PC Game Piracy Examined

[Page 3] The Economics of Piracy

I'm originally an Economist by training, but that's not the reason why I've decided to look at the economics of piracy. The fundamental reason why piracy is illegal in most countries is due to the potential Economic Losses that it can incur. This is a highly contentious issue, so an examination of the concepts underlying these arguments is essential to really understanding the potential impacts of piracy. I can see your eyes glazing over already, but don't worry, I'm not going to bore you with long and complicated economic theory, we'll look at it in layman's terms.

Economic Loss

The argument is straightforward and both intuitively and logically sound: for every pirated copy of a product, there is some potential loss of income to the producer of that product. This is not the same as saying that every pirated copy is a lost sale. What it actually means is that firstly some proportion of the people who are pirating a game would have bought it in the absence of piracy. Equally as important however is the fact that even those who would never have paid the full purchase price for one reason or another may still have paid some lower amount to purchase and play the game which they pirated. This is because by the very act of obtaining and playing a game, they've clearly demonstrated that they place some value on that game. After all, if something is truly 'worthless', consumers won't bother to obtain or use it in the first place, regardless of whether it's free or not. Even if a game only gives the pirate a few hours of enjoyment, that's still worth something. In the absence of piracy they may have purchased the game at a discount several months after its release, or bought it second-hand for example. So the existence of piracy results in some loss of income to PC game developers, publishers, retailers and even other consumers.

Pure economic loss is actually very difficult to calculate in precise terms because it's largely hypothetical - there's no way of knowing exactly how many more units of a particular product would have sold if piracy did not exist, or how much money various people would have paid over time to buy discounted or second-hand copies in the absence of piracy for example. However examination of piracy figures combined with sales figures for similar products which are less affected by piracy does provide some indication of the scale of loss.

There are also more subtle aspects to economic loss resulting from piracy, such as damage to a producer's reputation. If a pirated copy of a game doesn't have decent performance or appears to be faulty, either because it's a leaked pre-release version, and/or because the method of removing its copy protection is faulty, and/or the game code has been altered badly in some other way, this can result in negative perceptions of the game's quality and thus further impact on legitimate sales of not only that title, but future titles by the same developer/publisher as well. For example Ubisoft has claimed that the pre-release pirated version of Assassin's Creed not only resulted in many directly lost sales, it also adversely affected the general sales potential for the game because the leaked version has a deliberate bug which crashes the game halfway through, and this resulted in some misleading negative early reviews of the game. Similarly, Titan Quest was leaked early and as noted in this post by the game's developer, the badly cracked pirated copy would crash at certain points in the game because of a deliberate security feature. The misunderstanding over this feature resulted in the game incorrectly being blamed as being a buggy by many people when in reality it was the poor quality cracking of it that was the real culprit, and this adversely affected its reputation and possibly reduced potential sales.

You'll notice throughout this article that I don't provide specific examples of actual dollar loss figures; again this is because economic loss is notoriously difficult to measure, and those who have attempted to measure it usually grossly under- or over-state it, such as pointed out in this article. But bear in mind that just because something is difficult to measure with accuracy, doesn't mean that it's not significant. We'll see just how potentially significant a bit later on.

The Free Rider Problem

If for some reason you don't accept that there is some economic loss associated with piracy, there's an equally important economic concept worth considering: the Free Rider Problem. This is a general problem facing a range of goods and services, not necessarily related to piracy, and essentially it states that those who actually pay for a good or service are bearing all the costs of production while those who get the good or service for free are not contributing at all. The classic example is for Government services such as roads, hospitals, welfare and defence. Every citizen can access and hence directly or indirectly benefit from these services, but if left solely up to voluntary contributions, most individuals would likely not pay much if anything for them, citing a range of excuses. Therefore the Government enforces involuntary contributions from all applicable citizens in the form of taxes. If it didn't, many of these essential services could not be adequately provided as the costs of provision would outweigh the voluntary contributions.

In the case of PC games which can often cost tens of millions of dollars to develop, distribute and support, the costs are first borne solely by the developer and/or publisher, typically over several years during development, and then eventually only passed on to those consumers who actually purchase the game. Pirates who illegally obtain the game for free receive exactly the same benefits without contributing anything at all to the game's developers. This results in two issues: the first is an obvious lack of equity in the distribution of the costs; the second is that if the number of people who legitimately purchase a game is not high enough, developers will not be able to justify the costs of PC game development, and will attempt to adjust how they conduct their business to make development viable again. This can include measures ranging from simply cutting development and support costs which can lower game quality, through to completely shifting their focus to a new audience and/or new platform on which development is viable. We look at these issues more closely in the PC vs. Console and Changing Business Models sections.

The free rider problem is not a static issue. It usually grows over time as people catch on to the fact that they can get away with obtaining something without contributing, and hence more and more people go from being contributors to free riders. This is normal human behavior because contributing incurs costs of various kinds, and consumers inherently try to minimize their costs if at all possible.

