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Software piracy pushes companies to be more competitive, study claims

So, do copy that floppy?

Software piracy, long a source of anxiety among app makers and large software companies, may have some beneficial effects.

Wendy Bradley, assistant professor of strategy, entrepreneurship, and business economics at Southern Methodist University's Cox School of Business, and Julian Kolev, an economist at the United States Patent and Trademark Office, recently examined the impact of software piracy in a paper [PDF] titled "Software Piracy and IP Management Practices: Strategic Responses to Product-Market Imitation."

The economists looked at mentions of piracy in the SEC-mandated annual 10-K filings of 106 publicly traded companies that generated 40 per cent of their revenue between 1991 and 2000, based on the belief that software firms, so dependent upon patent, copyright, and trademark protection, "benefit disproportionately from cumulative innovation."

They compared the intellectual property (IP) strategies of these firms, alongside a control group of companies not facing significant IP risk, before (1991-2000) and after (2001-2007) a major "piracy shock" – the debut of BitTorrent in July, 2001.

The authors consider the arrival of BitTorrent in July, 2001, to be an ideal dividing line because the decentralized file sharing protocol can handle large files in a way that Napster could not, and because IP rights holders were unable to shut it down.

What they found was "piracy shock" pushed affected firms to innovate, as measured by an uptick in research and development spending and in patent, copyright, and trademark applications.

This increase does not appear to be driven by efforts to directly prevent software piracy. Instead, it may be the result of companies innovating and changing strategies to, at least in part, overcome any effects of piracy.

"When comparing the IP strategies of software firms at risk of piracy (the treatment group) against those of not-at-risk firms (the control group), we find that our treatment group significantly increases its innovative activity after the piracy shock in terms of R&D expenditures and granted copyright, trademark, and patent applications," their paper says.

"Our analysis also reveals a dynamic response: firms tend to increase their R&D expenditures and copyright filings sharply in the first two years following the piracy shock, while the impact on patents is most significant over longer horizons of three to seven years."

Previous studies on film and music piracy, the authors note, did not establish an increase in IP-based innovation, though those research projects did indicate that unauthorized copying does not reduce the number of films made per year (Danaher and Smith, 2017 [PDF]) or the number of songs (Waldfogel and Aguia, 2018 [PDF]).

Bradley, in an email to The Register, said, "Fortune 500 companies have long understood the importance of IP management practices to their bottom line, from Xerox to IBM; there’s a lot of value in patents, including (but not limited to) patent-licensing royalties."

"Many people thought piracy was going to have a tangible and immediate negative impact on firms, especially in the software industry," she said. "Our results show that, instead, increased rates of piracy led software firms to innovate more. This innovation was in the form of new, highly-cited patents in the software sector, specifically."

Asked to what extent this innovation was defensive – efforts to protect existing revenue – and to what extent it was creative – efforts to explore new opportunities – Bradley said the research data indicates the innovation was not defensive.

"Defensive patenting would not likely generate citations, and our citation-weighted patent outcome specifically aims to address this concern," she explained. "The citation-weighted results are broadly similar to the unweighted patent measure, so I’d conclude that most of the patenting is not defensive."

Bradley said that she and her co-author did look at the revenue impact of software piracy and found that it increased disproportionately among the piracy prone "treatment" group.

"We don’t delve into the content of the patents, so we don’t know whether this innovation is about new features or business processes, but we do think this is an opportunity for follow-on research, particularly case studies or qualitative work," she said. "For example, subscription-based software has meaningfully changed the competitive landscape in recent years."

Tolerate or not?

Asked whether the piracy findings suggest adopting policies that aim to tolerate piracy, based on its perceived benefit, Bradley said she's not making that argument.

"The policy implications are tricky, and we wrote the paper for a managerial audience suggesting that more innovation is an effective response to piracy," she explained. "There are plenty of reasons to support anti-piracy policies, particularly coordinated efforts across countries attacking the supply-side.

"Without overreaching in terms of policy suggestions, I think one implication is that anti-piracy efforts could be focused on industries that are already highly innovative or highly competitive. We aren’t pushing for 'tolerance' of piracy, but there are limited resources governments can dedicate to enforcement, and we would want to send those to areas where piracy’s net effect is most negative."

Similarly, she said managers dealing with these issues should consider whether it makes more sense to invest in anti-piracy policies like litigation or to develop new and better versions of their products that motivate people to buy them legally.

We aren’t pushing for 'tolerance' of piracy, but there are limited resources governments can dedicate to enforcement, and we would want to send those to areas where piracy’s net effect is most negative.

Bradley contends her research is applicable even in dominated markets where there's little competition.

"We are highlighting the interpretation that innovation increases because of a rise in competition," she said. "We do want to be careful when talking about two-sided platform markets, like the iOS App Store, where the concept of competition is more complex. Using a platform lens, our paper is more about competition between apps than competition between operating systems."

Bradley said that in a monopolistic environment, firms have little incentive to innovate and while that's outside the scope of this particular research project, she nonetheless sees the findings as an indication that, even in the absence of policy intervention, piracy increases those incentives.

"Another way to think about it is: for a dominant incumbent firm in a strong position, piracy could push them to increase innovation more so than they would without it," she said. "Past examples include telephone features and the old Bell monopoly, or more recently, Apple adding in the features that the jailbreak community pioneered in the iPhone."

Piracy, she suggests, encourages people to try out and compare products without committing to a purchase and that can provide a way for smaller software firms to gain traction through word-of-mouth.

"This, in turn, pushes large companies to innovate to stay competitive and maintain their market dominance, as opposed to relying on a potentially anti-competitive position or low consumer awareness of alternatives (given Apple, Google, and Microsoft’s superior marketing and branding advantages)," said Bradley. ®

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