Working Paper
Network Externality and Software Piracy

The pervasiveness of the illegal copying of software is a worldwide phenomenon. Software piracy implies a huge loss of potential customers of original software buyers, which directly translates into revenue losses for the software industry. Given this, conventional wisdom would suggest the need for the legal software firms and governments to take a harsh approach on piracy of software. Interestingly, there is a trend of literature, which establishes that it is actually profitable for the original software developer to allow limited piracy in the presence of network externality. The present paper wishes to demonstrate that these results cannot be accepted as a general explanation for the existence of software piracy in the real world. To prove the point, this paper comes up with a model where it shows that in the presence of intense effect of network externality, protection as opposed to allowing piracy is always optimal for the original software developer. It also shows that the incentive to protect is even higher with the presence of network externality as opposed to the case of no network externality. Whether piracy is profitable or not to the original developer depends on the market structure, demand environment and the nature of the competition.