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Journal ArticleDOI

Peer-to-Peer File Sharing and the Market for Digital Information Goods

TL;DR: The size of the p2p network is characterized as a function of the firm's pricing strategy, and it is shown that the firm may be better off setting high prices, allowing the network to survive, and that the p1p network may work more efficiently in the presence of the company than in its absence.
Abstract: We study competitive interaction between two alternative models of digital content distribution over the Internet: peer-to-peer (p2p) file sharing and centralized client-server distribution. We present microfoundations for a stylized model of p2p file sharing where all peers are endowed with standard preferences and show that the endogenous structure of the network is conducive to sharing by a significant number of peers, even if sharing is costlier than freeriding. We build on this model of p2p to analyze the optimal strategy of a profit-maximizing firm, such as Apple, that offers content available at positive prices. We characterize the size of the p2p network as a function of the firm's pricing strategy, and show that the firm may be better off setting high prices, allowing the network to survive, and that the p2p network may work more efficiently in the presence of the firm than in its absence.

Summary (3 min read)

1 Introduction

  • On the other hand, by sharing, a peer also supplies upload bandwidth to the network and this may result in lower network congestion.
  • Third, the authors show that the firm has an additional incentive to charge high prices, compared to what a standard model of vertical differentiation would predict.
  • The authors model shows that file sharing networks strictly benefit from improvements in broadband capacity, creating value for all participants.

1.1 Literature

  • This paper contributes to an emerging literature in Strategy that explores competitive interaction between organizations with different business models.
  • Golle et al. [20] and Antoniadis et al. [3] consider agents that derive utility from contributing content to the network.
  • Networks depends on individual contributions and a high proportion of users consume network resources without contributing their own, congestion is one main problem in p2p.
  • Content distributed through p2p networks has several advantages over licensed content distributed through iTunes.

3 The model

  • Consider a population of M agents that obtain utility from the consumption of digital information goods.
  • 10See ‘France Poised To Soften Controversial iTunes Bill,’ CNNMoney.com, June 21, 2006.
  • As will become clear shortly, the scarce resource in their model is bandwidth.
  • This captures the opportunity costs of computing resources employed, the bandwidth for signaling traffic required to remain connected to the network until a download completes, and possible legal action against the peer.
  • Clearly, if the network allocation was not stable, at least one peer would have incentives to update her link and connect to a different sharer.

4 Network foundation

  • This provides a foundation for download time td in the second stage of their model, a central variable of their analysis.
  • In that paper the authors show that S/N is a good approximation to the expected bandwidth of both sharers and freeriders.
  • Numerical simulations suggest that sharers with larger upload capacities end up obtaining more bandwidth unless upload capacities are very asymmetric.
  • Consider for example a p2p network with three peers only: two sharers and one freerider.

5 Equilibrium network configurations

  • In this Section the authors analyze the first stage.
  • Thus, the most impatient peers prefer to share while the more patient peers are better off freeriding.
  • Therefore, to perform comparative statics the authors need only look at how changes in the parameters affect the position and ‘slope’ of G (ρi).
  • Their simulations show that sharing can increase the download latency experienced by sharers, particularly when the level of sharing in the network is high, in turn reducing the incentives to share.

5.1 Full vs. partial sharing

  • An equilibrium network configuration where n > 1, that is, both sharers and freeriders are present in the network.
  • One may argue that for many individuals, uplink traffic is very small (e.g., a click requesting a web page) and the congestion cost to sharing should then be small.
  • Compared to the self-interested approach their model is similar in that individuals care about the total amount of public good available and different in that the decision of how much to share is discrete (all or nothing).
  • If, on the contrary, network congestion grows with N , the value of the p2p network decreases with size.
  • Proposition 2 Let ρs(N) be the most patient sharer in equilibrium.

5.3 On the empirical relevance of the analysis

  • To the best of their knowledge, no empirical estimates exist for the model’s main parameters (cs and cn) or the distribution of ρ.
  • And to the extent that music genres may be good proxies for boundaries between interest groups, the relevant Ns become much smaller.
  • Given this, it is not entirely clear that inequalities (3) and (4) are reasonable drivers of peer behavior when S is large: the cost/benefit trade off appears to be too insignificant for peers to pay much attention to it.
  • The explanatory power of endogenous congestion, incentive schemes, social preferences, and unawareness is likely to be different at different stages in the life cycle of p2p networks.
  • Even with such a threshold, their main results would not change: the authors would still have a positive level of sharing in equilibrium, and congestion would worsen as N grows.

