Digital Piracy and Game Theory
Illegal copying and distribution of digital media such as software, music, and movies have been a major source of concern for the sellers in these markets. In the cited paper, the author uses game theory to determine whether or not sellers should enforce strict copyright protection of their intellectual property. A game is played between two sellers (for competition analysis) and two types of buyers: buyers who always buy the legitimate product and buyers who may pirate based on the copyright enforcement policies of the company. It turns out that sometimes, sellers can expect higher profits by not enforcing strict copyright protection based on certain factors about the market such as network externalities and price-sensitive consumers.
Network externalities (or network effects) is a phenomenon that states that the value of a product will rise as more consumers have the product, e.g. the telephone and social networking sites. For these types of products, if the market is still in its infancy, it may be beneficial for the sellers to allow free sharing of their product so that the value rises as more people own it. Sellers can expect higher long-term profits by taking advantage of the distribution power of piracy. However, as this market matures, sellers should start enforcing strict copyright protection, since the value of the product has already risen because of network externalities. As an example, an indie band may start out by giving away free copies of their music, but as they grow in popularity, they should start selling and protecting their intellectual property to make profit. Microsoft prefers strong copyright protection for Windows since Windows is already a well-established product in their market; while Microsoft isn’t known for suing its customers for pirating Windows, it was not trivial to get a pirated copy working as well as a legitimate copy. This network externalities effect is intuitive and has been demonstrated many times before this paper. However, sometimes sellers may prefer less stringent copyright protection even for a product without significant network externalities.
Sellers may make higher profit in a market where there are a large number of price-sensitive consumers who will pirate instead of purchase if copyright enforcement is weak. The effective removal of these consumers allows the sellers to charge higher prices without price-competition. The profit from being able to charge higher prices may outweigh the losses from piracy. This effect is especially pronounced in places with high income disparity, where consumers with high income will still pay the high price for a legitimate copy. This fact may explain why piracy of movies is not harshly punished in places like India or China. It seems to also explain why popular software like Adobe Photoshop or Matlab is so expensive for individual purchases; established institutions and professionals are willing to pay a high price for a legitimate copy of the product, and price-sensitive individual consumers can either opt to pirate or look elsewhere for a cheaper alternative.
The ease with which media can be copied and shared is a double-edged sword. It can allow relatively unknown media to spread, allowing the seller to make money as network externalities take place. It can also cripple a well-established company that depends on sales of their products. Sellers can choose to enforce copyright protection to combat the adverse effects of piracy. The legitimate consumers on the other hand, are typically left worse off without choice. They either pay normal price for products others are getting them for free without consequences, or they pay higher prices since their demand is relatively inelastic. Not only that, some companies have instituted digital rights management for their software, which can result in a product that is inferior to a pirated one. In this game, the legitimate buyers are the ones who end up with the short end of the stick.
However, the game analyzed in the paper also mentions that piracy can effect innovation. It is my opinion that, while companies should protect their intellectual properties, they should focus on providing a product that is superior to any copy that can be made of it. Grooveshark provides free music in an interface that is more pleasing than most peer-to-peer software. Hulu provides streams of high-quality TV shows at the cost of only a few minutes of commercials. Under this light, even the legitimate buyers benefit as well, and the market has a chance to leave sellers with profits and buyers happy with their purchases such that most need not resort to piracy. At first glance, piracy may appear as a threat to digital markets, but it is also an opportunity for new sellers to enter with superior products and services that will make profit in new and innovative ways.
Source: http://people.tamu.edu/~sjain/papers/published%20piracy%20paper.pdf
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