Two Truths and a Lie about Software Piracy
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Digital piracy is the boon of budget-squeezed teenagers and small entrepreneurs everywhere and the scourge of large U.S. companies like Microsoft (NASDAQ: MSFT) and Adobe (NASDAQ: ADBE). Pirated software comprises 42% of all installed software and 57% of computer users worldwide pirate software, according to the most recent report from the Business Software Association. Yet Microsoft, Adobe and other software producers keep publishing positive earnings reports instead of disappearing under a wave of shadowy internet pirates. What does digital piracy actually mean for your software investments?
Truth: Businesses Install Pirated Software
Business “decision-makers” use pirated software at a higher rate than the average person, according to the BSA. The BSA reports that 35% regularly install and use pirated software at their companies and 28% do so occasionally. Business piracy represents a serious threat to software companies, particularly Microsoft and Adobe. Microsoft’s business division carries the company’s revenue as its individual consumer base falters; the division depends on both expanding sales and coaxing existing customers to buy new products. Creative Suite products drive Adobe’s revenue and with 70% of that revenue coming from licenses for the whole family of products, which start retailing around $1,200, businesses make up Adobe’s main customer base. Adobe's smaller divisions primarily target business customers as well.
The rub is that most businesses can actually afford legitimate, licensed software. Businesses that pirate are actively choosing to substitute the pirated product for the legitimate product and put the difference elsewhere. Business piracy is a worrisome trend and one that these companies must actively combat through pricing innovation, legal channels and consumer education.
Truth: Most Individuals Pirate Software
Most individuals engage in some kind of piracy, but that 57% figure hides a lot of interesting data. What percentage of their software do most people pirate? What percentage do they pay full price for? Emory University professors Ramnath Chellappa, Yuanyuan Chen, Sriram Venkataraman found that many people pirate software as a kind of test drive and then consider the cost of licensed software as they continue to use a program. They suggest that the real financial impact of piracy rests on a company’s pricing model. The study concludes that global pricing – the type that Microsoft, Adobe and Rosetta Stone currently use – does not deter piracy. This implies that these companies will continue to lose ground to piracy in developing countries unless they change their pricing models.
These figures should be particularly worrying for Rosetta Stone (NYSE: RST) shareholders. Two thirds of Rosetta Stone’s revenues come from U.S. consumers, according to their first quarter earnings report. International sales have been declining despite sustained efforts from the company to sell to individual consumers in new markets. The company cited pricing problems as one of the reasons for this decline. Before Rosetta Stone generates profits, it may need to revise pricing with an eye to reducing piracy in new markets.
Lie: Digital Piracy Costs Tens of Billions Annually
Digital piracy cuts into companies’ profits and it cuts very deeply into some. However, every Peruvian teenager that downloads a pirated Xbox game does not simultaneously deprive Microsoft of $50. Some people pirate software that they can afford and would buy at full price if piracy were not an option. Many people – probably most, looking at the BSA’s statistics for piracy by country – cannot afford to pay full price for the software they use and would not use it if piracy were not an option. Then there is the grey middle ground of people who could afford the software they pirate, but would probably choose not to buy if a free version were not available. BSA estimates that the value of software piracy last year topped $63 billion. They report arriving at that number by multiplying the estimated number of pirated programs by their commercial value. While $63 billion may be the abstract value, piracy costs companies far less because only a fraction of people using pirated software could or would buy it at full price. In fact, as Chellappa et al show, piracy may take customers away while encouraging a smaller number to buy a licensed product after an initial test drive.
Software piracy is growing, particularly in developing countries where PC and internet access are increasing faster than per capita income. Software companies lose a lot of potential profit to piracy and rely almost entirely on legal channels to fight a losing battle. However, companies could reduce the damage or even increase profits by also increasing consumer education and introducing new pricing models that address market by market income disparities.
CallaMarie owns shares of Microsoft. The Motley Fool owns shares of Microsoft and Rosetta Stone. Motley Fool newsletter services recommend Adobe Systems, Microsoft, and Rosetta Stone. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.If you have questions about this post or the Fool’s blog network, click here for information.