Economics of piracy

Public debate over Internet piracy is riddled with contradictions and fingerprints of vested interests.  In the US, congress is considering the Stop Online Piracy Act (SOPA), while in Australia, an alliance of internet service providers had their proposal to crack down on piracy rejected by the Australian content Industry Group (group of music, software and games content owners).  The proposal:

…would see an ISP provide one education notice, three warning notices and one discovery notice to customers alleged to have infringed on copyright by the copyright holder, and, if a customer continued to infringe after this, the ISPs would tell the rights holder, which may then decide to apply for a subpoena to get access to the customer’s details for legal action.

Given that the application of knowledge is the engine of economic growth, one must intuitively consider copyright and patent laws as a significant burden on growth (China?).  Moves to curb piracy, as many economists are keen to point out, generally reduce consumer welfare, and in many cases reduce the profits of content owners who benefit from platform effects.

A key misapplied economic theory in the piracy debate is that greater incentives ‘bring about’ greater supply. That somehow, without a massive payoff, people would stop inventing and creating.  Imagine, people following their passions, even in something as obscure as blogging about economics, for their own rewards, rather than monetary payment.  History shows that creative contributions are independent of copyright and even patent protection.

Or, as The Economist magazine put it recently, “copyright theft robs artists and businesses of their livelihoods”.  Given that regulations create markets, and market actors play by the rules of the game, this point is partly true.  But is begs the question of whether markets provide better outcomes for both producers and consumers with or without copyright laws (or the evasion of the laws).

Consider the music industry.  Recent research suggests that music piracy can be beneficial to the music industry as a whole, but not those who are already superstars.

The effect of this is that piracy increases the diversity of music in the short run, and increases the supply of superstars in the longer run. In this sense, piracy is efficient, as it corrects a market imperfection.

This raises the possibility that opposition to file-sharing is strongest amongst those performers whose success depends upon their fame more than their ability.

In software markets the ‘victims’ of piracy gain substantial benefits through platform effects (the result of strangely named two-sided markets).  The battle between mobile operating systems is demonstrating how platform effects work.  If Apples iOS is a platform for selling apps and music through online stores, Apple should be happy with piracy of its operating system, because the more ubiquitous their system, the more valuable their platform dependent inline retailing.  Microsoft, especially with its Office suite, shows that being ubiquitous means a cornering the market so that competitors cannot crack it.  Everyone insists on perfect compatibility with Office, because it is so common.  And it is partly so common because of the degree of piracy, rather than of sales.  Without piracy, these effects are greatly diminished.

Microsoft has even suggested that if you are going to pirate software, make sure it is theirs.

For some time, big software companies have tried to make the argument that a copy of pirated software is equivalent to a lost sale This is pretty ridiculous for a couple reasons. For one thing, there’s no reason to think that a given user of pirated software would have actually purchased a legitimate copy.

Furthermore, the argument ignores the fact that companies actually benefit in some ways from piracy, because a user of pirated software is likely to purchase software from the same maker at some point down the road. This latter point is something that even Bill Gates has admitted, even while Microsoft continues to talk tough about cracking down on piracy.

Now the company is stating more clearly that it knows there are some benefits to piracy. Jeff Raikes, head of the company’s business group, said at a recent investor conference that while the company is against piracy, if you are going to pirate software, it hopes you pirate Microsoft software. He cited the above reasoning, noting that users of pirated Microsoft software are likely to purchase from the company later on. He said the company wants to push for legal licensing, but doesn’t want to push so hard so as to destroy a valuable part of its user base.

The company recently got a stark reminder of this lesson when a school in Russia said it would switch to Linux to avoid future hassles with the pirate police. Of course, this moderate stance seems at odds with the company’s recent hyper-aggressive anti-piracy push, which resulted in many mistaken piracy accusations. Either way, Raikes’ comments completely destroy the line about pirated software being equivalent to lost sales; if it actually were, Raikes would be telling people to pirate the software of Microsoft’s competitors.

