How Serious is Piracy in the Videogame Industry? - SSRN

The Empirical Economics Letters, 10(3): (March 2011)

ISSN 1681 8997

How Serious is Piracy in the Videogame Industry? Fukugawa Nobuya Graduate School of Engineering, Tohoku University 6-6-11-814 Aramaki, Aoba-Ku, Sendai, 980-8579, Japan Email: [email protected] Abstract: Downloading pirated videogames enables users of portable game machines to play downloaded videogames on a platform without purchasing the original versions. Based on a questionnaire survey, this study is the first to examine how familiar users of portable videogame machines are with downloading pirated videogames and how this affects whether they purchase genuine versions. The results show that although approximately 40% of surveyed users know how to download and play pirated videogames for free, most of them do not actually download pirated versions. Furthermore, no significantly negative relationship can be found between downloading pirated videogames and purchasing the original versions. Keywords: Piracy, videogame, file-sharing JEL Classification Number: O34, D03, K42, L86

1. Introduction The recent proliferation of pirated videogames via the internet threatens the game industry. When a videogame program is digitally decoded and replicated, the original videogame and the pirated version are functional equivalents. If users of portable game machines such as the Nintendo DS and the Sony PSP download pirated videogames via file-sharing program and modify the firmware of game machines, they are able to play various videogames without purchasing the genuine versions. The game industry is seriously concerned that the diffusion of pirated versions reduces sales of genuine versions. Business leaders fear that this will cause serious financial damage to videogame developers, will result in a decrease in the variety and quality of videogames, and consequently will deteriorate platform sales. Platform manufacturers such as Nintendo and Sony have tackled this issue by developing a new model that prevents the modification of firmware and by filing for an injunction against a hardware device that is believed to help consumers to play pirated versions. Nintendo DS's Dragon Quest V, released in July 2008 by Square Enix, was designed to prevent users from continuing the game if they were playing a pirated version. In July 2008, Nintendo and 54 videogame developers sued dealers that had imported and distributed Magicom (Magic Computer), a game backup device that could be attached to portable game machines. Although Magicom was originally developed to save game data,


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it came to be utilized in playing pirated videogames. In February 2009, the Tokyo District Court ruled in favor of Nintendo. The Nintendo DSi, introduced in November 2008, was designed to prevent the use of Magicom. Sony has also demonstrated concern about the use of pirated videogames. Sony introduced the PSP-3000 in October 2008, only a year after the introduction of the PSP-2000, to prevent users from modifying firmware and playing pirated versions. The PSP-go, introduced in November 2009, was also designed to prevent users from playing pirated videogames by improving the firmware and hardware of the game machine. Although the game industry is seriously concerned about the proliferation of pirated videogames, economic theory suggests that the negative impacts of piracy (lost sales) can be canceled out via the expansion of the market only when direct network externalities are large. Therefore, a gap between the conventional wisdom in the industry and the theoretical consequences must be filled by empirical research. However, no quantitative evaluation of this problem has been conducted so far. This is primarily because it is difficult for researchers to establish a dataset on illegal economic behavior. Based on a large-scale internet survey of users of Nintendo DS or Sony PSP, this study is the first to examine the statistical relationship between downloading pirated videogames and purchasing genuine versions. The remainder of this paper is organized as follows. Section 2 reviews prior studies on piracy and firm performance. Sections 3 and 4 introduce the empirical method and the implications of the results, respectively. Section 5 notes issues for future study. 2. Prior study The videogame industry is characterized by indirect network externalities through which an increase in users of hardware enhances utility of software users and vice versa (Clements and Ohashi, 2005; Prieger and Hu, 2006; Corts and Lederman, 2009). Game machines or platforms on which numerous videogames can be played tend to be the preferred option for latent consumers because such platforms can offer users more opportunities for enjoyment than platforms supporting a limited variety of videogames. The market position of the dominant platform is further reinforced when videogame developers provide manufacturers of such platforms with newly-released videogames. This feedback loop allows a dominating firm (a losing firm) to wholly dominate (lose) the market within a short period of time, as took place in the market share competition between Sony's PlayStation and Sega Saturn in 1996. Given the nature of the industry in this regard, if the concerns of the videogame industry regarding the diffusion of pirated versions as reducing sales of genuine versions are relevant, then the whole industry will suffer serious damage because this would decrease


