The Economics of Video Piracy

For centuries, when someone thought about piracy they thought about boats, the sea, and scurvy—not computers, the world wide web, and viruses. Today, though, online piracy is significantly more detrimental than maritime piracy. A 2010 study conducted by the One Earth Future (OEF) Foundation estimated that maritime piracy costs the global economy between $7 billion and $12 billion annually (Bowden, 2010). That same year the Directors Guild of America (DGA) estimated that global online piracy cost the United States economy $25 billion and 375,000 jobs a year (DGA, 2010). Given the harm that is caused by illegal streaming and downloading, it is amazing how often these activities are practiced. Researchers at Columbia University estimate that 45% of American adults, 76% of young adults (ages 18-29), and 90% of college students have illegally consumed movies and television shows online (Karaganis & Renkema, 2013). If Internet piracy is really this widespread and detrimental, why has there not been more done to prevent this activity and how will it affect the entertainment industry? Piracy could end Hollywood. According to Academy Award-winning actress Dame Helen Mirren, “It’ll be the Internet and piracy that will kill film. There’s a philosophy that the Internet should be free, but the reality is that piracy will destroy the film industry and film as an art form because it’s expensive to make a movie” (as cited in Walters, 2011).

Considering the film industry is not just surviving but thriving currently at an estimated worth of $1.9 trillion (PwC & The Hollywood Reporter), it might be best to reexamine the extent of online piracy damage. If piracy was truly as dangerous as previously assumed, then why have some content producers spoken out about the advantages of illegal consuming? The creator of Breaking Bad, Vince Gilligan, even said, “Illegal downloading has helped us, certainly, in terms of brand awareness” (as cited in Spangler, 2013). Jeff Bewkes, CEO of Time Warner, said piracy is “better than an Emmy” when talking about the hit TV show Game of Thrones, the world’s most pirated series (as cited in Tassi, 2014). Bewkes also said, “Our experience is, (piracy) leads to more penetration, more paying subs, more health for HBO, less reliance on having to do paid advertising” (as cited in Tassi, 2014). These surprising claims are a result of how much the entertainment industry has changed since the DGA study in 2010, especially in regards to how media is consumed. Hulu, Netflix, and Video on Demand (VOD) all existed back in 2010, but nobody predicted quite how popular they would become. Additionally, increasingly popular platforms such as Crackle, HBO GO, and Amazon Instant Video have risen to prominence. In order to determine how to deal with piracy while ensuring the socially optimal outcome, it is necessary to understand exactly why people pirate and how much piracy truly affects the economy.

Anyone who wants to end online piracy needs to focus on young adults, the demographic with the highest proportion of pirates by a significant margin. There have been many case studies and surveys with the intention to pinpoint the factors that lead young people to illegally download and stream. One of the most common justifications is that the activity is so rampant that one additional pirate causes no damage (Jacobs, 2010; Yu, 2012). Other common reasons include the lack of availability at a low cost (Yu, 2012) and the desire “to see rare and new movies” (Jacobs, 2010). Since the vast majority of students are in this demographic, it is logical to reason that people who cannot afford to buy or rent TV shows and movies are going to find other, cheaper means to stream and download.

Other reasons for the propensity of college-aged students to pirate are their technological savviness, the internet age they grew up in, and the lack of law enforcement (Jacobs, 2010). Studies show few college students find pirating is morally wrong and that the lack of effective law enforcement on the matter reinforces this position (Jacobs, 2010). In a separate study of university students, researchers found that if an action was more physical, students were more likely to question the morality of it (Yu, 2012). This explains why many people repeatedly “steal” content online without thinking about it twice, while those same people would probably find something morally wrong with shoplifting a DVD. The perception of many respondents in the study was that physical crimes lead to victims, while something detached like illegally downloading is not “hurting anyone” (Yu, 2012). The main deterrent of piracy is legal retribution, which has been extremely ineffective since most students do not fear any repercussions due to the lax and feeble attempts of law enforcement on the subject (Jacobs, 2010). The chief factors that currently prevent piracy are the difficulty in finding reliable pirate providers, the typically lower quality of pirated videos, and the fear of viruses and malware (Al-Rafee & Cronan, 2006).

To best manage piracy, it is imperative to fully understand how much piracy truly costs the economy and to know exactly what benefits may be produced. Many economists have questioned the most prominent estimates of the price of piracy, including the study by the DGA. These economists believe that the actual effect of piracy on the economy and on the job market has been vastly exaggerated. The two most common mistakes in studies like this are what is called the “multiplier” effect and the assumption that every pirate would alternatively be a paying customer (Sanchez, 2012).

