Why would a company turn a blind eye to this “black market” activity even though there is a risk it may reduce the availability of their product in the launch phase and later, inflate the price so much that some consumers give up on their purchasing bids altogether? Do companies benefit from speculative reselling? If a company can benefit from speculative activities, why would they restrict it at all?

These are perplexing questions that researchers attempted to answer in their research paper titled Restricting Speculative Reselling: When ‘How Much’ Is the Question. The paper was written by Liao Chenxi, Assistant Professor at the Department of Marketing at The Chinese University of Hong Kong (CUHK) Business School in collaboration with Prof. Dmitri Kubsov at the University of Texas at Dallas.

Besides finding answers to the above questions, the researchers also sought to find out the level of speculative reselling a company is willing to allow, and the level of total capacity it will arrive at, in order to achieve optimal profits.

A Symbiotic Relationship

To do this, the researchers built a theoretical model simulating a market where a company with a monopoly on a product launches a new item. In this market, the company does not drastically change the capacity of production over time. Instead, it uses a limited capacity as a tool to create the perception of “scarcity” in consumers’ mind. This facilitates the phenomenon of “buying frenzies.”

There are two distinct periods in which the new item is sold: the initial sales period and the phase immediately after this. In the initial sales period, consumers don’t have a clear idea of how they will like the product because no one has used it yet, or/and some uncertainties (e.g., weather on the day of the concert) can only be resolved in the second phase. Consumers naturally want to hold out on their purchase and wait till the product has been out in the market for a while or until the second phase.

But some consumers may rush to make the purchase during the initial sales period because they fear that the product may be sold out quickly. When speculators are in the picture, the purchasing dynamics changes accordingly. “The mere existence of speculators may push consumers to buy the product immediately.” says Prof. Liao. “This is because speculative activities may artificially jack up the price of the product. So, instead of waiting too long and ending up paying a higher price to the speculators to secure the product, some consumers will prefer to make their purchase immediately.”

How would that dynamics impact the company? Prof. Liao explains with a hypothetical example: “If consumers unanimously wanted to wait until the end to buy the product, perhaps only five would end up buying it. But if they felt the pressure to get it now, perhaps 10 would end up buying it. When the pressure to purchase immediately is present, the company benefits from selling more of its product. As we have seen earlier, the presence of speculators creates this kind of pressure and further fuels the buying frenzy.”

As speculators tend to snatch up a proportion of the capacity early on in the initial sales period, which helps to increase the product scarcity, the company may decide to adjust its capacity slightly upwards in the planning stage so that there will be more to sell to both speculators and those consumers who are willing to buy immediately. This is likely to result in increased sales volume.

Compared with a market without speculators, the company doesn’t have to restrict its capacity to the lowest possible level in order to create buying frenzies, says Prof. Liao. “The speculative activities will automatically ramp up the buying frenzies. That’s why companies actually benefit from speculators, even though they may appear to compete directly with each other. It’s a win-win for both the company and the speculators. Essentially, they have a symbiotic relationship. That solves the puzzle of why companies turn a blind eye to speculation – to a certain degree.”

Restricting Speculative Competition

After the initial sales period, consumers have digested early shoppers’ valuations of this product and will have decided if they are willing to pay the same price or a higher price from speculators if the product is sold out. During this time, speculators may try different tactics to discern how much individual consumers are willing to pay, and in the process charge different consumers different prices.

Another scenario that can happen during this second phase is that speculators may compete among themselves to maximise profits. In such a case, the company’s profits would drop.
The more competition there is, the more the company is motivated to restrict speculative behaviour to protect its profits. However, the researchers found that an intermediate level of speculative activity is still helpful in boosting the company’s profits.

“It’s a balancing act,” says Prof. Liao. “While a certain level of speculation can help the firm create a heightened sense of consumer uncertainty and motivate them to make purchases faster, too much competition among speculators can have the opposite effect. Prices will drop and fewer consumers end up wanting to buy the product at a high price from the company.”

Another scenario this study considers is that, some consumers who have purchased the product at the launch period may want to resell their goods during a later period. “When this happens, our model finds that this company’s profits will absolutely suffer, ” says Prof. Liao. “Unlike speculators, whose very existence tends to drive up the price of products in a spot market and encourages consumers to bring forward their purchases, resale by consumers tend to have the opposite effect.”

“That’s because prices in the consumer resale market is lower as more consumers resell the products, and that’s why for some companies they should actively come up with strategies to discourage consumer resale at all costs.”

Making Money Writing Digital Books

In China as in any other part of the world, anyone can start writing and distributing their material on the internet, but not everybody can make money from writing. To start off, aspiring internet writers typically sign up for an account with a digital publishing platform to benefit off the latter’s reach. Doing so allows writers to freely offer their material to the platform’s readers, but at this point aspiring scribes are not permitted to monetise their writings.

