Weatherhead Center Fellow Michael Impink shares his research on the effect of business factors on software piracy in high-growth countries.
Depending on the industry, piracy either stifles economic growth or fosters innovation. In many technology and pharmaceutical industries, piracy impedes innovation because of its deleterious effect on profits, whereas in the fashion industry, piracy drives participants to produce the latest, trendiest designs. The business strategy of software producers, intellectual property owners, and computer device manufacturers has a substantive impact on piracy, not fully captured in the current literature. My research focuses on how business factors—the competitive landscape of device manufacturers, the evolving strategy of intellectual property owners, and the shift away from traditional licensing models—affect intellectual property rights and software piracy in high-growth countries.
Has Piracy Declined?
From the literature, we find two universal truths: piracy is pervasive, and piracy varies widely by country. There is a misconception that piracy has declined substantially over the last several years. In some markets, this is true: with the advent of streaming services such as Hulu and Netflix, the rate of overall media piracy in developed markets has declined. However, software piracy worldwide is relatively unchanged. The growth in the number of devices sold in emerging markets—where piracy is most pervasive—continues to outweigh the growth in low-piracy markets, such as North America and western Europe. Every new device sold creates a possible “socket” for operating system and software piracy. On average, software piracy has increased in the Asia-Pacific region to 61 percent of total devices in 2015 from 59 percent in 2009 (BSA, The Software Alliance, 2016). Even though most countries in Asia have improved their control of software piracy, the high-piracy countries in this region are growing faster.
Pulling in Experts from Microsoft
Harvard’s Weatherhead Center for International Affairs hosted lectures earlier in the academic year on intellectual property, featuring speakers affiliated with Microsoft. Kurt Kolb, retired vice president of licensing and emerging markets, spoke about Microsoft licensing programs with device manufacturers in the 1990s and early 2000s. He said that Microsoft’s business strategy at that point in the company’s history was focused on Bill Gates’s vision that working with governments to reduce piracy would strengthen intellectual property rights, enhance the rule of law, and create valuable high-technology industries. Looking at current trends, Nick Psyhogeos, president of Microsoft intellectual property licensing, noted that the intellectual property landscape in the United States is changing, due to a downturn in patent valuations and licensing. Psyhogeos added that policy and judicial efforts to limit software patentability by Congress and the courts in the United States, as well as a more entrenched mindset by defendants in patent litigation, have resulted in a pendulum swing against patent owners and licensors in this market. In contrast, China is emerging as a significant global force in intellectual property. The Chinese government has stepped into the intellectual property void left by the United States’s weakened position through policies of aggressive domestic subsidizing and encouraging the exploitation of intellectual property by Chinese companies. These developments, Psyhogeos said, have made China the largest market for patent filings and intellectual property litigation cases. China’s ambition to build a leading intellectual property ecosystem locally shows no sign of slowing down.
Variations in Piracy by Country
Broadband internet speed is a key factor in shifting the piracy transaction point from a physical location to the internet, because high-speed internet connections let users download software in minutes, with reliable file integrity. There is much less regulation for software downloaded from the internet; if you were to take down a webpage enabling downloads of pirated software, it would likely emerge hours later on a different site.
However, that doesn’t mean physical piracy is gone. While law enforcement raids quickly shut down physical locations selling pirated software in most developed countries, the same is not true for developing countries. In Southeast Asia’s emerging economies and rural China, piracy still primarily occurs in store fronts in what is commonly referred to as a “PC mall.” A PC mall usually resembles a warehouse in which shop owners rent individual storage units and fill them to the brim with consumer electronics. Such warehouses are “one-stop shops” for the average emerging market consumer looking to purchase the latest technology—a new computer, peripherals, and individual disks or flash drives of, almost always, pirated software or media. In the past, the shop would even download pirated software onto a new device for a nominal charge. But with the availability and accessibility of reliable pirated software online, this practice has become less common.
What Factors Drive Piracy?
Initially, research pointed to a significant negative correlation between some economic factors, such as GDP per capita, and software piracy (Goel and Nelson, 2009), suggesting that lower prosperity is associated with higher rates of piracy. More recent studies have fine-tuned this association, pointing to several factors that are more significantly correlated to lower rates of piracy: greater legal infrastructure, less access to pirated materials, and more innovation-orientation of the economy.
