“Converting Pirates without Cannibalizing Users,” B. Danaher, S. Dhanasobhon, M. Smith & R. Telang (2010)

“You can’t compete with free,” right? Somehow, iTunes and other online distributors manage to sell a large number of TV episodes a la carte, even though free pirated copies of these shows are widely available on BitTorrent. Are there just two different types of consumers with different moral preferences? Or might many consumers become pirates if incentivized to do so? How much does piracy eat into sales?

Danaher et al have a great natural experiment. In 2007, NBC played hardball with Apple over iTunes pricing of individual episodes. From December 2007 to September 2008, NBC and affiliate shows were not available on iTunes, the dominant legal site for TV downloads. The authors scraped daily reports on torrent traffic for a huge number of TV episodes, as well as daily Amazon sales date for the box sets of these shows.

The results are insightful. Piracy of NBC shows jumped 11% after the shows were removed from iTunes. This increase may be understated since it is 11% above and beyond the increase in piracy of non-NBC classic shows during the same period – if NBC’s actions led some users to try piracy, and those users also began to pirate ABC shows, the actual effect of removing the legal channel for NBC shows on total online piracy may be even bigger than 11.4%. To put that number in perspective, the increase in NBC downloads per week was approximately twice the total number of downloads of these shows via iTunes when they were available. The impact of DVD box sales is close to zero, perhaps suggesting that “digital consumers” are in this instance quite separate in their demand from buyers of DVDs.

What might lead to this result? One explanation is that piracy involves a fixed cost, such as learning BitTorrent or “getting over one’s moral qualms.” Once that price is paid, all content is free, hence demand will be higher than demand for $2 episodes on iTunes. This is further supported by the fact that NBC piracy did not fall back to its November 2007 level after legal NBC shows returned to iTunes in 2008.

Two takeaways here. For piracy researchers, modeling consumers as “non-pirates” and “pirates” who do not respond to incentives across this divide is probably not accurate. For firms, when facing competition with free bootleg copies, the costs of mistakes in pricing strategy can be severe indeed!

http://www.heinz.cmu.edu/~rtelang/ms_nbc.pdf (Final WP version – published in Management Science 2010)

[Hat tip to the commenter who pointed me to this article.]

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