Ironically, even pirates implicitly recognize the free rider problem, most notably by distinguishing between those who are 'leechers' and those who contribute something. There are various methods used within piracy to stem the tide of free riders, because of the potential harm they can cause to the system. Usenet for example requires monthly subscription fees to access; FTP piracy requires login details to monitor and prevent abuse; file sharing services limit the amount of free downloads and require payment for full access. However it's the most popular piracy channel, the Torrent protocol, which faces the greatest exposure to the free rider issue. As a result, by default all torrent client software is designed to ensure that those downloading pirated material also automatically upload a proportion of it at the same time. Indeed aside from certain torrent trackers being entirely private to prevent excessive public leeching, some torrent trackers enforce a specific 'share ratio', meaning those who don't contribute a certain amount eventually can't download. The BitThief software demonstrates this issue perfectly. The program is specifically designed as part of a scientific experiment to allow leeching (downloading/benefiting) without seeding (uploading/contributing) on torrents, and the developers note in their findings that:

The lack of incentives to upload potentially results in a total collapse of the [torrent] network, implying that it is essential for a completely decentralized system to incorporate protocols that ensure a fair sharing of resources.

Even the groups which are part of The Scene - the private and elite originators of most pirated material - often make public statements specifically targeting the generally non-contributive and damaging nature of P2P and other non-scene piracy. For example the scene group 'Reloaded' announce at the beginning of their pirated games the following:

We, RELOADED members, would like You - Dear User, to know the following:

1. We do not want You to spread our releases outside of The Scene.
2. Do NOT contact technical support if You have some issues with our releases.
3. We hate Peer2peer networks (torrents, bearshare, …), rapidshare etc.
4. We do not make our releases for YOU - Mr. P2P user, we make them for The Sceners, who contribute something - unlike YOU.
5. To all people who repack our cracks/keygens with spyware/malware: F*** YOU
6. We do NOT fix game bugs, unless we can.

And the most important:
7. IF YOU LIKE THIS OR ANY OTHER GAME: BUY IT!!! (Yes, we mean it)

As the points above indicate, even among pirates themselves, there is clear acknowledgement of the fact that the concept of free riding and a lack of contribution are a significant problem to the viability of the system as a whole. Whether it's hypocritical of The Scene to make such statements given their material forms the backbone of P2P piracy can be debated, however obviously even the most hardcore of pirates recognize the concept that taking without giving something in return is not a sustainable outcome, which is precisely what pirating games without giving the developers or publishers anything in return is all about.

Economies of Scale

Piracy can also result in higher prices for those who are legitimate purchasers, based on the well-known concept of Economies of Scale: the less copies of a game which can be sold, the higher the unit cost and thus the higher the likely sale price. While digital distribution can help reduce production and distribution costs, the major fixed cost of developing the game remains the same and must be covered from sales revenue. The less copies of a game are sold (or are predicted to be sold), the less room the publisher has to lower the retail price of a game. So escalating piracy creates a vicious circle, because less legitimate sales mean prices typically start off high and remain high, with less scope for discounts, which in turn makes it much more likely that a game will be pirated under the excuse that games are too expensive. As we'll see in the following sections however, games which are lower in price are still pirated heavily, so simply reducing the price is not necessarily a viable solution to this problem for games companies.

Piracy & Marketing

One of the economic arguments in support of piracy is that it imparts benefits to the producers because the mass distribution of pirated copies of a product effectively provides valuable free publicity and marketing via word of mouth. This can be particularly useful for low budget releases which don't have large marketing budgets. For example if a hesitant purchaser obtains a pirated copy of a little-known game and then loves it, there's no doubt they're much more likely to encourage their friends to get that game. This argument is logically sound, in that there is indeed a great deal of power in the way in which widespread positive word of mouth can influence the perceptions and decisions of the general public, and propel an otherwise unknown or underrated game to greater popularity.

However the argument deliberately ignores one fundamental problem: there's no evidence to suggest that positive word of mouth from pirates results in anything other than more people pirating a particularly popular game. After all, if a person can tell others about a pirated game he likes, he can just as easily tell them how and where to obtain it illegally, or give them a copy for example. So it's unclear as to how much this additional positive word of mouth due to piracy actually results in increased sales rather than simply increased piracy. Looking at the data in the next two sections, we can see that the more popular a game, the significantly higher the number of people pirating it, though sales may also benefit as well. So the net effect of this claim is unclear.

As a corollary of the marketing argument, many people will also point out that a pirated copy of a game allows them to sample a game before committing to its purchase. This makes sense, especially in cases where a game doesn't have a demo - this is one of the reasons why I recommend in the conclusion to this article that developers should release demos for their games. However again there's no solid evidence to substantiate the fact that a pirated copy leads to a purchase. In fact given that a pirated copy is a perfect duplicate of a retail copy, and hence there is no quality difference between the two, logically it would be rare for consumers to pirate a game, play it, and then go out and purchase essentially the same game again at additional cost. Certainly given the very large numbers of pirated copies via torrent which we see in the next section, if a large proportion of those people eventually purchased the game they had pirated, then PC game sales would be extremely high rather than being many times lower than the console equivalents. Similarly, examining the evidence related to tech support requests by pirates for example, it seems the majority of people playing pirated versions don't have access to a legitimate version. To be sure, some proportion of the people who pirate a game may wind up purchasing a legitimate copy purely in a bid to support the developers or to resolve problems. More often however it will likely be to gain access to the multiplayer component of a game, or to get DRM-protected downloadable content for example. In any case the evidence does not support the claim that anything beyond a minority of pirates actually wind up purchasing the games they pirate.

Now that you have a basic grounding in the Economic arguments behind the piracy debate, the next section starts us on a closer examination of the actual data, beginning with The Scale of Piracy.