A Network Effects Perspective on Software Piracy
Notes lack of attempted copyprotection at odds with claims of theft: people in urban areas expect to have to lock up belongings. Usual answer is copyprotection is commercially or technically impractical. Author proposes that instead lack of copyprotection is a profit-maximizing behavior based on three elements:
1) "cross-sectional price discrimination, in which the lower tier of customers ‘purchases’ illegal versions fora zero price. In the face of network effects that exist in many software markets, such a strategy achieves the most expeditious and widest dissemination of software, maximizes the value of the network, and may also accelerate a tipping of the market in favour of the more dominant publisher. As a result, publishers are able to increase their profits compared to those earned in a smaller and less valuable network."
2) "dynamic pricing in a multiple-period setting. At a second stage, due to a lock-in phenomenon, higher than market prices can be charged to potential ex-pirates who face a threat of litigation and wish to legitimize their software"
3) "use of piracy as a means to maintain an incumbent’s monopoly position by creating higher barriers to entry, in a manner equivalent to strategic or predatory pricing."
Economists "have not addressed the question of why publishers might prefer tolerating piracy over adopting explicit methods of price discrimination. An answer to this question is the main contribution of this article, as well as its analysis of the increased opportunity to hold up customers that piracy creates and the analysis of the potential implications for legal policy."
Argues lack of copyprotection seen has to be in part a business decision, rather than due to infeasibility of copyprotection.
"Conner and Rumelt show that when the network externality is strong and protection acts chiefly to push pirates out of the user base rather than to move them into the buying camp, a policy of no protection might be optimal."
"unauthorized copying efficiently increases the network size, and this increase allows the publisher tocharge buying customers a price that appropriates the externality of the increased network size. Takeyama also suggests that the expanded output achieved by unauthorized copying can be exploited by the software monopolist to create a pre-emptive installed base"
"for certain types of software, where word-of-mouth interaction among users and potential users is critical to the growth of the user base over time, pirates play an important role in converting potential users into users of the software, many of whom will legally purchase the software. Piracy thus plays a dominant role in thegeneration of buyers over the software’s life cycle. In their empirical study of the diffusion of spreadsheet and word-processor software in the United Kingdom, Givon et al. found that from the late 1980s through the early 1990s, of every seven software users, six had pirated copies. On the other hand, the pirates significantly influenced potential users to adopt this software and, in fact, contributed to generating more than 80 percent of the unit sales for these two types of software"
Various reasons to prefer piracy over explicit price discrimination
- possibility of "parallel imports" from cheaper locale
- different pricing might attract regulators
- allows signal of commitment to high prices; no reason for customers that want to pay to wait for lower price
"At any given price of software, the rate of piracy is a measure of the potential deadweight loss that would have occurred had the law been strictly adhered to."
Ambiguous policy implication for antitrust and copyright policy.