Containing piracy with product pricing, updating and protection investments

We consider a monopolistic producer offering software that is updated periodically, but, by the end of one period, a pirated version is available at a transaction cost. This presents the consumers, who are different in terms of their willingness to pay for the original compared to the pirated version, with possible strategies for either buying a new product or pirating it. We address pricing and protection investment strategies to regain the profits affected by the piracy. In particular, we find that even when the transaction cost is exogenous, the producer does not necessarily want to fully price out the piracy. The decisive factor in such a case is the level of product newness relative to the transaction cost. If the producer is able to achieve high newness for the updated product relative to the transaction cost, then a high retail price ensures that he will gain the largest profit possible even though some of the demand will be lost due to piracy. On the other hand, when the transaction cost is endogenous, the producer may have two alternatives, in terms of profit, for dealing with the piracy—pricing the software out or investing heavily in software protection. As newness levels rise, the option of pricing out the piracy becomes increasingly preferable.