Google is probably the best example of a platform business.  Their Chief Economist Hal Varian has been known to comment that whatever new software Google produces, if it increases the attraction of the Internet, then it is good for Google.

Content piracy has improved our lives, with some very minor costs to a small group of content owners whose lobbying efforts have already results in having the rules changed in their favour (thank Walt Disney). Whether this trend persists in the light of rapidly evolving content distribution methods I am not sure.

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  1. I have mixed views about piracy. I have worked for a software company who had a fairly relaxed attitude about it on the basis that at least the product was getting out there and being used — but that attitude was more towards markets they were not currently in rather than existing markets where frankly they were willing to engage the full force of the law. Presumably the thinking was that more users, begets more users, ultimately begets more revenue whereas if it occured in existing markets it would/could cannibalize revenue.

    I personally don’t pirate software but have no problems about pirating TV shows that have been shown free to air elsewhere in the world but are not available here, or are eventually available with an unacceptable delay (e.g. How else would you have watched season 4 of breaking bad as it screen?)

    On the other hand as patent holder and copyright owner I’d like to get some $. People will always create so to that extent the existence of IP neither helps nor hinders. I didn’t weigh up the existence of IP laws before having a patent, book, software etc. However we must recognize that there are many things that take the collective efforts of many plus large capex and opex to create. Unless you can ensure IP rights it would be difficult to make the business case for spending on such projects.

    (I’m particularly thinking more along the lines of big pharma here — which is off topic. It is trivial to identify another company’s compound and copy it. Therefore without IP you would have parasitic companies ultimately creating a disincentive for R&D.)

    • “It is trivial to identify another company’s compound and copy it. Therefore without IP you would have parasitic companies ultimately creating a disincentive for R&D.”

      WRT pharma you’ve got it backwards. IP laws create parasitic companies. It trivial to identify a naturally occurring compound and patent it.

      “In 1995 the U.S. Department of Agriculture and a pharmaceutical research firm received a patent on a technique to extract an anti-fungal agent from the neem tree (Azadirachta indica), which grows throughout India and Nepal; Indian villagers have long understood the tree’s medicinal value.”

      • apples and oranges.

        My quote that you have reproduced is true. Given the development of a compound it is trivial for a competitor to identify it and copy it (once the patent protection runs out). The generic manufacturer has to fork out capex for their factory (to build or modify) but all the R&D and clinical testing and regulatory approvals process has been undertaken by the patent holder. This is true whether the patented compound is derived from a natural product or not.

        You then cite an example of natural product chemistry which is a subset of R&D. If there is customary/traditional use of a particular natural product then part of the initial grunt work in identifying a natural product with possible bioactive properties has been done for the pharma co. Whether the pharma company should or should not receive a patent is a good discussion. They would presumably argue that initial discovery of a natural product is only the tip of the iceberg. Instead of doing combinatorial screening of millions of random things they can fine it down. But this still has to be followed by research on appropriate synthesis methods or extraction followed by extensive clinical testing and scaling up to manufacture. A large amount of money is still required to get the thing on to market which is why they presumably seek patents. IMO the debate would therefore be about whether a traditional owner, if they can be identified as a person or group, should share in the patent or not or be otherwise compensated. The information owned by the traditional culture clearly has value. So IMO they should be compensated either by up front sum or share of the patent. But that is just my 2 cents. I might describe the behaviour as unethical or ethically questionable but I wouldn’t call it parasitic within the context of how I used the word in my initial comment.

  2. In some cases there isn’t even a choice. Many good US shows are inaccessible in Australia full stop.

    In some cases, it makes sense to copyright infringe (and please let’s call it that). Australia has some of the worst consumer protection laws in the world when it comes to copyright and DRM (remember a few years back it was technically illegal to listen to music on the ipod).

    Currently in Australia, it is illegal to watch any DVD or Bluray video content (ie. movies, shows, etc) on the Linux operating system due to the fact that open source applications (are forced to) bypass media encryption, and this is considered illegal in Australia. In the US, they have a specific exception for this in their copyright laws, we do not. Ironic.

