'Valuable Words: The Price Dynamics of Internet Domain Names' by Thies Lindenthal in (2014) 65(5)
Journal of the Association for Information Science and Technology 869–881 estimates
the first constant quality price index for Internet domain names. The suggested index provides a benchmark for domain name traders and investors looking for information on price trends, historical returns and the fundamental risk of Internet domain names. The index increases transparency in the market for this newly emerged asset class. A cointegration analysis shows that domain registrations and resale prices form a long-run equilibrium and indicates supply constraints in domain space.
The study explores a large dataset of domain sales spanning the years 2006-2013. Differences in the quality of individual domain names are controlled for in a hedonic repeat sales regressions.
Lindenthal comments -
Internet domain names bring the location back to the otherwise location-less Internet economy. A domain name provides a virtual street address for any website or service on the Internet. It is comparable to a tract of land on which a business or just a private homepage can be built on. This space-network analogy is as old as the World Wide Web and numerous terms related to the Internet exhibit a spatial connotation: Labels for technical network addresses, for instance, are called domains, users are visitors, Internet browsers have been baptized Navigator or Explorer, websites are home pages, users communicate in chat rooms – the list can be easily extended.
Understanding domains as a novel form of land offers the opportunity to transfer established theoretical and empirical frameworks for the pricing of land into virtual space. Theoretically, Alonso-Muth-Mills models of urban layouts (Alonso, 1964; Mills, 1972; Muth, 1969) explain differences in land rents by differences in the distance to jobs or amenities. Applying this reasoning to domains, the price of a domain is hypothesized to depend on its ‘proximity’ to potential users. Since a voyage on the world wide web usually begins with the user entering the domain name of the desired website into her web browser, distance to the user can be seen as the effort a user is required to make to correctly remember and type a domain name. An appealing domain name like Apple.com is easy to recall and quickly entered. In this sense, an intuitive domain name is like a convenient down-town address linked to excellent transportation systems. Long or cryptic domain names are more burdensome, which is comparable to a longer commute to a location somewhere in the outskirts.
Ieong et al. (2012) provide a similar, albeit non-spatial explanation for the value of domains. They show that domains help users to evaluate the reliability of search results from online search engines. Domains serve as brands for the displayed information. Based on this line of thought, differences in domain prices could also stem from the brand-potential inherent in the domain name. Again, the catchy and easy to remember names will sell at a premium above registration costs.
Differences in ‘location’ and ‘brandability’ fuel a heated race for the shortest and most memorizable domain names that sprung up since the very first domain was created in March 1985. By now, more than 240 million unique domain names are registered (Verisign, 2012) – with no end of growth in total numbers in sight. An active secondary market facilitates investments in domains. Exclusive domains oftentimes trade for 5 or 6 figure dollar amounts, and some for even more. The current record in reported sales prices is the widely covered 13 million US dollar transaction of sex.com in 20102. Trading of and investing into domains has quickly evolved from a geeky pastime of a few to the serious bread and butter industry feeding hundreds of professionals today.
The focus of this paper is to estimate the first constant quality price index for Internet domain names. It adapts an empirical framework borrowed from real estate research which is suitable for valuing infrequently traded and non-standardized assets like houses, antiques, pieces of art – or, by analogy, virtual locations. The linguistic nature of Domains causes substantial heterogeneity in their quality, which makes domain names very comparable to traditional asset classes where the intrinsic value of an asset is not directly observable as well. The index spans 7 years and is updated on a monthly basis.
Despite all rapid growth in the last decade, domain names are still a relatively small investment class that lacks any information on its inherent risk and return profile. Market participants and investors simply do not know whether domain names are a ‘good’ investment. Did domain holdings deliver positive returns in the last years at all? How big were any returns?
Rational investors evaluate return and risk of their holdings simultaneously. The market index is the best proxy fundamental risk of domain names. The price volatility of a market portfolio hypothetically containing all domain names cancels out any domain-specific volatility. The fundamental or market risk of domains can be compared to the risk of an investor’s portfolio, which puts any return on this portfolio into a risk-adjusted perspective. Furthermore, the fundamental risk of domains can be compared to the risk of other investment classes like stocks, bonds or real estate.
The massive increase in virtual space and new extensions (ICANN Internet Corporation For Assigned Names and Numbers, 2012a) scheduled for 2013 and 2014 by the Internet Corporation for Assigned Names and Numbers (ICANN), is, among other reasons, motivated by a perceived scarcity of domains. This paper provides first evidence that supply of domain space is currently constrained indeed.
Finally, any cautious economist will surely ask: Are domains names for real or just another fad? Or does an economic rationale justify the prices paid? A comparison of domain prices to share price indices for IT companies shows that domains are not a totally detached ‘new economy’. The value of locations on the web is closely correlated with e.g. the NASDAQ 100.
The remainder of this paper first presents a primer on Internet domain names, including a brief introduction on the nature of domain markets. Section 3 provides an overview of the data this study analysis relies on. This motivates the choice of an adequate index estimation methodology in the subsequent section. Section 5 discusses the empirical results leading to general conclusions.
