If You Think The Cost Of 'Piracy' Is High, What About The Cost Of Enforcement?

Economics

from the why-is-that-always-missing-from-the-equation? dept

We’ve all seen the crazy high claims by the legacy entertainment industry about the “costs” of infringement. Most of these reports have absolutely no basis in reality and have been widely debunked — even by the US government itself. But, even if we grant that there are some “costs” to infringement, why is it that we rarely — if ever — hear about the costs of enforcement? Julian Sanchez has a great post riffing off of the news that Hulu is thinking of requiring proof of pay TV subscriptions to get any free content, and does a neat little thought exercise on how distorting the “cost of piracy” discussions are if you don’t also look at the cost of enforcement. He puts forth a hypothetical:

To illustrate, let’s imagine television show that initially streams online for free with advertising, garnering a million viewers per episode and earning $1 per viewer in ad revenues, for a total of $1 million. A small number who really dislike ads, or have connections too slow for streaming, let’s say 5,000, download pirate copies anyway—but the vast majority watch legally. After building an audience and generating some good word of mouth, the accountants suggest that it might be more profitable to stop the free streaming and instead sell ad-free episodes for $4, in hopes that enough dedicated fans will pony up to compensate for the predictable drop in viewership once the program is no longer free to watch. The paying audience does indeed drop to 255,000, which still leaves the company slightly better off for the switch, but 100,000 viewers decide to keep up with the show (at least initially) by downloading pirated copies. A subsequent price hike to $10, however, turns out to be a money loser. Now the show has only 80,000 paying viewers, while 150,000 are engaged in piracy.

Undoubtedly that piracy is costing the show’s producers something: If piracy were impossible, some unknown fraction of those who download illegally would be willing to pay the asking price. But just crudely using the actual market price at each stage—even if modified by some constant “displacement rate” to acknowledge that not every illicit download represents a lost sale at that price—yields some perverse results. As the pricing strategy for the show changes, the “cost” of piracy rises from $5,000 to $400,000 (even as revenue rises) to $1.5 million (while revenues drop by $20,000). Obviously, something is wrong here.

It’s no great mystery what: The problem is that the rate of piracy, the price of a digital good, 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, and you can tell plausible stories according to which this might keep prices higher or lower than they’d be under perfect enforcement, depending on your assumptions about the conditions under which a particular audience will substitute the pirate for the legal good.

But it goes further than that, which is that when you factor in the cost of enforcement, the equation changes somewhat:

Returning to our imaginary program, suppose that under perfect enforcement—a zero piracy world—there would be 110,000 paying viewers at $10 per episode, netting the creators an additional $80,000 over what they’d make with their revenue maximizing strategy ($4 per episode) in the world of imperfect enforcement. That’s great for them, if not for consumers, but we haven’t factored in the costs of enforcement. Some of these are likely to be borne by the creators themselves—hiring lawyers to hunt down pirate copies circulating online and the like—but in practice they’re often shifted to taxpayers, in the form of direct enforcement expenditures, or to other parts of the economy, in the form of DMCA compliance costs or innovative services that are deterred entirely. It’s possible that, in this hypothetical scenario, the revenue maximizing strategy for the producers is to charge $10 while externalizing the costs of perfect enforcement, but the socially efficient outcome is to accept imperfect enforcement and let the producers revenue maximize against that background at a $4 price point.

As Sanchez admits, many of these numbers are theoretical, just for the sake of the thought exercise. But what we know in reality is that the cost of enforcement — whether direct or through externalities — almost never enters into the discussion in any meaningful way, even though it’s absolutely there.

What’s amazing is that even when the costs are explicit, they barely enter the conversation. Take, for example, the predecessor to SOPA/PIPA: the ProIP Act, which passed in 2008. A report by the Congressional Budget Office showed that the cost of this bill, which is almost entirely focused on increased enforcement was $435 million. Yes, you read that right. Taxpayers have been on the hook for nearly half a billion dollars for the increased enforcement initiatives — like the spectacular flop known as Operation In Our Sites. Is this really a wise use of taxpayer resources?

Add to that, of course, the negative externalities created by such enforcement — such as the chilling effects of increased censorship, expensive court cases and other such efforts, and it’s kind of amazing that these costs never seem to even enter the public debate, even though many of them are a lot more real than the “costs” presented by the industry for “piracy.”

Filed Under: pay tv, pipa, piracy, proip, sopa
Companies: hulu