The Effect of Piracy on the Market Penetration of Subscription Software*

Software piracy refers to the illegal use of software by end users. The Business Software Alliance (BSA) in its 2002 annual report states that 40% of business software installed on computers is pirated, resulting in $11 billion in losses (BSA 2002). Given that piracy is ubiquitous in software markets, managers need to consider it in their marketing decisions. While piracy on a large scale is clearly detrimental to profits, a strategic tolerance toward some piracy may actually increase profits. Specifically, piracy may help in diffusing the software to its target market because it increases the size of the user base, resulting in benefits to legal buyers due to network externalities. A network externality is the additional utility derived from the size of the user base (Katz and Shapiro