A new paper, "How To Fight Ad-Sponsored Rivals," provides insight and strategic guidance for fee- and subscription-based companies faced with new, ad-supported rivals. Ramon Casadesus-Masanell, an associate professor at Harvard Business School, wrote the paper with Feng Zhu, an assistant professor at Marshall School of Business at the University of Southern California. The two researchers studied the strategies used by incumbent media companies to compete with ad-supported rivals and discuss the implications for managers.

Download the 58-page paper here (PDF file) and read the executive summary here.

The researchers say an incumbent's best response to an ad-supported rival is usually "competing through business models," or changing the business model to address the competitor. In the music industry, this type of competition is commonplace (though efficacy is not always apparent). Subscription services add MP3 sales to compete with rivals with pure business models (such as iTunes) and create an ad-supported version to compete with ad-supported newcomers.

In addition, the researchers say an incumbent tends to compete using a pure business model (either subscription or ad-supported) rather than a hybrid model (see the iTunes example below).

Amidst the academic language and game theory jargon are thought-provoking concepts and issues for media companies to consider.For example, the advertising rate determines what strategy an incumbent will take. When rates are low, the researchers say, an incumbent will choose to coexist with the newcomer, content to take some ad revenue and not cannibalize the main product. When rates are high, however, the researchers say the incumbent "has incentives to push the entrant out as it wants the market share from the entrant to earn ad profit even at the cost of cannibalization."

The paper looks at iTunes (as well as some other real world examples) and notes that its strategy has been not to respond to ad-supported entrants. "Apple has kept competing through a pure-subscription-based business model, just as it did before these players entered the market," they wrote. "Moreover, Apple has chosen not to lower prices." Why? The model suggests Apple believes ads would add irritation and diminish its users' experience. Ads, they believe, would not only hurt iTunes but also sales of other Apple products.

Some other parts of the paper discuss topics currently being sorted out in the music industry. A high-quality start-up has better chances of success when it the level of its ad annoyance is low relative to the ad rates it charges. If annoyance is low relative to its ad rates, a startup can be squashed by the incumbent's own ad-supported service. When annoyance is high relative to ad rates, the incumbent will allow the startup to enter the market.

The models lack one legitimate competitor, however: file-sharing services. Free, ad-supported services are not the only free services on the Web.