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Intellectual property theft, particularly digital piracy, has been in the mainstream news for many years. More recently, intellectual property (IP) protections have been in the policy spotlight with the trade wars between the U.S. and China. In a new study, strategy professors Julian Kolev and Wendy Bradley analyze the link between digital piracy and innovation for technology firms in the software business. Interestingly, they find that large incumbent firms like Microsoft and Adobe Systems increased innovation after disruptions to their business model occurred from file-sharing technology that allowed their product to be more easily copied or pirated.

Kolev notes that normally one would expect piracy to be a bad thing for industry and undermine the rate of innovation. “If you expect your ideas and innovations to be pirated, you might not feel as motivated and incentivized to invest in those innovations,” he says. “Our research findings see the opposite: there was an increase in innovative activity on a broad spectrum of measures, including R&D spending, patenting, copyrights, and trademarks.” The analysis used intellectual property and the development of improvements in product software to investigate the effects of piracy on innovation.

A torrent of filesharing

The authors compared the rates of innovation over time for firms developing business-to-consumer (B2C) software subject to piracy against innovation by firms producing business-to-business (B2B) software, a control group, which is less affected by digital piracy. They found piracy had strong positive effects across all measures of innovation, and specifically an increase of over 50% in R&D expenditures, trademarks, and patents. Although firms increased innovative activity, the research showed B2C software firms were slower to release new products following a notable piracy shock, when large files could be more easily exchanged over the Internet.

The piracy shock used to compare innovation by B2C and B2B software firms was the release of BitTorrent technology. Large files, such as movies, software and games, became more easily transferred with the release of BitTorrent technology in 2001. BitTorrent, intended for legal purposes, remains the most efficient method for sharing large data files in both the corporate world and the world of the darknet, note the authors. Uninterrupted software piracy on public “torrent” websites occurred during the study’s treatment period, divided into a window period from 2001-2002 and a post-piracy period from 2003-2007.

After the introduction of BitTorrent, the findings suggest a possible shift in innovation strategy by B2C firms. Firms increased their innovation efforts by filing more patents, trademarks, and copyrights, as well as increasing R&D spending. However, firms released innovations to the public less frequently, with significant implications for pricing and product lifecycles. Total annual revenue significantly increased in the post-piracy period, which indicates that firms were able to capture value from their innovations, despite the threat of IP theft. Additionally, in the window period, firms captured higher profit margins, although this effect was temporary.

From the rise in digital piracy, the research highlights a strong rise in innovative activity by firms threatened with reduced intellectual property protection. It sheds light on the strategic responses of for-profit developers in response to the disruption caused by software piracy, with valuable information for both policymakers and managers in the areas of digital innovation.

Implications

Kolev notes that the impact of piracy is greater for established firms that are monetizing the IP that they have already created. “The dominant perspective has been that piracy is a bad thing for all firms and in all cases. But in software, if your user base becomes larger, there are benefits from network externalities,” he says. Since the software is used by more people, it means there is a bigger base of individuals who may choose to upgrade to a new release or purchase related products and add-ons. Instead of doing everything they can to stop piracy, which is difficult to do, Kolev and Bradley suggest that companies consider a more pro-innovation stance. Given that previously-released software is likely to be pirated or copied by illegal means, companies may decide to focus on new, better versions to motivate people to upgrade legally.

The research has a message for public policymakers, according to Kolev, which has been discussed in terms of China and the lack of IP enforcement and abuses. “Companies with existing IP want to make the most money from it,” he says, “but in the long term, the true measure of success is your ability to continuously innovate, rather than just monetizing your previous innovations.” Broadly speaking, the authors are not against improving IP protections but think the primary goal should be to maintain the level of innovation that has allowed the U.S. and other developed economies to produce those advanced technologies in the first place—a pro-innovation focus.

Electronic product lifespans are getting shorter, notes Bradley. “In areas like software or video games, firms are already changing their business models when it comes to appropriating IP, from subscription pricing, ad-based revenue, or open source options with sales from complementary goods,” she offers. “In the digital economy, management must decide: what kind of benefit do they derive from a defensive position—litigating pirates, for example—versus investing those same resources offensively.” Strategy is about tradeoffs.

As the economy transitions into being technology-driven and knowledge-based, more and more value will be created where digital piracy is possible, the authors write. Globalization and specialization have drastically decreased the price for the hardware and infrastructure required in networked industries. Given these trends, piracy will play an increasingly important role in firms’ value-capture strategies, they conclude.

The paper “Can Piracy Increase Innovation? The Software Industry’s Response to Online File Sharing” by Wendy Bradley and Julian Kolev was recently presented at the 2019 Strategic Management Society’s Annual Conference. The authors received the “Best Paper Prize” from the Knowledge & Innovation Group.

Written and summarized by Jennifer Warren.