interactive process in the case of search services is in fact the process of customization. That is, a search service "customizes" the product on the basis of a customer's requested criteria. However, once produced in this way, the product is simply delivered to the customer. Many online services use consumers' requests as an input to their production processes. These involve producer-consumer interactions, but they are not interactive services in terms of transfer mode.
True interactive products are becoming more common on the Internet. One area of expanding business is online consumer services, including health services such as telemedicine and remote diagnostics and tele-education. Other types of interactive products are based on real-time—i.e. live!—video and audio communications such as video conferencing, Internet telephony and the real-time Internet broadcasting or multicasting, and entertainment such as Internet Relay Chat groups or games played in Multi-User Dungeons or
Domains (MUDs). While the latter may appear to be a frivolous use of this valuable resource, it is often the place where new technologies and uses have been test-driven—in this case, a truly interactive service. Such interactive digital products may actually be the most profitable services in electronic commerce because they are less prone to personal arbitrage and reselling.
Interactive services are fundamentally personalized products which have consumption value for only the targeted individual. To maximize such benefit, sellers can also prevent copyright violations by converting delivered products into interactive products, an alternative strategy to a costly, technology-based control mechanism.
Timeliness: Time-Dependent vs. Time-Independent Products
The second criterion for our taxonomy is timeliness. Time dependent products lose value rapidly, which may be a deterrent to offering them for resale or distributing without authorization. Timeliness is critical to the daily news, stock quotes, and other information needed for quick decision-making. The timely value of these products can be maintained by periodic updates and sold as subscription goods whereby sellers retain some control.
Examples are stock quotes, government-issued economic data, and journal abstracts.
Time-dependent products become obsolete and worthless when they are out-of-date.
Artificially created time-dependence, however, can be useful. For example, it can convert time-independent, durable goods into non-durable goods. Considering the indestructibility of digital products, this is the most important aspect which firms can exploit in marketing. For example, a Web page providing information about a resort town may be visited once. To entice re-visits, the content of the Web page should be updated periodically. Updating in this regard is an arbitrary means to make old products obsolete and open new marketing opportunities. When a digital product is time-independent, sellers tend to use such strategies to transform it into a time-dependent product. Time-dependence may be specific to the individual or may be applied to all consumers. The timeliness of news and stock quotes, for example, is general to all

consumers. The freshness—and the value—of the information diminishes at the same rate for everybody. When such products are offered the next day, their prices would reflect their reduced valuation across the market. However, the result of searches and queries made by a consumer for a specific decision-making is time-dependent to that consumer only.
Suppose Alice wants to buy information on the sales figures of a firm in which she is considering investing. This information is time-dependent for Alice since it is useful for her decision. But after the decision is made, the information is no longer needed.
However, it may still be of considerable value to Bob who compiles a table of sales revenues. In such case, Alice will be able to use the information and still sell it to Bob at the full price. In keeping with this, time-dependent products can be further divided into two subgroups. Most databases, including indexes and directories, are time-dependent specific to individuals, while news and stock quotes are time-dependent general to all buyers. This difference is apparent if we consider a similar distinction in TV programs. Producers of many programs, in particular of sitcoms and TV movies, depend on revenues from reruns and syndication. These programs find audience who missed the first time. In contrast, news and sports programs in general are not rebroadcast because of their timedependence across all consumers. Magazine-format news programs have been popular despite this disadvantage because of low production costs. More to the point, these programs often deal with time insensitive topics, and they themselves recycle old programs— for example, features about 'This Day in History' and update segments. Similar adaptive strategies may be applicable to digital product marketing. To sum up, time-dependence may or may not be advantageous to marketers. Since timedependent products lose their value rapidly, there is a limited window for marketing. But on the other hand, time-dependence discourages reproduction and reselling, and avoids the problem of a durable good—competing with its own past sales. When consumer reselling is not a concern, products may be more valuable if they are made time independent. Bundling information into large databases, archives, and references helps to reduce time-dependence. When the durable goods problem is present, sellers increase time-dependence. Software, including computer programs and games, is generally time independent. Here, software vendors use updates quite often, as discussed earlier, to force people to buy new products.
Intensity in Usage: Single-Use vs. Multiple-Use Products
The third criterion against which to distinguish product categories is the intensity in use.
In this respect, single-use products resemble conventional non-durable goods, and multiple-use products may correlate with durable goods. As with traditional durable goods, consumers get benefits from a multiple-use product over time whereas a single-use product is used only once. An example for a single-use product is a search result which is no longer needed once it serves its intended purpose. In contrast, software programs and most games can be used repeatedly.
By definition, the total value of a multiple-use product must increase with use since the value accumulates. But its growth rate may be diminishing, constant, or increasing. In
Figure 2.1, graph A shows an example where a consumer's utility is increasing, for example as he learns more about a program and becomes more efficient in its use. Graph
B depicts a case of a product whose utility declines over time, for example a computer game which becomes less fun after each use. These are not the only possibilities. A

