Nearly 1.5 percent of retail inventory never made a cash register ring, according to a 2015 survey conducted by the National Retail Federation. Instead, those potential sales were lost to shoplifters, sticky-fingered employees, miscellaneous damage and administrative errors. In retail, such losses are called shrinkage.
If you ran a water utility, this kind of depletion would be called non-revenue water, and the American Water Works Association estimates that it accounts for as much as 15 percent of the water U.S. utilities treat and pump through their systems. Theft equals about 40 percent of these revenue losses.
In software markets, producers aren’t looking at 1 percent loss or even a 15 percent forfeiture. According to research from the Business Software Alliance, 43 percent of software installed on personal computers in 2013 wasn’t licensed properly and, worldwide, that costs software providers some $63 billion. The term used for such theft is piracy.
So, what can software makers do to steer clear of all those thieving revenue raiders who are swiping big cuts out of their profit margins? There are piracy controls, of course, as well as product positioning approaches, such as cost changes or the addition of product-line extensions.
Information Systems Professor Raghu Santanam worked with Assistant Professors Aaron Baird of Georgia State University and Chadwick Miller of Washington State University (both W. P. Carey Ph.D. alumni) to see which approach worked best to bring software companies the greatest gains. The team found
Improperly licensed software costs producers some $63 billion a year, what does it take to sell more of the software you’ve created? W. P. Carey researchers found that there’s strong interplay between piracy controls, product extensions and consumer willingness to pay for software (and piracy).
But the efficacy of these approaches varies depending on the initial price of the software and whether it fits into high- or low-cost markets.
The high cost of free
When this team talks about low-cost markets, they’re talking free — or very nearly free — because that’s the software world’s reality in these app-filled days. As of July 2015, there were some 1.6 million apps available in the Google Play store and 1.5 million in the Apple store, where the average app cost $1.16, according to pocketgamer.biz, an industry news outlet.
Even complex and business software has its freebies, Santanam noted. Microsoft certainly has its Office fans, but it also faces competition from OpenOffice, Libre Office, Neo Office and Google Docs, all of which cost consumers nothing. Likewise, Adobe Photoshop Element is a highly pirated software and it, too, has its free alternatives, including GIMP and Pixlr.com
“Complicating matters is that there is a trend toward giving the product away free in hopes of making more money off of engagement with consumers,” Santanam adds. That money-maker might be something like the 99 cent micro-transactions you finally decide to buy in Candy Crush to get more lives, moves, wrapped candies and the coveted color bomb that explodes in a score-building frenzy when you’re lucky enough to move one across the screen of your cell phone. It also could be bigger transactions, such the mandatory shift to paid TurboTax instead of the free version because you discover that free TurboTax doesn’t accommodate things like mortgage deductions, income from stocks and bonds or, for the self-employed, the all-powerful Schedule C tax form.
No, for the feature-rich software, consumers need to pay — or pilfer. PC software from Microsoft and Adobe are among the most-frequently stolen, Santanam says. Games are high on the pirates’ preference list, too.
Between the piracy and the competition from freebies, software companies are scrambling for ways to protect their revenue streams. Among the defensive weapons these companies employ are piracy controls, such as product-activation keys, license restrictions and purchase-verification platforms used by many gaming software creators. Another set of tools are product-line extensions, or feature add-ons that enable software providers to offer multiple product versions of the software at diverse price points. The idea is to appeal to different types of consumers who have varying willingness to pay.
All things considered
Just as software providers are keenly aware of the many freebies and feature-set options available for their products, so are consumers. That’s why Santanam and his colleagues drew upon the theory of context-dependent preferences as the means of examining the impact of product-line extensions on consumers’ willingness to pay versus the impulse to purloin. Whereas, classical choice theory maintains that preference between two options is not altered when a new option is introduced, context-dependent preference theory shows that preferences can change when option sets change. Santanam and team therefore conducted a series of experiments designed to see how consumers responded to multiple price and product-feature alternatives. The researchers also tested how perceptions of price fairness and brand quality impacted willingness to pay and piracy intentions.
In the experiments, the research team used Adobe Photoshop as their focal product. Why? Because the researchers felt they had to split the market into low- and high-cost options. At $99, Photoshop Elements fits the high-priced category and the $4.99 Photoshop Express is its low-cost mobile version. What’s more, Adobe products are among the most frequently pirated consumer software around, Santanam says.
To test how product-line extensions impact willingness to pay for the high priced product, the team queried experiment participants about their willingness to pay for a premium extension costing $149, as well as a free version of Express. The research team also offered study participants multiple price and anti-theft options to see how all the alternatives impacted consumer demand and inclination to steal.
As it turns out, piracy controls do reduce the predisposition to pirate software. But, they do little to impact willingness to pay for that software.
Product-line extensions, however, do have impact. “If you introduce a free product extension in a high-cost market, you’re going to get higher willingness to pay from consumers,” Santanam notes. The flip side is true in low-cost markets. “If you introduce a premium extension in the low-cost market, that could help sales.”
The research team also used participant responses to estimate a demand distribution. “If you offered your product at $100, what portion of the market is willing to pay that price?” Santanam asks. Demand analysis reveals the optimal price at which consumers would buy and companies would generate maximum total revenue.
“Let’s say you sell your product at $50, and you are able to get 60 consumers to buy it, you bring in $3,000. But, if you lowered the price to $30 and get 200 people to buy it, you make $6,000,” he explains. “Now you’ve expanded the market, and when you expand the market, especially in the software context, your revenues go up and profits will go up, as well.”
Santanam adds: “The first copy of the software is the most expensive copy to make. All the other copies are free of development expense, so the more you sell, the more you make in terms of profits.”
The researchers found strong alignment between consumer and supplier interests at current prices as well as optimal ones. In other words, suppliers can charge what it takes to maximize revenues.
And, to maximize sales, here’s the formula this team thinks will work best: Suppliers of high-cost software should introduce piracy controls along with a free, low-feature version of their software to let consumers give it a try and to spread the good will that freebies generate. Low-cost software makers can likely benefit from reduced piracy controls and adding a high-end extension. That premium add-on signals a jump in quality to the consumer, and demand is likely to jump, as well.