    Thus regardless of whether I would buy a new movie on bluray or download it from the Internet, the legal end effect is the same for me. So why buy it and support the assholes who lobby governments to make such stupid laws?

    • “Currently in Australia, it is illegal to watch any DVD or Bluray video content (ie. movies, shows, etc) on the Linux operating system due to the fact that open source applications (are forced to) bypass media encryption, and this is considered illegal in Australia.”

      Technically speaking they’re not “forced” to at all – the various Open Source OSes simply haven’t licensed and implemented the necessary capabilities to provide a secure path.

      There’s no _technical_ reason OSS developers couldn’t do it. There are plenty of political ones, though

    • “In some cases there isn’t even a choice. Many good US shows are inaccessible in Australia full stop.”

      We need Hulu and Netflix and other internet on-demand providers over here. Until that happens, I will continue to get all of my TV series via “illegal” means. And don’t tell me about the T-Box or Foxtel.. you don’t need proprietary hardware anymore to view videos on your TV and you shouldn’t be forced to use such devices. Not to mention having hardware forces the price to be far more expensive than it needs to be.

      Unfortunately that’s not going to happen any time soon, the broadcasters (especially Foxtel) go to extreme lengths to get “exclusivity” agreements so that noone else can license and broadcast. This forces you to use their sub-optimal medium.

      Foxtel is the biggest rip-off ever. While they have taken some movements to provide on-demand for movies, they continue to only screen TV shows when they want. You can only record the shows using their system (Foxtel IQ) which doesn’t allow you to watch on other devices at your leisure.

      ABC are the only broadcaster in Australia that have the foresight to understand that the internet is going to become the broadcast medium of choice over the next few years. Their iView application works well, and sometimes even has some US shows on it (Jon Stewart and Stephen Colbert were up for awhile until Foxtel bagged em).

      • “Unfortunately that’s not going to happen any time soon, the broadcasters (especially Foxtel) go to extreme lengths to get “exclusivity” agreements so that noone else can license and broadcast.”

        Which reminds me of the covenants that the big supermarkets made with the shopping centers to block competition. Anticompetitive until it was recently legislated out. So there is a precedence to say, “For fair competition, you must always allow a direct download option”.

  3. Brand protection or copyright suits American business profit protection and therefore laws are being changed for this reason. No reason for us to help them. The Chinese sure don’t.

    Just like free trade benefits USA as it always seeks to protect their intellectual property, often purchased exploitatively and marketed back to the world as another American innovation.

  4. I have a huge issue with DVD regioning. When I moved to the UK for a few years I bought a DVD player there and could no longer watch a good proportion of my legitimately purchased DVDs. So I thought what the heck and contacted one of the companies and asked them to provide me with a replacement copy which worked in the UK.

    Strangely enough there response was that I should have bought a multi region DVD player, and they would not provide me with a replacement.

    So for 2 years I could not watch these DVDs (until the planned obsolecence of my DVD player kicked in) and I had to buy another.

    The issue is mainly flexibility. The world has moved and the content providers havent. People want to watch content on whatever platform suits their needs at the time, or at any time. They dont want to be locked in to a device/time or location.

    Anyway off the Soap Box and back to the grind.

    • yes, given the regioning is an entirely built in software constraint. The only upside is nearly every machine in the world can easily be cracked to play all regions via the remote.

      Indeed all DVD players are all region compatible, but have a code block to restrict the region.

      The history behind this is from the old days of different TV systems (PAL, NTSC, SECAM and their various flavours).

      The movie houses like the way that as they soon figured out (for most folks at least) a video purchased in one country wouldn’t play in another – it also made piracy much harder and more expensive.

      And there were good solid technical reason for this – the different formats were technically incompatible.

      One DVD was being designed they realised that this was not longer the case. So they intentionally built in software to emulate the same constraints.

      They were idiots really – the consumers weren’t that stupid and rebelled against it by moving to outright piracy and hacking the software and machines.