In addition, the business strategy of the device manufacturer shapes the landscape for piracy in a country where the manufacturer has a large market share. It turns out the best way to prevent piracy is for the device manufacturer to install genuine software at the point of manufacturing. For example, Sony, a Japanese manufacturer known for their Vaio line of PCs, reduced piracy significantly in certain markets where they had substantial market share by preinstalling entire device lineups with various types of genuine software, notably Windows. Certain device manufacturers preinstall genuine software on only some of their PCs and tablets, depending on the geography where the device will be sold. On the flip side, a change in manufacturer market share can lead to increased software piracy. For instance, when Sony withdrew its Vaio line from Vietnam, pirated operating system software increased substantially.
In countries where there is intense price competition among device manufacturers, piracy increases. For low-cost devices, where profit margins are thin, preinstalled genuine software is usually one of the first options dropped to reduce the cost of the device. Other manufacturers will quickly change device lineups based on changing market conditions, or competitor device specifications, and the share of devices with pirated software or operating systems can increase substantially, as referenced in markets such as Indonesia and Thailand over the past several years.
Are Companies Strategically Choosing to Allow Software Piracy?
Software and other forms of intellectual property have some level of fixed costs and minimal or no marginal costs. With insignificant marginal costs, a business could either price genuine software very low or license software “in bulk” to device manufacturers to reduce piracy in certain countries. My research suggests that traditional software businesses will seek to secure more users with the advent of open-platform operating systems such as Android or Chrome, and free productivity software. The valuation of most software is highly dependent on the number of individuals or businesses actively using the software, commonly referred to as network effects. For example, the value of the chat software WhatsApp, acquired by Facebook in 2014, is highly dependent on the number of active users sending and receiving messages. Since both parties require the same software to chat, there is motivation to download the software to communicate with those who already use the software.
As software becomes more sophisticated, software authentication systems will follow suit. A variety of technical blockers can be added to the product to prevent unlawful replication. Given the possible future monetization options, few companies seem willing to aggressively pursue consumer piracy. It’s possible there is an understanding that customers who engage in piracy have the lowest willingness to pay, such as students or first-time device buyers. In this case, software businesses adopt a form of price discrimination by overlooking consumer piracy when the customer does not have enough resources to purchase genuine software. It’s also possible that given multiple software options and increased market competition to retain active users, a company doesn’t want to either alienate current active users or jeopardize potential future paying customers. Active users of apps, software, or operating systems may be the ultimate predictor of long-term, sustained success. Secondary revenue streams focused on search or advertising and possible future revenue models focused on “pay per use” and “pay for additional features” continue to evolve and put pressure on the traditional licensing models.
The higher the royalty charged, the harder it is to sustain market share. Implicitly allowing piracy could be viewed as a lever to gain additional market share. Continued competitive pressure between paid and free software options present a clear tradeoff: short- to medium-term profitability from a traditional licensing model, or a medium- to long-term focus on retaining or increasing the number of active users.
What’s Next? The Cloud
The use of cloud-based software and sophisticated authentication systems has surged with improvements in the reliability and security of the modern cloud. Most cloud-based licensing models are now by subscription (often called “software as a service,” or SaaS), requiring continual payments to access the software or services, instead of the traditional, one-time licensing royalty. A move toward the former is likely to reduce piracy, as less affluent users can more easily pay small monthly fees than larger one-time payments. In terms of social benefit, the shift to the cloud may provide smaller software developers and entrepreneurs in emerging markets with the ability to effectively monetize their software, through subscription, and build on their creations. The cloud may ultimately produce a secondary effect of reducing piracy, by boosting technology industries in countries untouched by prior antipiracy efforts and enabling them to license their software through subscription. The expectation that device manufacturers should lead the effort to reduce piracy is no longer necessary. Because cloud-based technology makes it easier for software developers to monetize their software or applications, we can get closer to tapping the potential of underinvested emerging countries in order to build the “Silicon Valley” of, say, India, Vietnam, and Thailand.
—S. Michael Impink, Jr., Fellow, Weatherhead Center for International Affairs
Michael Impink is a 2016–2017 Fellow at the Weatherhead Center for International Affairs at Harvard University, completing research on intellectual property rights and technology. He is also a senior manager of Windows product marketing and licensing at Microsoft Corporation.
1. Cartoon of a pirate steering a ship in a storm underneath the "cloud." Image credit: Shreyas Navare, former WCFIA Fellow