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Thursday, February 22, 2007

Overestimating the costs of piracy?

This report by the Los Angeles Economic Development Corporation focuses on the cost of piracy/counterfeiting to Los Angeles County.

The estimate is that all counterfeiting and piracy cost approximately $5.2 billion in 2005. I would cut and paste from the report but, alas, the security settings are as follows:

Printing: Allowed
Document Assembly: Not Allowed
Content Copying or Extraction: Not Allowed
Content Extraction for Accessibility: Not Allowed
Commenting: Not Allowed
Filling of form fields: Not Allowed
Signing: Not Allowed
Creation of Template Pages: Not Allowed
Submitting Forms: Not Allowed

I got it, they don't want me pirating, er copying, the text to post here. So I won't...

However, the report claims that Hollywood suffered a loss of approximately $6.1 billion (not all in Los Angeles County) due to pirating movies. While the authors assert confidence in their estimate, I wonder how accurate it is. Here's why.

Piracy is arguably a response to a price that is "too high" for the individual or legal quantities being set "too low." In other words, an individual is more prone to copying an intellectual property when it's market (not necessarily equilibrium) price is sufficiently high for the individual to incur the explicit and implicit costs of piracy. Moreover, if the market quantity of a product is artificially held low, individuals are motivated to obtain a knockoff version of the product.

Because the price of the product is too high (in some respect) for an individual to purchase the legitimate product, it is disingenuous to claim that if movies sell for $20 and five of them are pirated, the movie industry lost $100. The industry likely lost considerably less than $100 because it is not clear that any of these individuals would have purchased the product at the original price of $20. On the other hand, if knockoff movies are selling for $1, legit movies are selling for $20, and five illegal copies are sold for $1, the movie industry lost at least $5, likely more, but not necessarily $100. Why? It is not clear what price the legitimate movie would sell for when competing with the $1 illegal version. We know the price isn't $20, it could be $5 or $10 but most estimates of the value of piracy do not take this into account.

My stylized example could be abused, however. Consider an industry that seeks government protection, e.g., anti-piracy laws and their enforcement which will be financed by the entire population not just those who suffer economic damages directly. Assume, initially, that the government is not prone to providing said protection; perhaps the government has other issues on which it wants to spend its (our) money.

However, the industry's leaders/supporters are not stupid. They know that if they can generate a large enough estimate of economic damages then the government will not be able to ignore the industry's pleas for protection.

What if the industry estimates that 50 million movies were pirated rather than being sold at their normal "retail price" of $15. Economic damages would be calculated as $750 million. Yet this number might not be large enough. What to do? How about jacking up the "retail" price to $30 - now the damages are a full $1.5 billion, even though there would be no more movies pirated.

My example is stylized, but hopefully the point is made. If the product isn't going to sell at $20 why not claim a price of $40. The resultant amount of piracy is the same, but the estimated damages can be so much higher.

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