different product's utility cycle may be a combination of these two—increasing for a certain duration and then decreasing, or vice versa. From time t1 to t2, the total utility or value of a product is the area under the graph bounded by the two dates.
To the extent that consumers keep multiple-use products longer than single-use products, it is in the firms' interest to prevent a resale of single-use products. Since a 'consumed' product in this case is still equivalent to a new product, reselling by consumers directly competes with the product's original seller. Literary works and other forms of electronic publishing appear to be most severely affected by reselling. For these products, prohibiting resale as well as reproduction may be needed. Another way of countering this ill effect is to individualize products, thereby discouraging consumer arbitrage. For example, query information from a specific search is individualized (by the choice of the buyer). Therefore, reselling this information is not usually feasible unless two people happen to look for the same information. For single-use products, accommodating buyer choices is not only a good customer service but also a requirement for survival. This is important for most subscription-based database services.
Figure 2.1: Increasing and decreasing utility

Operational Usage: Fixed vs. Executable Products
Another criteria in our taxonomy is operational usage. Operational usage refers to

whether a product is an executable program or a fixed document. This distinction is meaningful not only because of the prevalence of computer software but also because producers can add control over consumer usage by converting any product into an executable program. Interactive CDs, for example, present materials, i.e. documents, in a controlled environment prescribed by programmers.
Today, executable programs tend to be multiple-use products, although not all multiple use products are executable, e.g. music or speech products. But a growing number of executable products will be found in single-use products. Instead of delivering a document, for example, sellers may incorporate it within an executable program which controls such aspects as viewing and printing. Increasing use of Java-based applets will help producers to deliver their products in an executable program that can be preprogrammed only for a certain function. Many application programs such as word processing can be downloaded as a Java-based applet and discarded after use. The increasing use of applets, then, signals the unbundling of unwieldy programs which today's word processors have become.
Similarly, the growing interest in network computer (NC) instead of PC as the Internet appliance points to the future when most programs and documents are delivered as executable programs on an as-needed basis rather than pre-packaging all functions in shrink-wrapped products. Furthermore, executable programs may be tailored to take advantage of the Internet's distributed computing environment. The strength of Java programming language
(http://www.javasoft. com/) lies in that a Java-based program can be used in different platforms by using only an interpreter. That, in turn, implies that duplicative effort and wastes inherent in today's multi-platform environment can be reduced. In view of these advantages, executable products may become dominant over fixed products in the near future.
Value Correlation: Positive-Externality vs. Negative-Externality Products
One final criterion of product categorization focuses on externalities. Positive-externality products are those that increase (average) consumer valuation if more people buy them.
Examples of this are interactive services such as chat lines and games. Negative externality products, on the other hand, have a kind of congestion effect if more people buy them. Negative externality can be thought of as 'wear and tear.' If I resell (or duplicate and sell) a product, its value declines as if it has suffered from wear and tear, except that this lowered value affects the seller as well as the buyer. Most entertainment and information products can be consumed without negative externality. A primary example of negative externality is when information is used for gain in a zero-sum game. For example, stock market investors benefit from exclusive information. If there were more people who had the same information, its value—or the profit-making opportunity from that information—would be less than if the information were to be exclusive. When there is negative externality as in this example, consumer arbitrage—reselling and exchanging information—is less of a concern than the faith in the exclusivity. For these products, buyers themselves place a stricter control over reproduction. We have discussed the externality of information products above.
Externalities of digital products affect pricing and marketing decisions as well as the level of competition. Free, shareware, and demo versions of software are given out to increase

