GAO questions piracy loss data

Sean Flynn
April 13, 2010

REPORT: GAO-10-423 Intellectual Property: Observations on Efforts to Quantify the Economic Effects of Counterfeit and Pirated Goods

The GAO release on piracy estimates contains a lot of the usual claims about effects on profits, consumers, health and safety and even organized crime. But it contains some interesting counter-currents as well, including a whole section titled “Certain Stakeholders May Experience Positive Economic Effects of Counterfeiting and Piracy” and another exlpaining that "Lack of Data Hinders Efforts to Quantify Impacts of Counterfeiting and Piracy."

http://www.gao.gov/products/GAO-10-423

From the summary:

“Some consumers may knowingly purchase counterfeits that are less expensive than the genuine goods and experience positive effects (consumer surplus), although the longer-term impact is unclear due to reduced incentives for research and development, among other factors. Three widely cited U.S. government estimates of economic losses resulting from counterfeiting cannot be substantiated due to the absence of underlying studies. Generally, the illicit nature of counterfeiting and piracy makes estimating the economic impact of IP infringements extremely difficult, so assumptions must be used to offset the lack of data. Efforts to estimate losses involve assumptions such as the rate at which consumers would substitute counterfeit for legitimate products, which can have enormous impacts on the resulting estimates. Because of the significant differences in types of counterfeited and pirated goods and industries involved, no single method can be used to develop estimates. Each method has limitations, and most experts observed that it is difficult, if not impossible, to quantify the economy-wide impacts.”

From the main report:

Some experts we interviewed and literature we reviewed identified potential positive economic effects of counterfeiting and piracy. Some consumers may knowingly purchase a counterfeit or pirated product because it is less expensive than the genuine good or because the genuine good is unavailable, and they may experience positive effects from such purchases. For example, consumers in the United States and other countries purchase counterfeit copies of high-priced luxury-branded fashion goods at low prices, although the products’ packaging and sales venues make it apparent they are not genuine. Consumers may purchase movies that have yet to be released in theaters and are unavailable in legitimate form. Lower-priced counterfeit goods may exert competitive pressure to lower prices for legitimate goods, which may benefit consumers. However, according to the OECD, the longer-term impact for consumers of falling prices for legitimate goods is unclear, as these changes may affect the speed of innovation.

There are also certain instances when IP rights holders in some industries might experience potentially positive effects from the knowing consumption of pirated or counterfeit goods. For example, consumers may use pirated goods to “sample” music, movies, software, or electronic games before purchasing legitimate copies, which may lead to increased sales of legitimate goods. In addition, industries with products that are characterized by large “switching costs,” may also benefit from piracy due to lock-in effects. For example, some experts we spoke with and literature we reviewed discussed how consumers after being introduced to the pirated version might get locked into new legitimate software because of large switching costs, such as a steep learning curve, reluctance to switch to new products, and search costs incurred by consumers to identify a new product to use.

Some authors have argued that companies that experience revenue losses in one line of business—such as movies—may also increase revenues in related or complementary businesses due to increased brand awareness. For instance, companies may experience increased revenues due to the sales of merchandise that are based on movie characters whose popularity is enhanced by sales of pirated movies. One expert also observed that some industries may experience an increase in demand for their products because of piracy in other industries. This expert identified Internet infrastructure manufacturers (e.g., companies that make routers) as possible beneficiaries of digital piracy, because of the bandwidth demands related to the transfer of pirated digital content. While competitive pressure to keep one step ahead of counterfeiters may spur innovation in some cases, some of this innovation may be oriented toward anticounterfeiting and antipiracy efforts, rather than enhancing the product for consumers.

. . .

Because of the lack of data on illicit trade, methods for calculating estimates of economic losses must involve certain assumptions, and the resulting economic loss estimates are highly sensitive to the assumptions used. Two experts told us that the selection and weighting of these assumptions and variables are critical to the results of counterfeit estimates, and the assumptions should, therefore, be identified and evaluated. Transparency in how these estimates are developed is essential for assessing the usefulness of an estimate. Two key assumptions that typically are required in calculating a loss estimate from counterfeit goods include the substitution rate used by consumers and the value of counterfeit goods.

Substitution rate. The assumed rate at which a consumer is willing to switch from purchasing a fake good to the genuine product is a key assumption that can have a critical impact on the results of an economic loss estimate. For example, if a consumer pays the full retail price for a fake movie thinking that it is the genuine good, an assumption can be made that a legitimate copy would have been bought in the absence of the fake product, representing a one-to-one substitution rate. However, this one-to-one substitution rate requires three important conditions: (1) the fake good is almost identical in quality to the genuine one; (2) the consumer is paying full retail price for the fake product; and (3) the consumer is not aware he is purchasing a counterfeit product. When some of these conditions are not met (e.g., the consumer paid a significantly lower price for the counterfeit), the likelihood that the consumer would have purchased the genuine product at full price is not clear. Substitution rates also vary by industry, since factors such as product quality, distribution channels, and information available about the product can differ significantly.

Value of fake goods. Valuation of the fake goods constitutes another set of assumptions that has a significant impact. There are several measures of value that can be used, such as the production cost, the domestic value, or the manufacturer’s suggested retail price. For example, CBP announced in a January 2010 press release that it had seized 252,968 DVDs with counterfeit trademarks. The agency reported that the manufacturer’s suggested retail price of the shipment was estimated to be more than $7.1 million and the domestic value was estimated at $204,904. Officials from the International Trade Commission stated that counterfeits are very difficult to price and estimates of economic impact would benefit from including a range of prices, from the spot price of the fake on the street corner at the bottom to the manufacturer’s suggested retail price at the top.

The level or extent of deception that consumers face is also an important factor to consider when developing assumptions for the substitution rate and value of the fake goods. If a consumer is completely deceived, it could be reasonable to assume a one-to-one substitution rate (i.e., the purchase of a legitimate good in lieu of the counterfeit one) and a full retail price (i.e., the manufacturer’s suggested retail sales price). Price, packaging, and location of the transaction are the most important signs to the consumer indicating the legitimacy of a good. Many of the experts we interviewed said that a one-to-one substitution rate is not likely to exist in most circumstances where counterfeit goods are significantly cheaper than the legitimate goods. Some experts also noted that the level of consumer deception varies across industries. For example, consumers who purchase counterfeit pharmaceuticals are more likely to be deceived, particularly when the counterfeit good is sold through the same distribution channel as the genuine product. Some experts observed that few, if any, consumers would willingly purchase a pharmaceutical product they knew might be counterfeit.15 However, the extent of deception among consumers of audiovisual products is likely lower because sales venues for counterfeit audiovisual goods tend to be separate from the legitimate ones. Unless the assumptions about substitution rates and valuations of counterfeit goods are transparently explained, experts observed that it is difficult, if not impossible, to assess the reasonableness of the resulting estimate.

. . .

Three commonly cited estimates of U.S. industry losses due to counterfeiting have been sourced to U.S. agencies, but cannot be substantiated or traced back to an underlying data source or methodology.

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