Effects of Piracy on Quality of Information Goods

It is commonly believed that piracy of information goods leads to lower profits, which translate to lower incentives to invest in innovation and eventually to lower-quality products. Manufacturers, policy makers, and researchers all claim that inadequate piracy enforcement efforts translate to lower investments in product development. However, we find many practical examples that contradict this claim. Therefore, to examine this claim more carefully, we develop a rigorous economic model of the manufacturer's quality decision problem in the presence of piracy. We consider a monopolist who does not have any marginal costs but has a product development cost quadratic in the quality level produced. The monopolist faces a consumer market heterogeneous in its preference for quality and offers a quality level that maximizes its profit. We also allow for the possibility that the manufacturer may use versioning to counter piracy. We unexpectedly find that in certain situations, lower piracy enforcement increases the monopolist's incentive to invest in quality. We explain the reasons and welfare implications of our findings. This paper was accepted by Lorin Hitt, information systems.