Wednesday, July 27, 2005

Why Piracy is Good for Microsoft

Microsoft has announced that Windows users will have to prove their copy is genuine to be able to update the software (excluding security updates). They recite the usual 'poor us; naughty pirates!' rhetoric, but it seems to me that piracy is a major reason that Microsoft has maintained its OS monopoly for so long.

Software produces what economists call network externalities: the more people who use a product the more valuable it is. The most obvious example of a network externality is in the phone service - not very useful if you're the only one using it, but helluva useful if everyone is. Operating systems produce such externalities through compatibility issues and the fact that if everyone uses the same OS you don't need to learn a new one when you use a friend's computer.
Given that there are reasonable free substitutes, you would expect many (more) people to opt out if they had to pay for Windows. This would loosen the network-externality-based grip that MS has on the OS market and make switching from Windows more attractive for those people who do pay for the software. As more and more people decide to use Linux, the exodus would gather pace and the MS monopoly would erode. Piracy stops this from happening, since if Windows is as free (as in beer) as Linux, there is little incentive for the average user to make the switch.

Of course, it may be that the extra market share MS enjoys through piracy would be outweighed by the lost revenue from customers who would have paid for their product if they had to, but managed to get a pirated copy instead.

So, is MS's move to not offer updates to pirating scallywags foolish? I think it's probably a good idea if we consider it as a form of price discrimination rather than an effort to stamp out piracy. To be able to price discriminate, MS needs to sort customers by their willingness to pay. Some people are not willing to pay anything, but are nonetheless valuable customers since they contribute to the network effect. MS should let them have Windows for free. But if they do that, they will be giving it to otherwise-paying customers for free as well.

By offering paying customers a better product than non-paying customers they can, to an extent, get around the problem. Those who want the updates (an imperfect proxy for those with a higher willingness to pay for windows) are charged, while those who don't much care for updates or can find a way of getting them without paying (an imperfect proxy for those with a lower willingness to pay for windows) get it free.

They would only lose those (non-paying) customers who value Linux more than un-updatable windows and would gain money from those who were previously pirates but value the updates at more than the price of the software, and so would pay up.

There is no reason MS couldn't have done this, and much more, years ago. The fact that they haven'’t leads me to believe that they see things the same way I do.

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