Impact of Piracy on Innovation at Software Firms and Implications for Piracy Policy

A Business software alliance (BSA) commissioned study in 2006, found that $34 billion was lost due to piracy of software in 2005. The BSA and its members invest significant resources in educating users about copyright, its value, and enforcing copyright laws. However, does effort spent in educating users about the harmful aspects of piracy, and taking action against end-users using pirated software always result in higher quality software? In this paper, we look at how innovation in the presence of piracy is affected by the policy choice of alliances such as the BSA. Surprisingly, we find that a stricter piracy policy, that increases the perceived cost to using pirated software for end-users, may in some cases lead to an increase in piracy (demand for pirated products), and a decrease in product quality. Thus an active BSA that tries to educate consumers and takes legal action against consumers, may actually be promoting piracy and hurting innovation in some cases. An intuitive rationale for this is that, in some regions, quality choice by the firm and the policy choice by the BSA are strategic substitutes in the fight against piracy. Thus an increase in the policy variable by the BSA, makes the firm choose a lower quality. Depending on the likelihood that the pirated product is functional, the BSA would choose a piracy policy ranging from an inactive to a very active policy.