Software Piracy in the Presence of Open Source Alternatives

We develop a model to investigate the manner in which the pricing, profitability and protection strategies of the seller of a proprietary digital good respond to changing market conditions. Specifically, we investigate how the optimal strategy of a seller of proprietary software (such as Microsoft Office) is impacted by product piracy and the presence of Open Source Software alternatives (such as Open Office). Our results, based on an analytical model, show that the losses incurred by sellers of legitimate goods on account of high quality pirated goods are amplified by the level of network externalities. Therefore, for products characterized by high network externalities (such as software), it is crucial for sellers to try to maintain a large perceived quality gap between their product and illegal copies. We also find that the appearance of an OSS alternative leads the incumbent producer to reduce both the price of the legitimate product as well as the level of piracy control. Further, although high quality pirated goods are detrimental to profits in the absence of OSS, they may actually limit seller’s losses and the need to adjust prices and protection strategies due to the introduction of an OSS alternative. Thus, a firm such as Microsoft may find it easier to compete with OSS in the presence of product piracy. Finally, the seller is less affected (i.e., has to make smaller strategic adjustments to prices and piracy control) by the appearance of an OSS alternative when the consumers’ valuations of the proprietary software and the OSS are strongly correlated (i.e., when the OSS alternative is a close substitute for the original).