      These days if you have a region constrained DVD, Google your DVD make and model and it will show you update the software to make it all region compatibale. This can usually be done via your remote by pressing the correct key combination.

      There is no reason except greed and stupidity for regional DVD issues. A DVD is like a CD and can play in any machine in any part of the world.

      See, my days working in broadcast TV have finally come in useful on MB 😉

  5. You know what’s piracy, $1.69au per song at iTunes. Which is an amazing over 50% more than American prices, and even at American prices it’s still an incredible ripoff for something that is just data. There’s no physical product to manufacture, distribute & retail, yet it’s priced just the same.

    • “There’s no physical product to manufacture, distribute & retail, yet it’s priced just the same.”

      I’m not defending iTunes pricing, but there *is* a hell of a lot of expensive infrastructure that is required for the large-scale distribution of data over the Internet. To say there’s no physical product involved is either very short-sighted, or very disingenuous.

      • And yet the Russians manage to provide a far better service, with many more options and superior customer service for about .09 US cents per track….

        Not that I would know. That is just what I heard. Just saying…

    • I am more peeved with the Australian Apple store than iTunes. The “Australian” store is run out of Singapore. If you need assistance with anything you get the USA. According to Singapore the Australian operations are now confined to warehousing ans shipping (the stand alone physical stores operate separately). Prices, even taking into account GST, are generally much higher than the US Apple store. I hope they are paying Australian taxes and not just siphoning off money via transfer pricing.

      • Oh, you would be surprised.

        I work in a completely unrelated industry, and we have a parent company in the Netherlands. Do you know how our company avoids paying Australian tax?

        All the revenue we make are charged as a fee by the parent company, so technically we make no money and don’t pay any company tax. And since it’s a global company, the practice is done for other branches in other countries.

        That’s the way global corporations roll these days, they only pay tax in countries that have the lowest tax rate.

        The question is if corporations like the one I work for can take advantage of a global economy, why can’t copyright holders?

  6. I have a friend who uses torrent sites. These torrent sites require you to be invited and everything you download you must upload. This makes sure everyone shares and you get the maximum speed possible. There are no virus’s as you must be approved to upload to this site and government authorities can’t tap into the download client to see which IP’s are downloading the pirated content.

    You can’t stop it, so why don’t studio’s or record companies implement this sort of website. All you do is pay a monthly subscription and to be allowed to download you must upload as well, this means companies don’t need to maintain servers as every member is a server for you.

    • Because they are idiots and would love to be rent-seeking entities.

      Books have dealth with this ever since the photcopier was invented.

      If books were sold at $1500 each, then people would photocopy books from the library.

      Book publishers thus had to adjust their pricing. The advent of the kindle/eReader has seen a noticable adjustment in recent times again.

  7. Since copyright and patents ostensibly exist to encourage further innovation, I have long believed that there needs to be some inverse relationship between the profitability of a copyrighted or patented good, and the term of its protection. Ie: the more profitable a song or invention is, the sooner its copyright or patent should expire.

    It seems to me there should be some way of setting up a variable copyright or patent term, based on the “production cost” of a copyrighted work or patented invention – once that cost has been recovered, the copyright or patent protection should expire. Obviously this would be easier in some cases (drug research) than others (first-time author).

    Some of the other aspects of “Intellectual Property” law that need review, IMHO, are automatic copyright protection (should only be for the “moral rights” of identifying original authors, etc) and the extension of copyright protection past the death of the copyright holder (shouldn’t happen).

  8. The history of the legal treatment of IP rights and the attempt to align this with general/physical property rights is curious.

    The basis for applying the laws that underpin physical property to protecting IP are somewhat spurious. The moral basis for laws protecting physical property rights flow from the fact that to take physical property is to deprive another of the ability to use that property.

    This is not case with IP rights and the moral basis for protecting it comes from not creating a dis-incentive for investing effort in creating IP.

    Most of the pressure for enforcing IP rights comes from those interested in enforcing monopoly use over an idea/concept. This should be debated on its social merits without regard to notions of physical property.