It is only when their work gains a measure of popularity from readers would the digital publishing platform then offer the writer a contract deal. This allows them to sell their material to readers on the platform and earn a proportion of the revenue from sales of chapters in their books, as well as any appreciatory “tips” paid by readers on top of this. The actual profit split between the two parties usually varies from contract to contract.

Both types of writers usually post their novels in series and are encouraged by the publishing platforms to update their work almost every day to attract and retain readers. Writers who are not on contracts can publish on as many competing platforms as they desire, but are unable to make any money off their efforts. Contracted writers meanwhile may only publish on platforms that they signed with and only the first few chapters of their books can be read for free. Readers who want to continue reading the book would have to purchase the remaining chapters, with the price of each chapter usually determined by length.

Successful Chinese internet writers who garner a loyal following are typically able to reap strong financial rewards. For example, one of the most successful is Tang Jia San Shao, a contract writer for online publisher Qidian, who reportedly made 122 million yuan from royalties in 2017, according to a ranking released by mainland Chinese media. In addition to the royalties generated from publishing digital books, many writers are also asked to turn their books into TV shows, movies or even cartoon series, opening new avenues to monetise their creative output. For example, Tang’s famous novel Douluo Continent was first adapted into a cartoon and then into a TV drama series recently.

Boost in Creative Output

The researchers went through close to 1,000 books written by both types of writers and examined their output by their creative quantity and quality, as measured by the length of each book and reader feedback, respectively.

The results show that money-making writers improved their productivity in terms of quantity without sacrificing the quality of the work after V-Disk ended its service. On the other hand, writers who are writing for free did not show any significant improvement in their creative productivity. On the contrary, the quality of their creative work went down after the free storage service ended.

“It’s quite clear that digital piracy poses an enormous threat for contracted writers because it affects how much money they bring home,” Prof. Liao comments. “That’s why we see increased effort in writing more and better books from contracted writers after V-Disk shut down.”

Prof. Liao explains that as readers could no longer easily access pirated books from the V-Disk service, these readers returned to the original publishing platforms and purchased the digital books there. As a result, writers who made money were not only more properly compensated by sales revenue, they no longer had to compete with the pirated copies and therefore could direct their full attention on writing their best work possible to compete with other writers on the same publishing platform. This resulted in an improvement in the creative efforts of these writers.

However, this is not the case for writers that are displaying their books for free. According to Prof. Liao, since their books are free to readers on the publishing platforms anyway, the livelihoods of these writers were unlikely to be affected by digital piracy because they do not make any money from their digital works in the first place. Also, Prof. Liao speculates that the decrease in their creative quality could be a result of increased competition from profit-making writers who had more time and effort to devote to writing.

Side Effects

However, the researchers found that while lower levels of digital piracy encouraged money-making writers to improve their creative output, it also led to a decline in their efforts to communicate with readers.

Readers can encourage writers who are signed by the publishing platforms through three channels: purchasing their book chapters, rewarding them with tips, or leaving comments. The study finds that both sales and tips would drive this type of writers to publish more work but they have no effect on motivating them to interact more with the readers, which typically involves replying to reader comments and acknowledging reader support. On the other hand, reader feedback led to both an increase in writer output and writer interactions with the readers.

The study notes that before the V-Disk termination event, profit-earning writers displayed more passion in engaging with their fans, perhaps in the hope of generating extra income through reader tips and to discourage their fans from reading pirated copies of their works.

“When the threat of ‘losing to’ pirated copies is gone, contracted writers became less motivated to interact with their readers and less bothered to elevate the reading experience of their fans. This could be bad news for publishing platforms because if reader experience falls, it’s going to drive traffic elsewhere,” Prof. Liao warns.

Designing Policy

Prof. Liao and her co-authors urge publishing platforms to be aware that when the threat of digital intellectual property piracy goes down, an improvement in the creative output of signed writers can come at the expense of reader experience. Therefore, platforms may consider designing a compensation plan that provides incentives for writers to maintain lively interactions with their fans.

For policymakers in emerging markets that lack IPR protection, this study provides evidence for the benefits of having strong IPR protection. The researchers urge policymakers in these markets to use economic incentives (for example, to make piracy more costly) to strengthen IPR protection.

“Many emerging economies are in the process of moving away from ‘imitation’ to ‘innovation’. Any kind of piracy would be a blow to innovation,” Prof. Liao comments. “Intellectual property needs to be protected because the lack of it will kill creativity.”

We live in the age of the social influencer. Nowadays, with the development of the internet and the growth of social media, it is increasingly easy for consumers to post a comment or a picture of a product and to notice whether somebody else uses or praises a product or a brand, making word of mouth and opinion leader recommendations more important than ever.

Online, a recommendation may come in a form of a selfie on Instagram, a short Tweet, a “like” on Facebook, or the fact that an opinion leader uses certain products. An entire cottage industry has seemingly risen overnight where internet celebrities – people who acquired or developed their fame online – make their entire livings from corporate endorsement, using their relative notability to peddle products or experiences to their followers.