6 The firm

  • The authors next introduce an online firm that sells digital information goods also available on the p2p network.
  • Because content is free on p2p networks, for the firm to persuade users of digital content to pay positive prices, it must offer added benefits that file sharing networks cannot match.
  • Let uf be the utility that consumers derive from content obtained from the firm, where uf ≥ ud, and let p be the firm’s price.
  • This effect ensures that fewer peers will leave the network in response to a price reduction when price is above pnd.
  • The effect of the network on the firm can be likened to a low quality firm competing against a vertically differentiated competitor.

7 Concluding remarks

  • The authors have presented a simple formal model to analyze some aspects of the interaction between p2p and online stores, two alternative models for the distribution of digital information goods.
  • It is more likely than not that they will endure.
  • The effects of p2p file sharing on content providers are significant, and can be compared to those of cassette recording in earlier analog technological generations.
  • The authors formal model is necessarily partial in that it is focused around characterizing the firm’s profit-maximizing pricing strategy.
  • More generally (but less formally), to compete effectively against p2p, online digital distribution must strive to become accessible and attractive to consumers.

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City, University of London Institutional Repository
Citation: Casadesus-Masanell, R. and Hervas-Drane, A. (2010). Peer-to-Peer File
Sharing and the Market for Digital Information Goods. Journal of Economics and
Management Strategy, 19(2), pp. 333-373. doi: 10.1111/j.1530-9134.2010.00254.x
This is the accepted version of the paper.
This version of the publication may differ from the final published
version.
Permanent repository link: https://openaccess.city.ac.uk/id/eprint/14893/
Link to published version: http://dx.doi.org/10.1111/j.1530-9134.2010.00254.x
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City Research Online

Peer-to-Peer File Sharing and the
Market for Digital Information Goods
Ramon Casadesus-Masanell
Andres Hervas-Drane
August 4, 2009
Abstract
We study competitive interaction between two alternative models of digital content distribu-
tion over the Internet: peer-to-peer (p2p) file sharing and centralized client-server distribution.
We present microfoundations for a stylized model of p2p file sharing where all peers are endowed
with standard preferences and show that the endogenous structure of the network is conducive
to sharing by a significant number of peers, even if sharing is costlier than freeriding. We build
on this model of p2p to analyze the optimal strategy of a profit-maximizing firm, such as Apple,
that offers content available at positive prices. We characterize the size of the p2p network as
a function of the firm’s pricing strategy, and show that the firm may be better off setting high
prices, allowing the network to survive, and that the p2p network may work more efficiently in
the presence of the firm than in its absence.
We thank the Coeditor and three anonymous Referees for suggestions that helped improve the paper substantially.
We also thank Alexei Alexandrov, Jernej Copic, Albert Creus-Mir, Ig Horstmann, Rahmi
˙
Ilkili¸c, Jeff MacKie-Mason,
Felix Oberholzer-Gee, Markus Reitzig, Alan Sorensen, and Pai-Ling Yin, and seminar participants at the Bosphorus
Workshop on Economics Design, the CoCombine conference, The Wharton School of the University of Pennsylvania,
London Business School, Harvard Business School, MIT, Ross School of Business (Michigan), Robert H. Smith
School of Business (Maryland), the CRES-Second Annual Foundations of Business Strategy Conference, the 2006
NetEcon workshop, the 2006 NYU Summer Workshop on the Economics of Information Technology, the 5th Annual
International Industrial Organization Conference, the Harvard EconCS Group, the 2007 NET Institute Conference,
the Third International Conference on Ultrabroadband Networks, the 2007 Annual Meeting of the Academy of
Management, the Summer Institute in Competitive Strategy at the Haas School of Business (Berkeley), the 2008
INFORMS Annual Meeting, and the TILEC Workshop on Media Markets at Tilburg University. The second author
conducted this research at the Universitat Aut`onoma de Barcelona and Harvard University. We are grateful for
financial support from the HBS Division of Research, Fundaci´on BBVA, Fundaci´on Caja Madrid, the Public-Private
Sector Research Center at IESE Business School, the Real Colegio Complutense, and the FPU program of the Spanish
Ministry of Education and Science.
Columbia University and Universitat Pompeu Fabra
Harvard Business School

