What are the economics of piracy?

In this part of the series, we’re going to look at the arguments TweakGuide has presented to point out how the economics of piracy adversely affect the PC Gaming ecosystem. This is basically the first “offensive” so to speak, which sets the stage as it is used to interpret the data which the author has gathered in the later sections.

In the spirit of criticism, I will use the same headers as the author to point out the weaknesses of each of his arguments.

Economic Loss

The author rightly notes that the oft cited argument of “One download = One lost sale” is totally bogus and that any economic loss is impossible to calculate but then spends the rest of the section arguing that economic loss exists. He does this by completely ignoring all the possible positive aspects of file-sharing an by taking the old business models as basically good and immutable.

With this, the author shows that he does not really understand the economics of free and how it affects the gaming market. This is the standard way that old-school publishers are treating the internet and free distribution: As if it doesn’t, or shouldn’t exist and thus the old ways of doing things should continue working. Take for example the idea he proposes, in that because someone did pirate the game, it means that they would be willing to pay something for it and thus the publisher is losing some money down the road from discount sales. Of course someone’s judgement of the value of a game is not made before they play it (barring marketing and hype) and it can very well be adjusted downwards once they spend even a few minutes doing so. Anyone who has had the feeling of being ripped of with a nice-looking box and fancy ads and getting a polished turd as a game should know what I mean. As such, it should be perfectly acceptable for someone to decide that the game is worthless after downloading it.

Discount sales on the other hand are precisely the kind of old-school thinking that the industry is unwilling to discard because they were so profitable. In a time of instant zero-cost distribution and overhyped multiplayer gaming, companies should not expect people would wait for months or years on end in order to play a game they can’t afford at its overinflated prices. This is totally missing the dynamics of gaming. People want to play the same stuff their friends are playing now and if they can’t afford it (or think the price is a rip-off) they will select the closest candidate. Barring price-ranges in their budget, the nearest option is free. Instead of recognising this and offering the game at lower prices that everyone could afford, or even doing a pay-what-you-want scheme which would allow people to pay what they can, they keep acting as if people have no other option. In fact, with the current technology, discount is not anymore used as a way to sell excess stock as it was in brick-and-mortar shops or generally physical goods, but rather as a boost to their normal sales, as a perpetual value machine. By sticking to the old methods, that worked for other industries and other business models in different technologies, in short, by trying to fit a square piece in a round hole, the gaming publishers are asking to be out-competed by those who do recognize how things work. And they have. Of course this natural evolution of business models is a form of “economic loss” for those who use the old ones. It’s also their damn fault.

Next the author argues that while economic loss cannot be accurately calculated, by comparing the two markets we can get a better indication of such a loss. I won’t go into the details as this is explored on another section in more detail but I will say that the comparison will be flawed. The customer base of those two is not the same and the purchasing habits are neither. Whatever the analysis shows, it’s going to be pure correlation, not an indication.

Finally the author points out that a potential harm from piracy comes from the support costs they have for supporting unauthorized copies. At this point, I’m surprised he didn’t count the cost of DRM measures as an “economic loss” for the publisher as well. You see all these costs come about because the gaming companies refuse to recognize that the value of their product in a zero-cost distribution environment does not lie in the content but in the service. If they accepted that their product can be received for free and worked with that in mind, then this wouldn’t have been an issue in the first place. If they didn’t try to punish unauthorized file-sharing with buggy DRM and hidden security measures, they wouldn’t have a problem. If they worked the price of support in their price and sold it as a service instead (i.e. require a valid serial before allowing someone to post a support question or something like that) this wouldn’t have been an issue. If they open-sourced their games and allowed the community to find bugs and patch them, this wouldn’t have been a problem. You can see once again that this issue only exists because the companies refuse to recognise the environment they are in and embrace solutions to work with it.

The Free Rider Problem

Here the author argues that there is an ethical dimention to piracy in the form of allowing some to have all the benefits and none of the costs and that even file-sharers recognise that. Ironically he points out that even though file-sharers have to deal with the same problem, they have figured out ways around it. Passwords, subscriptions, bandwidth caps and share ratios are all implemented in order to naturally and without centralized intervention curb any free riding.

You see, these methods did not just spring up randomly one day. It evolved. The methods and tools by which people file-shared kept changing until one was found that was better than anything else. In the current time, it’s the BitTorrent protocol which crowdsources bandwidth and automatically punishes those who do not contribute accordingly. It’s not perfect but it’s better than anything else, which is why it has proliferated so well.

Do you notice however the big difference between the way File Sharers have solved their problem and the way Gaming Comanies still fight with it? The first ones have changed their methods when they reached their limits and couldn’t anymore rely on universal goodwill, while the gaming companies have persisted in what they have always done and insisted that everyone should become a better person or they’ll take their ball and go home.

