Thursday, August 25, 2005

Economics, Piracy, Bullshit

I've blogged previously about why some piracy can be good for software vendors (specifically Microsoft) because network externalities mean that even a non-paying customer can be a valuable one.
Chris Anderson of The Long Tail argues that piracy can be good for other content providers as well. He has two arguments for this. Firstly,
Any protection technology that is really difficult to crack is probably too cumbersome to be accepted by consumers. We've seen all sorts of failures of this sort before, from dongles to laborious and confusing registration schemes. Each seems better at annoying consumers than at building markets. The lesson from these examples is that zero-percent piracy is not only unattainable, it's economically suboptimal. If your content is uncrackable, it means you've probably locked the market down so tight that even honest consumers are being inconvenienced.

I agree with this. Crippleware is shit and unless a company has extreme monopoly power (which would exclude a black market) and customers really want the product no matter how crippled it is, i.e. it has a low convenience-elasticity-of-demand (look Mum, I made a new economic term), it will lose customers. But it isn't really that piracy per se is good for the content-provider, but that its prevention has unintended consequences.

His second argument is that

piracy can let you raise your prices.

The usual price-setting method is to look at the entire potential market, from the many at the economic lower end to the few at the top, and set a price somewhere in between the top and bottom that will maximize total revenues. But if you cede the bottom to piracy, you can set a price between the top and the middle. The result: higher revenues per copy, and potentially higher revenues overall.

This is complete bullshit. I'm not sure what he means by those at the "economic lower end to the few at the top", but will assume he is ordering consumers by their willingness to pay (~demand). It's true that if a firm ignores consumers with a low willingness to pay (I'm simplifying the economics here, we should really be talking in terms of price-elasticity of demand), they will be inclined to increase prices. But if they could increase revenue that way, why wouldn't they do it whether there is piracy or not. When a firm with market power sets their price they are always making a trade-off between receiving a higher price from a few and a lower price from many. The rational firm looks at the entire market and chooses a price which maximises profit. If a portion of that market leaves, revenue will either decrease (if the price was sufficiently low to sell to that portion) or stay the same (if the price was too high for them anyway).

Anderson does point that network externalities come into play, particularly regarding emerging technologies.

Add to this the familiar (if controversial) argument that piracy helps seed technology markets, and can be a net benefit. Especially in fast-developing countries such as China and India, the ubiquity of pirated Windows and Office have made them de-facto national standards. Few users could have paid for the retail versions at the start, but now that the spread of cheap technology, including free software, has led to an economic boom, Microsoft is finding a nice market for commercial software at the very top, in big companies and government offices.

This kind of seeding could well help some non-software content (not normally thought of as producing network externalities) become more commercially successful over time through word-of-mouth advertising, but I doubt it would help your average Hollywood blockbuster.

In summation, piracy is often good for software vendors, rarely good for music and movie vendors but its prevention is often very, very bad.

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