Anti-piracy regulation and competing with free

By: Michael D. Smith

In a New York Times op-ed earlier this month, Nick Bilton used the metaphor of “Whac-A-Mole” to suggest that the creative industries are hopelessly naïve in their efforts to regulate online piracy. The editorial, “Internet Pirates Will Always Win”, argues that anti-piracy regulation is a lot like Whac-A-Mole: hitting one target only causes two or three new targets to emerge — content identification systems can be fooled, shutting down some sites only causes new sites to open, and new filesharing protocols make it harder and harder to monitor pirate activity. In a way, the argument parallels the “you can never compete with free” arguments that have been advanced by those in favor of anti-piracy regulations, but this time with a very different conclusion: Because you will never stop piracy, the creative industries should stop trying.

“Those who don’t know history are destined to repeat it.” Edmund Burke (1729-1797)

The problem with this formulation of the “competing with free” argument is that it doesn’t learn from the history of online price competition. Harken all the way back to 1998 where conventional wisdom said that the Internet would allow consumers to easily find the lowest price and therefore would inevitably lead to “fierce price competition, dwindling product differentiation, and vanishing brand loyalty.”

This argument seemed plausible enough: Why would you pay more for something that you could get for less? Unfortunately, the argument ignored the power of product differentiation. Differentiate your product offering on things like reliability, convenience, service, quality, and timeliness and consumers will cheerfully pay more for a product they know they could get elsewhere for less. In joint research with Erik Brynjolfsson, we found that while Amazon’s prices were well above the lowest price online, they still retained a dominant share of the market in head-to-head competition with much lower priced alternatives from online retailers like altbookstore, booksnow, and musicboulevard. We also found that shopbot consumers, arguably among the most price sensitive consumers online, were willing to pay several dollars more to buy from Amazon.com even when lower priced alternatives were displayed on the same search page just one click away.

What does this have to do with anti-piracy regulation? Possibly quite a lot if one views “competing with free” as simply a special case of price competition. Imagine competition in the digital media space where the media companies and their online distribution partners play the role of Amazon, and where pirate sites play the role of lower priced alternatives from the likes of altbookstore. The twist on this example is that while Amazon could only control the differentiation of their own offerings, media companies can use anti-piracy regulation to impact the differentiation of their pirate competitors’ offerings as well. Thus, media companies can use iTunes and Hulu to improve the convenience, quality, and reliability of their paid products, while also using anti-piracy regulation to reduce the convenience, quality, and reliability of the free pirate competition.

Which brings us back to Mr. Bolton’s argument about the (supposed) ineffectiveness of anti-piracy regulation and raises the question: Can anti-piracy interventions cause people to switch from piracy to legitimate purchases? This is an empirical question, and our early empirical evidence suggests that both a French “3 strikes” anti-piracy law and the recent shutdown of the Megaupload site have been effective in increasing digital sales.

In the case of the French “HADOPI” law, in a co-authored paper with Rahul Telang, Brett Danaher and Siwen Chen we examine the impact of the law on consumer behavior by comparing digital sales patterns in France to a control group of statistically similar countries, and we find that the French anti-piracy law caused a 20-25% increase in music sales in France relative to the control group. We also find that the increase is larger for heavily pirated genres (Rap and Hip Hop, Rock) than it is for less heavily pirated genres (Classical, Jazz, Folk, and Christian). Finally, we show that these results are robust to a variety of counter-explanations including accounting for sales of Apple iOS devices which changed at about the same levels as they did in the control group countries. Likewise, in a recent working paper we analyze the impact of the January 2012 shutdown of Megaupload’s piracy-enabling cyberlocker service,  and find that this shutdown led to an increase in digital sales relative to historical norms and that the increase was larger in countries that were heavier users of Megaupload prior to its shutdown.

Together these results suggest that anti-piracy regulations don’t have to be perfectly effective to get the job done. In that way, anti-piracy interventions may be less like “Whac-A-Mole,” and more like horseshoes where you can score points just by getting sufficiently close to the target.

Cross posted to the Digitopoly blog