The fact that people free ride is something to be expected under a Capitalist system where wealth is power. Naturally people have an incentive to save as much money as possible, in every way possible. Capitalism is notorious for making ethical considerations and all human values irrelevant for the sake of Greed. And this is considered as good. Supposedly, everyone being greedy works out for the best and we don’t really need extra ethical values to guide us as rational self-interest will guide us to practically the same results. To claim that some people are bad because they do what the system itself compels them to do is simply misguided. If you want to change this behaviour, you’re far better off dismantling the system which promotes it, rather than try to play the losing game of having people embrace a particular ethic when it goes against their material self-interest. It’s a losing game because those people are simply going to be naturally selected against. Someone who avoids free-riding when he can because of ethical reasons, is simply going to be at an economical disadvantage to someone who does, and will lose out in future opportunities and success. And in Capitalism, everyone want to be successful. Unfortunately, if your problem is free riding, your only solution is to embrace a system which minimizes the incentive to do it. If you want to minimize it while staying within Capitalism, then your only solution is to evolve and make it systematically impossible or unnecessary.

The Economies of Scale

In this section, the author displays a stunning degree of misunderstanding of how economics works. First of all, economies of scale simply means that larger companies can produce the same products at a lower per-unit cost than smaller companies. Now, not only is this primarily related to actual physical production but it has also been shown to be wrong. We actually have diseconomies of scale.

Nevertheless, the funny thing is that even if this were true, it would run counter to the argument of the author, which is that big projects require bigger prices to cover the costs. Under an economy of scale, the big software companies would produce the same quality game as a smaller company at a lower cost, or they would produce a higher quality product at the same cost. And yet what we routinely see is that big companies produce high quality products and yet charge a higher cost (usually more than double the amount of an indie game.) Something does not fit.

Of course things are completely reversed to what the author claims they are. We do in fact have the standard diseconomies of scale in game production as we have everywhere else. You quickly start running into diminishing returns the more you increase the budget for a game and the size of a company which then requires state intervention in order to make it profitable to do so. Let me say it again: The only reason why big budget games even exist, is because the state grants them special privileges in order to do so. Namely, copyrights. Now one may say that if this what it takes to have ultra-high quality games, then it’s good because having ultra-high quality games is also good. To this one can counter that the drawbacks of having state intervention and special rules to promote one type of content are far greater than the benefits of having luxury games for the few who can afford them. In short, this discussion will take us on the road to challenge the validity of copyrights (which of course the author took for granted) which we’ll do in another section.

It is in fact interesting that the author chose to bring up state-subsidized roads and transportation in order to make his point during the free rider section, claiming :

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.

One can easily call into question the necessity for any of those services when we consider that first the state subsidized many of them (often at the behest of corporate lobbying) and then the rest of the system morphed around them. For example, the subsidy of roads made car ownership far more viable, resulting in most people now owning a car. Where it not for the state subsidy of roads, most people would not have one and would rather rely on other means of transport (i.e. living closer to work or public transport). That is to say that without government intervention, life would not come to a halt, but would rather work with it. One can easily argue that Govt intervention unnecessarily skewed the evolution of such means towards corporate ownership and power while perpetuating its own (unnecessary) existence. In short, it provided far more drawbacks than benefits. Similarly, the State-provided laws on copyrights made Big Budget games, monopolistic OS companies and consumer-hostile attitudes possible and taking copyrights away does not mean that gaming and computers will stop, but rather that they will take another form.

Finally, I have to challenge the argument of the author that if companies could sell more games, they would lower their prices sooner and therefore piracy keeps the prices high. This claim is absolutely nonsensical. Companies who’s high-cost games keep selling have no incentive to lower their prices as…they keep selling. Whether they cover their costs is irrelevant as their primary focus is profit, not consumer value (unless it affects their primary focus).  To put it simply: High demand will keep a high price. As the demand drops, so will companies drop their prices in order to increase it. As such, if anything, pirating a super-expensive game instead of buying is more likely to help discount the prices sooner and bring them to the point where they are affordable to the pirate. Therefore piracy brings up a positive result in that it helps prices move towards their appropriate equilibrium sooner.

Furthermore, if someone pirates a game because he can’t afford it, this has absolutely no change to the argument he’s making. If one cannot afford it at his current price, we won’t buy it anyway. The end result (in regard to this particular argument) for the company is going to be the same. As such, the solution would in fact be to start at a lower price or to find some way with which people can pay what they can afford compared to their income (because 50$ for the upper-middle class is not the same as 50$ for the lower-middle class). I will counter the argument that low cost games are also pirated in another installment.