The multiplier effect occurs when the same figures are accounted for twice or maybe even three times when attempting to calculate the monetary value of something (Sanchez, 2012). For example, if Walmart sells a DVD for $10, it would keep $7, give $1 to the movie studio and $2 to the manufacturer. When estimating the impact of that DVD on the economy, an economist would add the revenues of the three firms together, $7+$1+$2, and calculate the appropriate impact of $10 (Lee, 2006). An economist that uses the multiplier effect when estimating how much the DVD contributes to the economy would mistakenly assume that the movie studio receives the full revenue from the DVD while still adding up the revenues earned from the other firms in the scenario. That economist would calculate that the impact of the $10 DVD is $10+$7+$2, or $19. In this instance the value of the DVD is exaggerated to be almost twice its actual worth and the movie studio is assumed to have earned 1,000% more than it actually did (Lee, 2006). This example demonstrates how an economist, Stephan Siwek (2006), once estimated that piracy cost the U.S. economy $20.5 billion by using the multiplier effect to increase the data from a previous study that estimated the cost of piracy to be $6.1 billion (Sanchez, 2012). Ironically the organization that commissioned the original study, the Motion Picture Association of America (MPAA), admitted that its $6.1 billion estimate (Siwek, 2006) was overestimated by a mere 300% (Smilovitz, 2008).

One very common mistake that is only exacerbated by the damage created by the multiplier effect is the erroneous assumption by researchers and movie studios when estimating the costs of piracy that each pirate would alternatively be a paying customer (Raustiala & Springman, 2012). Since income is a very strong indicator of how likely a person is to pirate (Karaganis & Renkema, 2013), few people would be paying if piracy was not an option. For these people, piracy can actually benefit studios because illegally streaming or downloading may lead to future customers that previously would not have been able to see the content alternatively (Smith, 2012). If the pirate likes the content, he will probably become a paying customer at some point (Smith, 2012). People that pirate are viewing content that they would not have seen any other way, which means that they will likely pay for that content when they no longer need to pirate, whether that be when their income rises or during future budget planning. The possibility of watching a show or movie that would otherwise be unseen is a huge advantage to the entertainment industry, as seen in the earlier example of Breaking Bad (Spangler, 2013).

Another incorrect assumption about the negative effects of piracy is that by not spending money on the entertainment industry, revenue is lost, which means that employees will be laid off (Raustiala & Springman, 2012). Again, this is vastly overstated because the pirates that would not be paying for the content have no actual effect on the revenue earned, and people who might have alternatively paid without pirating spend their money elsewhere in the economy (Sanchez, 2012). While the job market within the entertainment industry might suffer from pirating, the job market of the economy as a whole would not be hurt because piracy means that people will be able to spend their money in other sectors, which could even increase employment in some markets (Raustiala & Springman, 2012).

Piracy’s effect on sales illustrates how the availability of free content through piracy has changed revenues in the television and movie markets. To see how the prevalence of piracy affects the revenue of the entertainment industry, broadband usage and DVD sales of local markets were compared between 2000 and 2003 (Smith & Telang, 2010). The results of the data analysis were shocking, and even suggested that not only is the damage caused by piracy more minimal than widely assumed but that the film industry can actually profit from piracy. The researchers found, even by “the most conservative results,” that approximately 9.3% of the increase in DVD sales over that period could be attributed to that market’s prevalence for piracy (Smith & Telang, 2010). They concluded that over their period of research that piracy accounted for the revenue of DVDs to increase by $1.3 billion; from that $1.3 billion the movie studios gained a profit of $630 million (Smith & Telang, 2010).

Piracy affects sales, but what about the other side of the equation? The relationship between content availability and pirating and the relationship between physical sales, digital sales, and piracy consumption are both indicative of what parts of the market prompt people to pirate. Researchers studied how NBC’s removal of its content from the iTunes Store from December 2007 to September 2008 impacted the market for pirated content on the infamous site BitTorrent and the market for physical DVDs sold on Amazon (Danaher, Dhanasobhon, Smith, & Telang, 2006). They found that the legally unavailable content was pirated more frequently by 11.4%, which amounted to NBC content being downloaded 48,000 times a day (Danaher, et al., 2006).

What is truly fascinating is that the rate of which NBC shows were being downloaded illegally was twice as large as the rate of legal purchases of those very same NBC shows on iTunes over the preceding period (Danaher, et al., 2006). This implies that while consumers are initially reluctant to start pirating, piracy becomes more attractive once someone does it for the first time. This means that it would be advantageous for the entertainment industry to keep consumers from ever being tempted to pirate. The study also found that there was no correlation between the amount of DVD sales on Amazon and the availability of shows on iTunes (Danaher, et al., 2006). This should mean media producers do not need to worry that increasing the availability of content online will hurt physical sales. If the amount of DVD sales stayed constant while piracy was increasing, then it stands to reason that relatively few people pirating would ordinarily be DVD purchasers.

