Undercover Economist

Piracy’s hidden treasures

What should top record labels, software giants and other media companies do about digital piracy? There are two obvious options: get tough and defend intellectual property rights with every legal and technological trick in the book, or tolerate some illegal copying in the hope of generating buzz and making money in some other way.

This is a debate that generates strong opinions, and where you stand seems to depend on whether you’re an industry accountant or a new economy guru. (Chris Anderson, editor-in-chief, Wired magazine, coined the phrase “Freeconomics” to describe giving cheap things away for free in order to create buzz.)

But look closer and you realise that the corporate suits aren’t all adopting the same strategy. The music industry doesn’t seem able to make up its mind: first it turned a blind eye to traditional mix-tape piracy, then it cracked down on illegal file-sharing while raising the price of CDs, and finally it slashed the price of CDs in an attempt to compete head-on with downloads, legal and illegal.

Even more perplexing, Microsoft seems to hold two opinions at once: doing its best to prevent piracy on the Xbox console, but (as far as this outsider can tell) accepting that piracy of its Office suite of software is a fact of life.

Karen Croxson is a young economist at Oxford University who claims that there is method in the madness. She argues that there will never be a single correct trade-off between sales lost to piracy and sales generated by the buzz from pirated copies in circulation. That is because there are different kinds of potential consumer in different markets, or even in the same market at different times. A company’s most profitable response to piracy depends on what sort of consumers it is facing.

For example, the consumers who would pay for console games if given no alternative are probably the type of consumers who are happy to use pirated copies: tech-savvy youngsters. That means that an extra pirated copy in the console market is quite likely to mean a lost sale.

But the customers who will pay most for corporate software are, well, corporations. They won’t want to risk being caught and sued for piracy, so an extra pirated copy in the corporate software market probably isn’t a lost sale at all. The guilty party isn’t a customer, but a home-user or a student who would never have stumped up full price. Thanks to piracy, though, that home user is now learning how to use Word and PowerPoint and making the legal copies of Microsoft Office more valuable.

Croxson can even make sense of the record industry’s apparent volte-face with the pricing of CDs. When Napster was starting up and piracy was still a marginal activity, it made sense for record labels to write off a few cheapskate customers as a marketing expense and raise average prices to everyone else – presumably the older, more prosperous customers who were willing to pay for legal music. But as the pirated sector embraced even those customers, the best strategy was to fight back by slashing prices.

In Croxson’s world, then, “promotional piracy” is an alternative to discounted pricing. Both approaches are a way for companies to advertise their products or expand their user base. And as with discounted pricing, promotional piracy only makes sense if there is a decent supply of customers who will eventually pay full price, which is not always true.

Corporations may be able to do more to maximise the gains or minimise the losses from piracy. Why not offer two versions of the product: a cheap-to-pirate, lower-quality product, and a high-end offering incorporating tight security? If Croxson is right, for some industries, piracy is a wonderful distribution channel.

Also published at ft.com.