Piracy & Marketing

Here the author finally brings up one pro-piracy argument, in that it increases the exposure and then spends considerably effort marginalizing it. While it is true that file-sharing increases word-of-mouth awareness of a game, he puts forth that this will result in increased piracy and not in increased sales although of course the results are inconclusive.

In fact there’s quite a lot of evidence that points to the fact that increased awareness does help, but only if one understand and embraces the economics of free. In short if one recognizes that it’s the scarce goods that increase in value and not the infinite (such as a digital copy of the game.) We again are left with pointing out that it’s the whole business model is flawed in focusing on the infinite content and not the scarce goods around it. What could the scarce goods be? Other than the classic paraphernalia surrounding any title, I can only think of hardware and providing a service (such as multiplayer or professional support). What one needs to remember is that if one does not need to spend money on games, they can spend it on other things and for a gamer, this is likely to be game-related. This is how collector’s editions sell in the first place.

Furthermore, the more people that play and have an interest in a game, the more valuable the community as a whole becomes. Game developers are notoriously bad at understanding this and they keep treating their communities like shit at worst, or as junkies to ignore once they stop giving you money at best. This can be seen by how often big-budget companies take away popular options from their games and stop supporing them once they don’t sell anymore. If companies understood that there’s value in loyal users, then they would be able to monetize it. Hell, stuff like facebook and twitter should have made it painfully obvious that there’s power in sheer numbers, even if those numbers are free –  and the more loyal and excited your customer is, the more willing they are to buy the extras and even provide you with free value.

As a case in point, I don’t even have to try a working example of this other than Valve’s Team Fortress 2, which 2 years later, with lots of free patches adding loads of new content, low costs and short discounts down to $2.5 has created basically a phenomenon. TF2 related art, jokes, videos and other content is everywhere. People talk about it all the time and inviting their friends to play. And Valve has given them a reason to do so. Achievements, guaranteed future support and content, low prices, promotions and events. A totally different  model than the “share and forget” of everyone else. And guess what, it’s super successful.

Finally, word of mouth does work. I will use World of Goo as an example since I am more familiar with it. As the author mentions, it had huge piracy when it was first launched. This generated enormous word-of-mouth advertisement so that when they offered it with a pay-what-you-want model, they made what some estimate at $100.000. It’s not a stretch to imagine that many of those who bought it where pirates who wanted to reward the developers. Take another example, Heroes of Newerth is an upcoming DotA clone still in development. They’ve been giving out their betas for free for a year now and have practically zero copy-protection. They have thus generated enormous buzz and community around them (20k people online for multiplayer often) and can basically guarantee a very successful launch for an indie game. Another similar example is the League of Legends, a similar game which is being given out for free and people can purchase extra perks (i.e more characters and stuff). Also working quite well. Do you know which didn’t work at all? Demigod, which is the exact same type of game, only it was big-budget, had a closed beta which you could get in only via an expensive pre-order and was sold in the usual old-business-model style. Naturally people pirated it rather than pay its huge price, even though they missed its basic functionality: multiplayer. In fact this by itself would point out how much people download games not because they have a lot of value for them, but because it’s low enough cost to not be an issue. Where Demigod to cost 10$ instead, they would have probably turned all those pirates into legitimate customers and ensured its continued success. Rather, they are left with a dying game, horribly outcompeted by 2 indie self-published studios who understand their market.

In conclusion

The basic argument the author is missing when discussing the economics of piracy is that people’s budget is zero-sum. They have only a limited amount of money to spend on luxuries like games and it’s unlikely that they will go over it just because of hype. As is natural again, everyone demands the highest quality for the lowest price they can get. If piracy where to become impossible tomorrow, PC game sales (in number of $$) would not increase. Prices would not drop. People would still spend approximately the same amount of money on PC games. They would either decrease their standard of quality so that they can play more, or stop playing so many so that they can play higher-quality games.

Practically, this would mean that there would be a far smaller community of gamers around each title, far less excitement, far less creativity and game communities would die sooner or be forced to die for the sake of sequels. The gaming culture as a whole would suffer as people would turn their interests in things they can afford, such as IRL sports, television or whatever. This means a diminishing pool of gamers, allowing less and less games to be created.

Piracy has existed since the dawn of personal computing and yet games never stopped being created. The only thing that has stagnated is quality during the time-window of late ’90s – early ’00s where the byte-size and low bandwidth limitations put a natural limit to internet and sneakernet piracy. Creativity and novelty in games actually started peaking again once piracy become trendy once more, as it was in the time of Amiga games. Sure, gaming will evolve but this is nothing to fear as the alternative, that is, to have a lot of high-budget titles also require a decrease in creativity, reduced consumer rights and increasing limitations and lock-ins in order to make it possible. In short, it requires us gamers to become the game industry’s bitches.

Personally, I prefer gaming evolution to consumer slavery.