The closure of popular piracy cite Megaupload in 2012 was another shock to the entertainment market that allowed researchers to get a better sense of how the availability of piracy affects the entertainment industry. If someone subscribed to the entertainment industry’s claim that piracy significantly inhibited movie revenue and industry profits, then one would expect that the removal of one of the most popular piracy platforms would significantly increase revenue derived from ticket sales. Shockingly, box office returns of most movies, and the market as a whole, did not see an increase in revenue after Megaupload closed (Peukert, Claussen, & Kretschmer, 2013). In fact, the box office revenues earned by many “mid-range” movies were actually hurt by the absence of piracy, and only the largest films benefited (Peukert, et al., 2013). All things considered, these results are not too surprising given that one of the main motivating factors of pirates is the desire “to see rare and new movies.” After having the chance to see something they would not have otherwise, they are able to recommend and spread the word about the film to potential paying viewers.

The section about what motivates and deters pirates briefly alluded to two methods to kill piracy: preventatives and deterrents (Al-Rafee & Cronan, 2006). The purpose of preventatives is to decrease piracy by making it a less attractive option through disincentives (Al-Rafee & Cronan, 2006). Deterrents, on the other hand, reduce piracy by increasing the “undesirable consequences” of piracy (Al-Rafee & Cronan, 2006). Currently the government, not the entertainment industry, has been the main enforcer of both piracy preventatives and deterrents. Even though the government is the only enforcer of legal deterrents, law enforcement ironically does not effectively deter piracy (Al-Rafee & Cronan, 2006). Relatively speaking, people tend to be more afraid of receiving computer viruses than getting in trouble with the law when deciding whether or not to pirate. Piracy is too ubiquitous for the government to fully cover, law enforcement officials tend to focus on professional rather than amateur pirates, and the the media rarely covers those who do get caught (Al-Rafee & Cronan, 2006). This leads to pirates scoffing at any possible legal repercussions.

The present preventative strategy of disincentivizing piracy has also been largely ineffective. The plan is to remove the content to make it harder to find (Al-Rafee & Cronan, 2006). The hope is that consumers will eventually give up trying to illegally view and download content if the effort becomes too much. Companies delete pirated videos and remove the sites that host pirated material from the Internet on the grounds of copyright infringement (Hinduja & Higgins, 2011). Preventive measures of this nature have been unsuccessful for the same reasons that few pirates have been punished by the law; there is too much pirated content online for the government to take it all down.

Since the current methods of piracy prevention and deterrence are failing, anyone that hopes to end piracy needs to better utilize and understand the incentives and disincentives of piracy (Walker, 2012). The most necessary component of any strategy to stop piracy is that it has to maximize not just the benefits of media producers, but of society as a whole. Considering that, if preventives and deterrents are the only ways to stop consumers from pirating, it is clear that piracy prevention is more beneficial than deterrence. Deterrence would eliminate the ability to pirate, which means that only the current legal methods of content consumption would be available. That would mean that all of the benefits created by piracy would be eliminated and society’s surplus would be lost. On the other hand, prevention only disincentivizes piracy, and many societal benefits would survive.

Preventatives are theoretically the best way to end piracy; it has only been ineffective thus far because content producers have used the wrong implementation strategy. Making it harder to find illegal content can only go so far since the Internet and the many illegal activities on it are so vast and expansive. Considering that one of the major downsides of piracy is the low quality (Walker, 2012) and that the majority of students would be willing to pay for higher quality legal content as long as the options are significantly more plentiful (Jacobs, 2012), piracy would decrease significantly if content producers just increased the availability of their products. Making piracy a less attractive option is not working because piracy is already extremely unattractive (Al-Rafee & Cronan, 2006), so it stands to reason that the only reason people pirate is because they have not been provided with an attractive legal option. The solution to piracy is actually quite simple: producers should provide consumers with what they want—a high-quality, paid streaming service (Walker, 2012). This system of “a la carte” television and movies would be the socially optimal option as there are advantages for both consumers and producers. Consumers would benefit from more attractive, safe, and high-quality legal options, while producers would benefit from the extinction of the black market without extinguishing the many benefits created by piracy.

If the legal ramifications for pirating were to increase significantly, piracy might end, but likely to the detriment of the entertainment industry. As mentioned, there are actually economic benefits to people pirating that would be lost if pirating was ended by the law. On the other hand, by increasing the availability of content by services such as Netflix and Hulu, piracy could end without losing the potential benefits. Studies show that people rarely pirate when there is a legal, cheap, high-quality alternative (Raustiala & Springman, 2012) (Jacobs, 2012). The benefits would be twofold: the increased visibility caused by piracy would merely be converted and producers would continue to benefit in much the same manner that they currently do from these services via advertising and paid subscriptions.

The current methods to cease online piracy are failing. Furthermore, if the entertainment industry ended piracy, all of the benefits it brings to society would also end. If media companies were to simply increase the legal availability of their products, then consumers would have no need to resort to illegal means. The best way to kill any illicit enterprise is to vastly increase the availability of preferable alternatives, which in the case of piracy is streaming. Having all content conveniently available through streaming would end pirating without eliminating the advantages created by piracy. Content producers would benefit with an increase in brand visibility and more viewers while still gaining from paid subscribers or money from advertising firms. When it comes to online piracy, society would not benefit from stopping the activity as much it would from channeling said enterprise into a mutually beneficial platform.