When all Products are Digital: Software Ecosystems and the Decline of Physical Goods and Services



How does the integration of digital components into products and services affect the intangible value of firms as reflected in economic measures such as Tobin's q?  This research investigates the premise that when two products are related because they require similar resources and capabilities, they will be produced in tandem, whereas dissimilar goods are less likely to be produced together.  A graph-theoretic ‘digital complexity’ metric for proximity to software is constructed in a dynamic network of complementary products and services.   We use this network to measure digital complexity at the firm level, using merger and acquisition data spanning the years 1990 to 2014.  Our analysis applied various panel regressions, demonstrating a positive relationship between firms’ digital complexity and their intangible value. Our results are also corroborated with a set of alternative firm performance measures. The identified relationship is robust for various model specifications that control for firm fixed-effects, mitigating the potential for endogeneity, and a list of possible confounding factors. Our findings suggest that digital complexity helps explain how firms develop sustainable value that is intangible, imperfectly mobile, and hence, difficult for competitors to replicate. Digital complexity, as such, is not a monetary investment or commodity; rather it should be understood as a form of socio-technological complexity reflecting firms’ unique combination of intangible resources and capabilities.  When these are difficult to imitate, they erect barriers to market entry for competitors in a quickly changing market.