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the variety and quality of videogames, and consequently platform sales. However, economic theory suggests that the negative effects of piracy can be canceled out via the expansion of the market when direct network externalities are large and consumers who pirate products would not buy the product anyway (Conner and Rumelt, 1991; Takeyama, 1994; Givon et al., 1995; Pietz 1999; Shy and Thisse, 1999). Another study argues that this is true even in the absence of direct network externalities (Jain, 2008). The general implications of economic theory seem to be that firms may lose sales because of piracy but will be able to earn profits that are larger than their losses because expanded user networks will make the product more attractive to potential customers. If this is true, the whole business (including hardware and software) may benefit from piracy given that the game industry is characterized by indirect network externalities. Therefore, there exists a significant gap between the conventional wisdom of the industry and economic theory, and empirical research should attempt to resolve this issue. Thus far, there has been no econometric analysis that has examined the diffusion of pirated videogames and its impact on the portable game machine industry. This is primarily due to the difficulty in establishing a suitable dataset. However, relevant information can be gained from empirical studies that examine the impact of downloading music files via the internet on sales of recorded music. In the US, Oberholzer-Gee and Strumpf (2007) examine the relationship between sharing music files via Opennap and record sales in the US. Their counterintuitive conclusion that there is no significant correlation between filesharing and record sales has sparked controversy over the reasons behind the decline in US record sales. Liebowitz (2007) reexamines quasi-experiments proposed by OberholzerGee and Strumpf with his newly established dataset and argues that their findings are not supported. He attributes the steep decline in record sales since the late 1990s to the proliferation of file-sharing. In Europe, Zentner (2006) shows that without file-sharing, record sales would have been 7.8 percent higher. In Japan, Tanaka (2004) examines the impact of file-sharing via Winny on CD sales and finds a positive relationship between the two. To explain this counterintuitive result, he suggests that file-sharing may act as a search tool for good music, thus promoting CD sales. Lastly, Hui and Png (2003) show that the negative effect of piracy is not serious for the music industry. Although it is intuitively-plausible that the diffusion of music file-sharing negatively affects record sales, empirical findings are unclear on this point. 3. Method In the aforementioned studies of the music industry, researchers installed file-sharing programs on their own and kept them running for a given period of time to collect their data. They then matched the dataset with record sales statistics for the same period. However, it is difficult to establish the dataset for downloads of pirated videogames in the


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same way. In this study, I have used an alternative method: I had a research company issue a questionnaire in July and August 2009 regarding how actively users of portable game machines (the Nintendo DS and the Sony PSP) downloaded pirated videogames and purchased genuine versions. The respondents were guaranteed that their response would be kept anonymous and confidential, which is important when the aim is to collect correct information on potentially illegal activities. Approximately one million people registered with the company as potential respondents. The sample used for the data analysis consists of 9970 Japanese users of either the Nintendo DS or the Sony PSP. Of the sample, 27.4% possess both machines. The composition of the observations by occupation is as follows: 2.4% were junior high school, high school, and university students; 61.4% were employed workers; 9.7% were self-employed; 21.1% were housewives or househusbands; and 5.5% were unemployed. 54.1% of the respondents are male. Average age of the respondents is 40.2 years old. 4. Results Figure 1 and Table 1 show that approximately 40% of the respondents know how to download and play pirated versions for free. It seems counterintuitive that users who know how to get pirated versions for free tend to purchase more genuine versions. It should be noted that the effects of experience and individual-level heterogeneity are not controlled for in these test. More experienced users are likely to learn how to get pirated versions for free via one information source or another. Users with a strong love of videogames tend to buy genuine versions as well. Such factors are controlled for in the regression analysis. Figure 1: The Sample Configuration and the Decision Tree for Playing Pirated Videogames E C A Sample

F D

B Know-how

Download

Play

A: Those who know how to get pirated versions for free B: Those who do not know how to get pirated versions for free


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C: Those who have downloaded pirated versions D: Those who have not downloaded pirated versions E: Those who have played all or a part of the downloaded videogames F: Those who have not played the downloaded videogames Table 1: Differences in the Number of Newly-Released Videogames Purchased

A B C D E F

N

%

DS

3549 5937 165 3384 159 6

37 63 5 95 96 4

8.25 6.34 6.61 8.33 6.71 3.83

Two-group meancomparison ** *

N

%

PSP

1238 1977 55 1183 51 4

39 61 4 96 93 7

5.78 4.05 4.49 5.84 4.60 3.00

Two-group meancomparison **

Note: Level of significance: ** p