However, using social influencers to market a company’s products or services can be tricky. Consumers nowadays are savvy enough when they encounter a product endorsement to consider not only that it is likely sponsored, but also whether the recommendation is purely based on high product quality. It is highly likely they would also think about whether it was because the social influencer selected a specific product (from a variety of offerings) that suited their particular taste, says Chenxi Liao, Assistant Professor at The Chinese University of Hong Kong Business School’s Department of Marketing.

Under such a scenario, is there an ideal number of varieties of a product a company could offer to maximise profits? This is what drove a group of researchers to look at the impact of product variety when consumers rely on the product evaluations of opinion leaders or experts to make purchase decisions. Entitled Opinion Leaders and Product Variety, the study was conducted by Prof. Liao in collaboration with Prof. Dmitri Kuksov of the University of Texas at Dallas.

“Absent costs of variety, to increase profit, an intuitive solution is to increase product variety. With more alternatives available, it is more likely that an expert can find a variant that fits their personal preference, and post a positive product opinion,” says Prof. Liao, adding that since consumers expect quality to be higher when the expert opinion is positive than when it is negative, they are willing to pay a higher price.

When More Variety is Bad

From this perspective, increased assortment can benefit the firm. However, when many product variants are available, consumers may expect an expert to find a better fit, and this consideration would then reduce consumer expectations of the product quality, leading to lower profits.

There is also the issue of market noise. Consider that opinion leaders are likely to be more knowledgeable and have a greater desire to educate themselves about a certain product, since this is typically how they gain popularity and the trust of their followers in the first place. These experts are likely to be able to better understand and choose which variant fits them best.

On the other hand, the everyday consumer may not be as familiar with the product or are not willing to spend the time and effort. This means they may not be able to choose the best-fitting alternative and may benefit less from having many alternatives.

“The idea is that the promotion of a smaller number of products makes communication easier and clearer.”

Prof. Chenxi Liao

Taken all of this into consideration, the researchers formulated a complex mathematical model and found that there does exist a point beyond which increasing product variety netted no significant benefits to a company.

Prof. Liao explains that two opposing forces come into play when a company increases the variety. First of all, when product variety increases, it raises the probability of getting a positive expert opinion and therefore the product being recognized by consumers as of high quality. On the other hand, it also decreases certainty by the consumer that the product received a good review because of its inherent high quality.
or a small number of variants, the first effect dominates the second, and for a large number of variants, the second effect dominates the first.

“We further find that the optimal number of product variants increases if the importance of fit for the expert or the expert’s unwillingness to provide a positive recommendation is higher,” Prof. Liao adds.

Another consideration is whether the company has a good grasp of how consumers would rate the quality of its products. The researchers cite as examples two similar products in recent years – the Apple iPod and the Microsoft Zune music players. Whereas the second flopped, the first became a phenomenal success, but because they were both conceptually new products, it was difficult to tell how consumers would rate their quality.

The research also found that, unsurprisingly, when the firm has a good understanding of how consumers will perceive the quality of its products, the firm with the lower quality product may seek to hide its inferiority by limiting the information transmitted through expert opinions and mimic the variety provided by a firm with a similar product but of a higher quality.

Real World Implications

Relating the findings to real world business practices, Prof. Liao notes that it is not uncommon for a company to introduce a product line with a small number of products, or even just one, promoted to opinion leaders.

“The idea is that the promotion of a smaller number of products makes communication easier and clearer,” she says, citing a successful promotional campaign by the U.S. luxury department store chain Lord & Taylor. In introducing its Design Laboratory collection, the company chose to promote a single dress to many influencers on Instagram.

The fact that a number of social influencers all agreed to create a post on Instagram with the same dress signaled to their followers that the choice was based on the quality of the dress itself, rather than because it complimented a specific fit or complexion.

Another prediction of the model is that when opinion leaders are more likely to be happy with the product regardless of the exact quality they see, a firm should prefer to offer a smaller product selection, says Prof. Liao. For example, Apple does not provide as many customization opportunities in iOS for iPhones as Android systems usually do. However, since many opinion leaders like Apple products more, they are likely to give a positive review.

Prof. Liao adds that one important assumption was that consumers are unable to tell exactly how much of a positive product review is because the product is suited to the reviewer’s tastes. This is changing in that many websites, such as the American NGO Consumer Reports, are providing more detailed information regarding the reviewer’s context. In these circumstances, the negative effect of having a large number of product variants will be diminished.

Looking at opportunities for future research, Prof. Liao notes that another assumption is that the expert always posts a product evaluation. “In practice, opinion leaders could be silent on many products. An absence of a recommendation may be interpreted as a negative opinion, as in the expert did not find it worthwhile to choose the product, or could be reducing the informativeness of the recommendations,” she says.

One interesting avenue is to consider the uncertainties facing the expert before and after the purchase, and how it affects the likelihood of a positive review, she adds.