The Hindu Business Line : Three levels of software piracy control

A recent research paper develops a simple model of piracy aimed at analysing the effects of piracy on prices and welfare, and also studying the optimal enforcement policy.

Microsoft has sued 26 US companies for piracy.

The software giant "gathered evidence for the cases through the use of a `secret shopper'-style program," as http://australianit.news.com.au informs in a July 19 story. "As part of its test purchase program, the company bought hardware and software from computer dealers across the US. It then tested the software and software components to determine their authenticity."

A recent research paper titled Piracy Prevention and the Pricing of Information Goods by Helmuth Cremer and Pierre Pestieau develops a simple model of piracy aimed at analysing the effects of piracy on prices and welfare, and also studying the optimal enforcement policy.

"A monopolist produces an information good (involving a `large' development cost and a `small' reproduction cost) that is sold to two groups of consumers differing in their valuation of the good," explains the abstract.

The authors distinguish two settings: "one in which the monopoly is regulated and one in which it maximises profits and is not regulated, except that the public authority may be responsible for the control of piracy."

If you have always wondered whether "copying or piracy might be welfare enhancing because it is a way to `provide' the good to some individuals (those with a low willingness to pay) without undermining the firm's ability to finance the development cost via the pricing scheme applied to high valuation consumers," well, that's exactly what the paper too postulates!

Different levels of control

On piracy control, the authors observe that the level of control has to differ according to the regulatory environment, and speak of three levels.

"The highest is the one chosen by the private monopoly. The next level is the one chosen by the regulated monopoly. The lowest, that can be zero, is the level of control chosen by the public authority when the good is sold (and priced) by a private monopoly."

At the time of writing this, a headline on Newark Star Ledger reads: `Microsoft files more piracy lawsuits.'

The report by Kevin Coughlin is about the `tooth and nail' battle, `the largest spate of legal actions yet by the world's largest software company'. Coughlin notes that critics have assailed Microsoft for its overly aggressive anti-piracy tactics.

"Recent class-action lawsuits have accused Microsoft of duping consumers into accepting spyware labelled as a security upgrade.

The Windows Genuine Advantage program quietly collects information about a user's computer settings, ostensibly to verify Microsoft software is authentic," adds Coughlin.

The class-action suit, though, can be a bigger topic for discussion.

Three reasons to study usage-fee pricing

Listed among the recent papers on www.ssrn.com is Pricing of Software Services, by Ram Bala and Scott Carr. The authors analyse and compare fixed-fee and usage-fee software pricing schemes. In the former, "all users pay the same price," while in the latter, "the users' fees depend on the amount that they use the software."

An example of usage-fee is what a user of an online-database service might be charged, say, a certain amount for each data query.

Fixed-fee pricing is today's dominant pricing scheme, say the authors, and mention the following as the reasons for their interest in usage-fee pricing:

1) Growth, though nascent, of the software services industry. For instance, "Application Service Providers (ASPs) offer industrial software such as CRM (e.g. Salesforce.com) to small and medium sized firms." ASPs monitor usage using the Web, which is the primary delivery platform for the services. Such monitoring facilitates usage-based pricing, as in the case of KnowledgePoint, which is cited in the paper.

2) "Usage-fee pricing is relatively common among computing infrastructure service providers," write the authors. Examples are Jamcracker and HP.

"In other areas such as media licensing, firms offer quite different pricing schemes; for example, Apple iTunes charges customers 99 cents for every song downloaded, while Realplayer's Rhapsody charges a fixed monthly fee with an unlimited number of downloads."

3) "Usage-fee pricing is a rebirth of an old business model that was once prevalent in the software industry," note the authors.

How so? Old-timers may remember how, "back in the days when all computers were huge and expensive, time-sharing on large IBM mainframes was common practice, so firms implemented usage-fee pricing schemes." As hardware became cheaper, the time-sharing model withered away. However, we may be dusting off that model in the context of `complex enterprise software', characterised by high costs of `software deployment and maintenance' as in the case of ERP. "Enterprise software firms such as SAP are turning to usage-fee pricing to reach small and medium size customers."

Usage alone may not be an adequate measure of the willingness-to-pay for consumers of software products and services, observe the authors. Reason: "Consumers vary in the value they derive with the same amount of use." What then can be the optimal pricing structure in the face of such consumer heterogeneity?

"Given a choice between fixed-fee and usage-fee schemes, a monopolist would find usage-fees to be optimal at low monitoring costs and a fixed-fee at higher monitoring costs," declares the paper. "However, the monopolist would always find it beneficial to offer both pricing schemes. This is because the nature of market segmentation enlarges the size of the market when both pricing schemes are offered."

When service quality is not too different among firms, pricing can be an important differentiator. Low costs of usage-monitoring costs can lead to intense price competition, alert the authors. Moral, therefore, is that service providers should be cautious when offering usage-fee pricing if the competitor is a vendor offering fixed pricing.

Research papers of practical utility.

http://IT-in-the-works.blogspot.com

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