Consumer Search, Producer Entry, and Product Variety: Theory and Evidence from a Digital Product Market

Many digital goods markets are characterized by large product space, functionality and design heterogeneity, and low cost of entry for producers. We examine the influence of incumbent digital products distribution on consumer search, entry of new products into different niche locations and market performance. A key characteristic of the research model is a search market where the crowdedness of niche locations changes the variance of consumer valuation. The producers in the market strategically choose to enter different niche locations according to their capability. We analyze the entry pattern and sales distribution that emerge endogenously as part of the equilibrium market structure, and how product variety changes the equilibrium. A large dataset on a mobile app market is used to empirically test the model implications. In particular, our dataset contains 103,241 new iPhone apps that were introduced into Apple’s iOS App Store in a one-year period as well as 403,325 incumbent apps that had already existed at the beginning of the study period. We observe the apps’ store listing information and their sales performance in terms of ranking on the store’s daily top selling charts. We first use a novel text-analytic approach to characterize a multi-dimensional functionality space of this market and map each app to a location in this space based on its feature combination. The exercise allows us to both measure product variety and operationalize “niche” as the nearby area centering an entrant app’s location in the functionality space. We then test the model results by analyzing (1) the relationship between crowdedness of niche location and developer quality, (2) the relationship between crowdedness of niche location and app sales, and (3) the comparative statics with respect to product variety. The empirical results strongly support the model predictions.