Piracy on File Sharing Networks : Strategies for Recording Companies

In this paper we study the impact of selling music as downloads, on piracy, and the strategies recording companies should adopt to increase profits. We find that total music sales and profit of firm is higher, and total piracy (demand on file sharing network) is lower, when the firm sells a downloadable version. We look at the firm's optimal choice of Digital Rights Management (DRM) protection, and find that revenue decreases with increased protection, and so it is optimal for the firm not to employ any DRM, in the absence of network effects. Listening to music or watching video protected by DRM is cumbersome to users. They have to download license files, there are restrictions on the number of times the file can be copied, and restrictions on the type of devices that can play the file. As a result there is a disutility to the legal consumer, because of which the firm charges lower prices. Loss in revenue due to decreased prices cannot be compensated by the increase in demand, and hence revenue decreases with higher protection. When network effects (NE) is high, and a nominal search cost is above a certain threshold, then non-zero protection becomes optimal. This result is exactly the opposite of what was found in previous research (Conner and Rumelt 1991), where protection was found to be optimal in the absence of NE, and zero protection was optimal if NE is high enough