Probing Piracy’s Costs

5/07/2012 12:01 AM Eastern

The popular video-streaming
site Hulu may soon limit its offering
to viewers who already pay
for cable television, in an effort
to deter subscribers from
“cutting the cord.” Whether
or not that makes business
sense for Hulu and the cable
companies, closing off a legal
viewing option for nonsubscribers
seems certain to
lead to a spike in piracy: As
Wired reporter Ryan Singel
joked on Twitter, The Pirate
Bay is probably purchasing
new servers already in anticipation
of the increased demand.

There’s a serious point buried in
that joke: Statistics purporting to
measure the high losses piracy inflicts
on U.S. companies — routinely
invoked as a justification for such drastic
enforcement measures as the controversial
Stop Online Piracy Act
(SOPA) — depend heavily on pricing
decisions made by those companies.

Once digital content is produced,
the difference in distribution cost
between selling 100 copies and 1
million is negligible. That creates
enormous flexibility in pricing strategies,
ranging from the pay-per-view
“premium” content model (high
price, small but devoted audience) to
the free ad-supported model of broadcast
television (much less profit per
viewer, but made up for by a much
larger audience). In practice, companies
usually employ many strategies
sequentially, in different “release
windows” — or even simultaneously
in different markets or formats.
This has various benefits for both
consumers and the studios, but also
makes it that much more difficult to
objectively estimate the “losses” attributable
to piracy.

If a company predicts it can sell 1
million copies of a video at $1 — or
make the equivalent in ad revenue —
or sell 500,000 at $2, it can flip a coin to
decide which strategy it prefers. Yet at
the higher price, the nominal value of
each pirate copy in circulation doubles.
Piracy has suddenly become much
more “costly” — even before we consider
whether the higher
price has increased the
number of pirates.

Even leaving aside the
many accounting tricks
content industries like to
employ to inflate the costs
of piracy, the true economic
impact of copyright
infringement is almost impossible
to assess, because
the price of a digital good,
the level of infringement,
and the “displacement
rate”— the percentage of the pirates
who’d buy at that price in a world of perfect
copyright enforcement — are not
independent variables. And, of course,
the interdependency runs both ways:
Pricing decisions are influenced by the
knowledge that we don’t live in a world
of perfect enforcement.

This doesn’t mean that content producers
are somehow at fault when piracy
increases after they raise prices:
They have a right to charge what they
please. But it does mean we’ve got to
exercise a bit of critical scrutiny when
deciding whether the “costs” of piracy
justify the “costs” of enforcement,
both in taxpayer dollars and compliance
burdens on tech companies.

The point here is not to argue for
more copyright enforcement or less.
It’s that we can’t say anything meaningful
about the net social costs of
piracy — and the costs we should incur
to reduce it — without taking into
account the fact that those “costs”
depend on pricing strategies that incorporate
substantial seller discretion,
and may already factor in assumptions
about the extent of piracy. That
may mean it’s impossible to generate
an estimate of the “true” cost of piracy
in practice, but the impracticality
of generating a realistic estimate is no
reason to take our existing — unrealistic
— estimates seriously.

Julian Sanchez is a research fellow
at the Cato Insitute.

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