‘Just Enough’ Piracy Can Be a Good Thing

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It’s become costlier for retailers and manufacturers to combat piracy in the digital age. But in moderation, it’s not all bad.

 

 

 

This spring, HBO’s television series Game of Thrones concluded after eight seasons. Throughout its tenure, the show was incredibly popular while also earning the dubious distinction of the most pirated television program. The severity of piracy is duly illustrated by the show’s season four finale, which, within 12 hours of its original broadcast in June 2014, was illegally downloaded 1.5 million times, amounting to 2 petabytes transferred in just half a day. While an upsurge in piracy around the time of the original broadcast may be natural, a steady level of interest for pirated copies of older episodes has continued unabated, well after the episodes became available at retailers online. Despite ongoing issues with illegal downloads — there were 1 billion of the show’s seventh season — HBO seems to have no real plans to counter the illegal streaming services and lets off perpetrators with only a slap on the wrist.

 

This inaction on HBO’s part may have some economic merit: Our research shows that a moderate level of piracy — not too much, not too little — can actually benefit the manufacturer, the retailer, and consumers, all at the same time.

Can Two Wrongs Make a Right?

The manufacturer does not usually set the retail price in a supply chain; the downstream retailer does. In this case, HBO charges cable operators, such as Comcast, a monthly per-subscriber fee, corresponding to the wholesale price, and each cable operator decides on its own margin, which determines the final retail price. A wide variety of information goods (music, movies, TV shows, video games, e-books, and software) in formats ranging from shrink-wrapped discs to streaming content is brought to the market through this wholesale model.

 

In this setup, the supply chain faces a situation known as double marginalization: Both the manufacturer and the retailer decide on independent margins, each of which gets assigned to the price of the good. Double marginalization manifests itself in a higher retail price and reduced consumption compared with when the manufacturer and retailer are owned by the same company. Hence, an information-goods supply chain faces two strategic challenges to pricing — piracy and double marginalization.

 

That’s why manufacturers and retailers may be better off with a moderate dose of piracy — two wrongs can actually make a right. When Comcast loses a Game of Thrones viewer to piracy, so does HBO, which limits the pricing power of each. Even though a limitation on its own pricing power is not good for the manufacturer, the limitation on the retailer’s power surely is, and vice versa. A moderate level of piracy thus can limit the negative impact of double marginalization on both sides, benefiting all parties in the supply chain. Meanwhile, consumers welcome the lower price.

 

‘Shadow’ Competition Can Benefit Everyone

Piracy injects a degree of “shadow” competition into a supply chain — that is, competition that comes from reproduced versions of the authentic original, as opposed to new offerings being developed and produced by an external company. In traditional upstream and downstream competition, more competition is good for some parties but bad for others. By contrast, piracy competes with the manufacturer and the retailer simultaneously, limiting each just enough so that both are better off.

 

Conventional wisdom holds that the inefficiencies in the supply chain, which manifest as double marginalization, could hurt consumer consumption and aggravate the situation for both parties. Reports from both academia and industry have illustrated that piracy reduces companies’ pricing power and hurts profits. But our findings challenge these ideas within the context of an information-goods supply chain, in which a manufacturer not only faces competitive pressure from piracy but also lacks direct control over the final price. When facing both of these hurdles, the manufacturer comes out further ahead in a moderate piracy situation than it would if it were dealing with just one of these supply chain challenges.

 

Moderate levels of piracy may benefit information-goods companies in other ways as well. For instance, companies and platforms can make gains through a positive network effect (the more people use the product, the more valuable it becomes) and consumer learning (pirate users may learn about the product and buy the legal version later on).

 

Although prior studies point out positive primary effects of piracy, the primary effect in our context is negative: It suppresses companies’ pricing power. However, the secondary effect of this is positive. When HBO reduces its margin, Comcast’s revenues rise accordingly; when Comcast in turn reduces its price, it gains more customers, benefiting HBO. Consumers, for their part, benefit from lower prices for the authentic product.

 

This surprising “win-win-win” situation reminds us of Adam Smith’s invisible hand: Even when all players act in their own self-interest — the manufacturer and retailer maximizing their profits and consumers maximizing their utility — somehow, every actor becomes richer in the process.

 

Of course, the benevolent effects of moderate piracy that we identify here should not be construed as an endorsement of piracy. When piracy is rampant, its negative impact dominates, making both companies worse off, much as one might expect. Nevertheless, antipiracy measures are often expensive, so before going full force against piracy, organizations should pause to ponder whether, and to what extent, doing so would be a worthwhile investment.

Feeling Your Way Toward ‘Just Enough’

What do moderate levels of piracy look like? “Just enough” is hard to define because it can depend on a number of factors, including size of the market, production costs, and details of supply chain contracts. It’s less difficult to identify instances where the levels of piracy or the levels of anti-piracy efforts are clearly immoderate.

 

The implication is that companies should engage in common-sense efforts to combat piracy, focusing on the most egregious and high-profile offenders and simply monitoring the more moderate pirates to ensure they do not get out of control. In the end, the smaller players may be too difficult and costly to combat — and they could play a valuable role in the information-goods supply chain ecosystem.

 

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