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strategy and business
 / Spring 2007 / Issue 46(originally published by Booz & Company)


Recent Research

On product piracy, CEO celebrity, me-too brands, and more.

Don’t Kill the Pirate
Julio O. de Castro ([email protected]), David B. Balkin ([email protected]), and Dean A. Shepherd ([email protected]), “Can Entrepreneurial Firms Benefit from Product Piracy?” Journal of Business Venturing, available from the authors.

Photo assembly by Opto
Product piracy is a global phenomenon. Everything from fake Rolexes to unlicensed software is available for a fraction of the list price if you know where to look. In China and Russia, for instance, it is estimated that 90 percent of computer programs in use are pirated. And recently, U.S. officials complained that an entire automobile produced in China was stolen from a General Motors design.

As many corporate law firms can attest, piracy is expensive to combat. Global sales losses from unauthorized software distribution alone are placed conservatively at $1.5 billion a year. Victims are pouring money into defending their wares. The Microsoft Corporation employs 250 people in its intellectual property protection department to police worldwide shipments of its products. And Cartier SA spends more than $3 million a year defending its intellectual property rights.

Yet, despite the costs, three researchers contend that companies may be wise to limit their attempts to repel pirates. Julio O. de Castro, professor of entrepreneurship and strategy at the Spanish business school Instituto de Empresa; David B. Balkin, professor of management and chair of the management division at the University of Colorado’s Leeds School of Business; and Dean A. Shepherd, associate professor of entrepreneurship at Indiana University’s Kelley School of Business, argue that product piracy can actually be beneficial to the originator by boosting the value of intellectual property. This bump can happen in four ways.

The first involves “network effects,” in which the value of a brand grows as more people use it. For example, over time many owners of pirated software acquire legal copies or convince others to do so. In 1995, U.K. researchers found that six out of seven spreadsheet and word processor users they studied chose pirated versions of the programs originally. But after becoming familiar with the programs, the users either purchased the legitimate products or, through word of mouth, persuaded others to buy them, eventually generating 80 percent of the programs’ unit sales. Thus, the more piracy increases network effects, the more it increases demand for legal versions of the product.

The second positive impact of piracy is from “signaling,” in which consumers act on cues from others. For instance, a man shopping for an expensive handbag for his wife may be influenced to purchase a real Gucci merely because he has seen well-dressed women carrying these types of purses, even though they may have been counterfeit ones.

Third are “bandwagon effects,” defined by the authors as “the desire to wear, buy, do, and consume like one’s fellows.” If a pirated video game is regarded as “cool” by leaders of a particular group of people, other members may, in turn, buy legal versions of the game.

Finally, there are “herding effects,” in which individuals copy the choices and behavior of others simply because they don’t want to be different. Unlike signaling and bandwagon effects, which are driven by the desire to be in the vanguard, herding relates to an unwillingness to be left behind. Therefore, a successful new product that is pirated can quickly establish itself as the de facto standard. This phenomenon helps explain the existence, for example, of markets in Hong Kong where sellers of pirated copies coexist with stores selling legal copies of the same products, such as Gucci handbags or Rolex watches.

The authors conclude that before taking legal action, companies should consider the positive and negative ramifications of piracy on their products. Where a pirated product competes directly with the legal version, such as in more developed nations, some sales of the fake will be at the expense of the original. There could also be costs to the brand, in terms of image erosion, for example, if the imitation is of inferior quality. The negative effect could be more pronounced, too, in mature markets where a software product is already established as the sales leader. But where there is little or no overlap, as in markets where potential buyers cannot afford the original, or when a company is seeking to establish its new brand, then the originator might do better to ride the pirates’ coattails.

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