the market share, especially when a wide-spread use and acceptance by consumers opens other venues of marketing—that is, when products have positive externalities. Many software firms, including Netscape (http://www.netscape.com), have used this strategy to establish dominance in their market. Once computer software becomes dominant, sellers of similar products often depend on the compatibility between their products and the dominant software. Due to the positive externality enjoyed by the users of compatible products, they often command a higher price than non-compatible products.
The dominant software firm, furthermore, enjoys a significant market power from controlling the standards in its software. The following example illustrates the importance of externalities in pricing and market competition. Lotus Development Corporation, the maker of Lotus 1-2-3 spreadsheet program, claimed that Borland's Quattro Pro infringed its copyright by replicating 1-2-3's user interface—menus and command structure—which affords Borland's customers to run macros written for 1-2-3 (Lotus v. Borland, 1996).
Equally divided—Justice Stevens absent—the Supreme Court let stand the lower court's decision denying Lotus' claim. Although Lotus's claim was denied, the nature of the decision clearly underlines the divided opinions of the court and the continuing debate on the merits of externalities.
Product Selection Strategies Based on the Taxonomy
The taxonomy presented here will give readers a means to categorize and compare different products being sold online. In each of the five criteria we discussed, a product can be changed from one characteristic to another—e.g. a time-independent product can be made time-dependent. One reason for doing so may be to shorten the life of the product even though it physically has almost an infinite life. Producers can also deal with digital products' reproducibility and transmutability by changing product characteristics.
Here we give a few examples of how such a change can counter the problems arising from the physical nature of digital products. A product may change in any of the five criteria we discussed.
Changing Time Dependence First in terms of timeliness, the indestructibility of a digital product means a long life, and a time-independent product, just like durable goods, may limit the number of sales because consumers simply make fewer purchases in their lifetime and/or second-hand products are always available. In this case, the size of the market shrinks as more products are sold—i.e. a seller competes with its own previous sales. A time-dependent product, on the other hand, has a short product life and, like consumption goods such as toothpaste or soap, sellers find new markets or sales as long as there is a need for consumption. Sellers also worry less about the negative effect of consumers sharing products because an outdated product in this case is like a used notebook. Sharing through unauthorized reproduction is a considerable deterrent to selling contents online. Thus, it is not surprising that companies who sell time-dependent information such as news are at the forefront of electronic commerce while copyright concerns discourage other digital product sellers. Even when products are naturally time independent, sellers can further increase their time-dependence by putting out new, updated versions of the product. Some information services guarantee timely updates only to paid subscribers, offering outdated information freely.

Changing Usage Patterns Products may also be changed to influence the way they are used in terms of intensity and operation. A single-use product is of course discarded after single use, or has no value to the consumer. But it may have a value and use to other consumers, which will encourage reselling given a chance. Computer software, reference
CD-ROMs and compilations such as movie databases are multiple-use products, whose value stream may be longer than their update cycles. A book in digital form is a single use product, but a list of books, perhaps with abstracts and reviews for each entry, becomes a useful reference tool, which is used over a longer period. Not surprisingly, references are one of the most popular digital information products. A book is also time independent, but can be turn into a time-dependent product by emphasizing the timeliness of its content or its temporary popularity. Likewise, multiple-use products can be time dependent, further protecting the market against reselling and reproduction.
Similarly, instead of selling an information product online, one can change it into an executable program to gain control over its consumption. For example, a table of daily average rainfall in Austin, Texas, may be sold as a table—i.e. fixed—or as a program that allows users to make queries or to graph. Other information such as a formula that calculates interest rates can be sold as a program that does not reveal the formula itself but only enables its users to derive desired results. A user's guide for a computer program can be made into an executable software agent, which not only offers some added functionalities—such as search, interface and execute functions integrated into the program itself—but also provides producers an extensive control over its usage and some protection against copyright infringements. Lastly, as mentioned earlier, an executable product if more likely to be a multiple-use product, an added protection against reselling.
Transfer Mode and Externalities In terms of transfer mode, interactive services have not yet reached their full potential for technological reasons. But they may eventually become products and services with the highest level of value added. Real-time interactive applications such as voice on the Internet, video conferencing and multicasting will change the way we access information and interact on the Internet. To support these activities, the next generation Internet infrastructure is needed such as faster modems, wider bandwidths, reliable and real-time transfer modes such cell relays, asynchronous transfer mode (ATM) and new protocols to support transmission.
For products with positive externalities like computer programs and games, we see sellers trying to create profit opportunities based on the externality. By providing freeware and shareware, programmers can create credentials and a reputation and establish a certain market position which can later be recouped from corporate sales. Similar strategy can be used for time-dependent products. For example, news companies freely distribute headline news, but charge for other services. Since free news is used to attract potential customers, its positive externality works to the seller's advantage. Such almost-free transactions seem to contradict the commercial aspirations of potential Internet merchants. However, it is important to recognize that these strategies are based on the characteristics of digital products, not an indication that the Internet marketplace lacks copyright protection or commercial opportunities.

Summary
We have defined information goods (digital products) and services in terms of their usage and physical characteristics, and offered a convenient taxonomy to classify various digital products highlighting their fundamental differences. Digital products include all goods that are already in digital format or that can be digitized. Purely physical products can also be partially digitized when they are made into smart products equipped with digital interfaces. But an equally important area of digitization is the business process itself. All aspects of digital communication and processing can be considered to be digital products.
In this way, electronic commerce extends to the commerce of physical products since many business transactions involving physical products can be digitized and be a part of digital electronic commerce. The physical characteristics of digital products are fundamental and raise contentious issues such as digital copyrights and the use of consumer information. At the same time, they are critical in analyzing digital markets in terms of many economic issues.
For example, indestructibility relates to the issues of quality degradation, personal arbitrage, and the mode of retailing—sale, renting, leasing, or subscription. Transmutability is also fundamental in understanding product development, customization, and differentiation strategies. In the process of customizing a product, firms also have to deal with the problem of consumer information and privacy.