    So – does an IP law really help the average artist/musician or merely the interests that buy their work for sale?

    • Current IP laws seem to protect the middlemen more than they protect the artists themselves. I remember reading somewhere that a large proportion of artists make more from their live shows than they do from their album sales.

      • That is correct.

        The biggest cash flow for bands actually is their merchandise. T-shirts and the like, because it is simple for them to go direct to the manufacturer.

        Concerts usually see promoters and venues take a large chunk.

  9. arescarti42MEMBER

    Leaving out the argument for the protection of intellectual property on the basis that firms need an incentive to innovate, isn’t piracy economically efficient?

    If some company makes a TV show, then the marginal cost incurred by that company in providing the TV show to me, if I pirate it, is zero. All the costs are incurred by myself (internet connection etc.) and the person who decides to philanthropically upload the show for me to download.

    Doesn’t that mean the efficient price for digital goods (which are non-rival) is zero?

  10. Interesting commentary here on the issue of DRM (Digital Rights Management) in relation to e-books but some of the same points apply:

    “As ebook sales mushroom, the Big Six’s insistence on DRM has proven to be a hideous mistake. Rather than reducing piracy[*], it has locked customers in Amazon’s walled garden, which in turn increases Amazon’s leverage over publishers. And unlike pirated copies (which don’t automatically represent lost sales) Amazon is a direct revenue threat because Amazon are have no qualms about squeezing their suppliers — or trying to poach authors for their “direct” publishing channel by offering initially favourable terms. (Which will doubtless get a lot less favourable once the monopoly is secured …)

    If the big six began selling ebooks without DRM, readers would at least be able to buy from other retailers and read their ebooks on whatever platform they wanted, thus eroding Amazon’s monopoly position. But it’s not clear that the folks in the boardrooms are agile enough to recognize the tar pit they’ve fallen into …”

    Same point HFW was making about DVD regioning.

  11. Tsk tsk. The primary reason for regulation is surely to protect the interests of existing businesses from unruly upstart competitors. Any benefits to customers are simply unintended consequences.

  12. Piracy, as has been mentioned above, goes both ways.

    itunes songs costing significantly more in Aus than the US.

    Region encoding of BD and DVD disks, purely to inflate the margin in certain markets.

    Many games from Steam, the largest game content digital distribution platform, costing $50 more if your IP address is located in Australia as opposed to the US. There simply are NO local costs for this distribution method.

    You can’t treat your customers like this anymore. It IS a global market place and the longer they ignore reality, the more smart businesses are getting the jump on them.

    To me it seems mostly about protecting very fat, monopoly, rent seeking distribution channels, and nothing to do with protecting artists or consumers. But I will disclose I am employed by an ISP, so am not impartial.

    While AFACT continues to take my employer to the high court, we will get on with developing and selling things like our IP TV product, with (legal) movies and TV on demand. Sure its a piddly amount of contact right now, but just wait….

    All they know is Lawyers and monopoly distribution. What we know is in a comparatively short space of time, people will be able to watch just about any TV channel or any movie, from just about anywhere in the world, any time they want.

    ISPs are the new content distributors, and the secret is developing platforms that empower the customers to access contact legally, economically, and in a manner that suits there needs.

    The reality is the consumer now has significant control in the exchange, not the distributor, and the market will respond accordingly.

    It’s not just distribution that’s changing, the internet opens up the possibility of crowd funding of content as well. Crowd funding of films and documentaries is happening. Even crowd funding for authors wanting to write books that the mega publishing houses won’t touch.

    Finally, while I understand the need for IP laws to protect research and development costs, much of what I see in patent infringement seems to be of the opposite effect. The laws are so extended and twisted now, they seem to mostly discourage development rather than protect it.

    The whole concept of the public domain has ceased to exist, the recognition that most ideas are based on the previous ideas of others. It’s all been eaten by Lawyers and large corporations with the cash to make sure they buy enough patents to prevent any upstart competition.

    • ** platforms that empower the customers to access content legally (lol not contact)

      It’s late for me, sorry about the typos 🙂