Wednesday, November 30, 2005

Piracy & Economics 101

You may have noticed that the Recording Industry, Movie Industry and Software Industry, all have something in common. No, it's not that they all like to sue their customers. Well, okay, they do like to sue customers, but that is not the point of this entry.

The point is, they all seemed to have failed economics in school. Personally, I thought pretty much everyone had to take economics. You know, supply curves, demand curves, graphs that show price and quantity in a marketplace? Really, it's pretty basic stuff.

Well, in their self-righteous outrage over the 'theft' of their intellectual property (yes, I know, this is usually in close proximity to suing their customers), all three glibly cite the tremendous amounts of revenue being lost to their respective industries due to piracy. I'm not suggesting that all forms of piracy are okay. But I do think it is important not to exaggerate in these types of discussions. After all, I believe it is precisely this type of thinking about how much revenue is being lost that led Sony down the path of the 'rootkit debacle' (see Sony, Rootkits And Digital Rights Management Gone Too Far).

A Word on Piracy
Now, I'm not talking about businesses that copy and sell music, movies, or software for profit. That's a different issue. But I am talking about:

  • I purchased a CD that I usually listen to in the house, but when I'm in the car, I like to use a copied version (if you've ever had your car broken into and your CD's stolen, you'll understand why you might do this).

  • Or perhaps a move I purchase on DVD that my children regularly handle - I'd rather have them handle a copy.

  • Or that PC that I purchase that came with a monopoly operating system with an 'OEM' license - the hard drive died and I put in one of a different size. Now I can't restore the OS through the legal means of the restoration disks, so I use a different physical copy of the OS CD that I happen to have.

Let's call this consumer piracy and define it as behavior that a reasonable person would not find criminal, but is under the current laws and licenses.

Now, back to the claims of lost revenue. Here are some examples:

Movies: "The Motion Picture Association of America (MPAA) and its international counterpart, the Motion Picture Association (MPA), estimate that the U.S. motion picture industry loses in excess of $3 billion annually in potential worldwide revenue due to piracy." See the MPAA's write-up Anti-Piracy.

Music: "Each year, the industry loses about $4.2 billion to piracy worldwide -- 'we estimate we lose millions of dollars a day to all forms of piracy.'" See the RIAA's write-up Anti-Piracy.

Software: "BSA estimates that software publishers lose roughly $13 billion to software piracy every year." See the BSA's write-up Anti-Piracy Information - Product Activation.

OK, now let's talk economics. Let's start with my copied CD in the car. If I go to purchase a new CD, it will likely cost me $13.99, or perhaps $14.97 with a little sales tax. Now, the CD's I purchase, have enough value to me, that it is worth my nearly 15 bucks to buy it. That's one of the basic economic principles at work here. If it doesn't have $15 worth of value to me, I don't buy it. Now, I carry a copy in my car to protect against theft. You could think of it as insurance. How much is the insurance worth to me? Well, certainly not $14.97, because the chances of the CD being stolen are small. It might be worth $0.30 to me (that's about a 2% probabability that the CD will get stolen and a little more than the cost of the blank CD).

Now, the music industry would say they are out $13.99. But would I EVER pay $13.99 to carry a second copy in my car? No. It's only worth $0.30 to me. Is the music industry out $0.30? No. They won't sell me a backup copy of the CD. They will only sell me another copy for $13.99. So how much money has been lost here? $0.00. If you could prevent me from making a backup copy of the CD, I would never pay for another CD to carry in my car - it's not worth to me. The music industry has lost nothing. Make sense?

Now let's get into something a little more grey - mostly because our definition was concerning behavior a reasonable person would not find criminal. But let's go a little farther. Let's say a friend of mine found a new band that he just loves and wants to share that with me. So he burns me a CD to try out (he doesn't want to lend me his, because he wants to keep listening to it). I'm sure you've had this happen. How many times do you share your friends enthusiasm for a new band?

Yeah, me too. Sometimes yes, but a lot of times, no. Now, being a good friend, I'm going to listen to this CD a few times so I can share the experience with my buddy. I'm not going to lie and say it's my favorite, but I'm going to find a track or two to that I like that I can talk about with him. Would I ever buy this CD? No. Maybe at $4.99, but not at $13.99 - it just doesn't grab me. Has the music industry lost anything? No.

Let's say they could prevent my friend from copying the CD. What would happen then? I'd either hear the CD in his car while driving somewhere, or we would listen to parts of it at his house or mine. Would I like the CD enough to go buy it? No. It's the same music that doesn't grab me. What has the music industry lost? Nothing.

Of course there is the case where I do like the band (maybe 40% of the time). And I like it enough to want to continue to listen to it. Here's where a little personal integrity comes in. Am I going to drive to Best Buy and buy it? Or maybe fire up iTunes and download it (geez, I only have to like it $9.99 worth to buy it from iTunes)? Me personally, I'm going to buy it. But let's say that only 40% of the people would do that. Now we have about 40% of the CD's that 'should' get bought, that don't get bought by 60% of the people. That works out to about 24% of the CD's that get copied. This is a much smaller number than number of copies x retail price. And remember, there would never have been the sales to the people who did buy, if they didn't get a trial CD to listen to. That's about 16% sold that wouldn't have otherwise. Now the true impact is the 24% - 16%, or only about 8% of the copied CD's in this scenario that represent lost revenue.

So there is lost revenue. But it is a much smaller number than number of copies x retail price. Why is that? If you get something for free, it says nothing about your willingness to buy it. My consumption preferences are very different at a price of $0.00 and $14.97. As are everyones. The question for the Recording, Movie and Software industries, is how much do you want to spend to recover what is likely to be a fairly small revenue number? You also have to remember that attempts to limit 'piracy' are mostly effective against the average consumer and piracy like I've described here. It is generally not effective against business piracy. It also tends to alienate customers and is likely to have an overall negative effect on sales. That would make that 8% an even smaller number.

I'm not advocating piracy for profit. I am advocating common sense and Fair Use. I think with a little basic economic perspective on what is going on here, will get the battle focused where it belongs. Delivering content and software in the way customer's want. That is what will cause revenues to grow in all these industries. Trying to criminalize consumers for doing what seems very natural to them is a dead end street.

For a more thorough analysis of the economics concerning the business of piracy, see On Software "Piracy", Lies, BSA, Microsoft, Rocks, and Hard Penguins.

Steven Beebe
6200 feet above sea level
email: steveATthebeebesDOTorg