The upside of digital piracy: greater investment in quality

Among the myriad debates concerning life in the Internet Age, there is at least one thing we can all agree on: digital piracy is bad.

Well, not all of us. There are the pirates, of course. And perhaps the consumers of those counterfeit information goods. And then there’s Atanu Lahiri and Debabrata Dey, a pair of researchers at the University of Washington Foster School of Business.

Lahiri and Dey acknowledge that digital piracy is a serious societal ill. But the rigorous economic model they built from a deep study of software, game and entertainment producers reveals that that a certain level of piracy actually has some positive effect, too.

Specifically, a certain amount of piracy introduces a kind of “shadow” competition that drives manufacturers of information goods to invest in quality. The result can mean greater innovation and better products at moderated prices.

“Even though piracy is bad, it still does the job of injecting competition into the market,” says Lahiri, an assistant professor of information systems at Foster. “And competition is good for consumers.”

Reality bites convention

This is not the conventional wisdom. Until now, academic researchers, governments and manufacturers have arrived at the same narrative: digital piracy reduces profits, leading to decreased investment in quality, leading to lower-quality products in the market.

But Dey and Lahiri found a very different story when they observed many of the world’s most significant producers of digital goods. Microsoft, Electronic Arts, Adobe, HBO, Valve. These global brands have expanded R&D expenditures in pace with the steady rise in global digital piracy. Rather than receding, they are innovating.

“It’s clear that, in the face of piracy, companies are actually investing in quality,” says Dey, the Marion B. Ingersoll Professor of Information Systems at the Foster School.

Using this insight, he and Lahiri modeled manufacturers’ decisions on quality in the presence of varying levels of piracy. Their analyses show that manufactures are always better off when there is no piracy. But at a certain level of piracy, consumers and society actually benefit.

Best defense is offense

Here’s why. Digital pirates chip away at a firm’s revenue by selling a facsimile of its content at a lower price. This disrupts a kind of content monopoly on individual consumers that many information producers enjoy—there’s no operating system exactly like Windows, no perfect replica of “Game of Thrones,” no game quite like “Half Life.”

Pirates break up that monopoly. “In effect,” Dey says, “the manufacturer has to compete with its own shadow.”

That legitimate manufacturer has one distinct advantage: the pirated version of a product always suffers from degradation in quality. A movie will screen at a lower resolution. A game will be missing a few features. Software will lack support. Downloads may be slower. The tradeoff is lower price.

But when producers continue to create and offer newer features for their digital products—like innovative content or enhanced service—they can provide a richer experience at a nominally higher cost. This can even woo back some illegal customers.

It’s already happening in the market. “Manufacturers of digital content are losing profits, as in any competitive environment,” says Lahiri. “But investing in R&D is keeping them in the game—if not ahead of it.”

Services, not products

Governments and firms are incurring massive costs in the generally losing war against digital piracy. Instead, Lahiri and Dey advise a judicious approach to enforcement. At a certain level of piracy, additional enforcement efforts only diminish the benefit to consumers and society.

“It is a prohibitively costly and probably unrealistic notion that a government could stamp out piracy completely,” Dey says. “We certainly don’t advocate piracy. But we shouldn’t assume that more enforcement is always better for consumers and economies.”

Legitimate producers of digital content, he adds, might do well to follow the example of Valve, the successful video game maker. Valve has decided to accept piracy as the new normal, the competitor that never goes away but can never compete on quality. In response to this threat, the firm has come to view its digital content as a service rather than a product.

Effects of Piracy on Quality of Information Goods” is published in the January 2013 issue of Management Science.