Managing Digital Piracy: Pricing and Protection

This paper analyzes the optimal choice of pricing schedules andtechnological deterrence levels in a market with digital piracy wheresellers can influence the degree of piracy by implementing digitalrights management (DRM) systems. It is shown that a monopolist’soptimal pricing schedule can be characterized as a simple combination ofthe zero-piracy pricing schedule and a piracy-indifferent pricingschedule that makes all customers indifferent between legal usage andpiracy. An increase in the quality of pirated goods, while loweringprices and profits, increases total surplus by expanding both thefraction of legal users and the volume of legal usage. In the absence ofprice discrimination, a seller’s optimal level of technology-basedprotection against piracy is shown to be at the technologically maximallevel, which maximizes the difference between the quality of the legaland pirated goods. However, when a seller can price discriminate, itsoptimal choice is always a strictly lower level of technology-basedprotection. These results are based on the following digital rightsconjecture: that granting digital rights increases the incidence ofdigital piracy, and that managing digital rights therefore involvesrestricting the rights of usage that contribute to customer value.Moreover, if a digital rights management system weakens over time due tothe underlying technology being progressively hacked, a seller’soptimal strategic response may involve either increasing or decreasingits level of technology-based protection. This direction of change isrelated to whether the DRM technology implementing each marginalreduction in piracy is increasingly less or more vulnerable to hacking.Pricing and technology choice guidelines are presented, and some welfareimplications are discussed.