1 Introduction
Since the inception of copyright law to grant intellectual property owners a temporal monopoly
on their works, the ability to capture value by copyright holders has persistently been threatened
by unauthorized reproduction of content. Technological innovations have not only presented new
market opportunities but also new threats. The radio, the cassette player, the video recorder, and
the compact disc have allowed the industry to deliver additional value and meet new demand. But
these same technologies have also been employed to replicate and distribute content without the
consent of copyright holders.
In recent years, advances in the digitalization of content paired with the widespread adoption of
broadband Internet have shaped a new and formidable threat with the emergence of peer-to-peer
(p2p) file sharing networks. Peer-to-peer file sharing has grown spectacularly in recent years. The
content industry has reacted, with limited success, by legally confronting the p2p phenomenon
and slowly embracing online distribution. Apple’s iTunes Store, built on a traditional client-server
architecture, has emerged as the dominant player in the market for legal digital downloads.
Peer-to-peer and licensed online stores constitute two fundamentally different distribution mod-
els that ‘compete’ against each other. Demanders of digital content are faced with the choice of
whether to download content from p2p file sharing networks or from legal sites. The ability (or
even the desire) of Apple to sustain high prices for downloads is affected by the presence of p2p file
sharing networks. Likewise, the success of p2p file sharing is partly determined by actions taken
by Apple and the majors such as pricing per download, the proneness to embark into legal action
against users of p2p, their relationships with and demands from Internet Service Providers (ISPs),
and the like.
In this paper we present a simple formal model to investigate how these two systems of digital
distribution interact. Our model begins with the observation that peers in p2p networks face a
fundamental choice between sharing content and freeriding. Sharing entails additional costs for the
peer: committing computing resources such as storage space and upload bandwidth to the network
and increasing the likelihood of legal action against her. When a peer in a p2p network decides
to share content, she is effectively supplying two different goods. On the one hand, she provides
1

content. Obviously, the peer who shares does not benefit from the content that she is sharing as she
already owns it. In the absence of social preferences (i.e., altruism, reciprocity...), providing content
has no direct benefit to the peer who shares. On the other hand, by sharing, a peer also supplies
upload bandwidth to the network and this may result in lower network congestion. Sharing results
in lower congestion if upload bandwidth is a scarce resource. Based on the available empirical
evidence, we assume this to be the case.
Similarly to content, bandwidth is a nonexcludable good. When a peer provides upload band-
width to the network she cannot decide who will or will not have access to that bandwidth. But
contrary to content, bandwidth is a rival good because its use by one peer prevents use by another
peer. We show that the nature of p2p networks, however, warrants that the provision of bandwidth
benefits all peers equally in expected terms. Indeed, when a peer decides to share content, the
average number of peers connected to sharers decreases (because there are more peers to connect
to) and this reduces average network congestion. In sum, peers face a trade off: by sharing they
bear costs that could be avoided by freeriding, but sharing also reduces average network congestion
and this benefits every peer, including the peer who shares.
Building on this insight, we construct a model where peers provide bandwidth in addition to
content when they share. Specifically, we consider a finite population of agents that derive positive
and homogenous utility from digital content. Peers suffer disutility from the costs associated with
downloading content. These costs are proportional to the time required to complete downloads,
the level of congestion, which in turn depends on the bandwidth provision available in the network.
Peers may reduce their expected congestion by providing upload bandwidth to other peers. We
model this decision as a binary choice: share content or freeride. By allowing agents to differ in their
disutility of congestion (or impatience) we show that an endogenous level of sharing emerges in the
network. This depends on the size of the network, the costs faced by agents, and the disutility
of congestion of the population. Selfish utility-maximizing peers are better off sharing because
by doing so they face less congestion. We fully characterize the congestion faced and the utility
enjoyed by all participants.
We build on this framework to analyze the optimal strategy of a profit-maximizing firm that
offers the same content available on the network. Contrary to p2p networks, online stores offer legal
2

and fast downloads, based on traditional client-server architectures, at positive prices.
1
We derive
the demand function faced by the firm and characterize its optimal pricing strategy. We show that
the firm may be better off setting high prices instead of attempting to shut the p2p network down
by lowering prices. Moreover, we show that the p2p network may function more efficiently in the
presence of the firm than in its absence.
The model captures important stylized facts identified by the literature. First, Asvanund et
al. [5] show that congestion worsens as the size of p2p networks grow. Our model generates this
result endogenously. In fact, the effect of network size on congestion helps explain the coexistence
of multiple p2p networks. The model can also accommodate positive network effects when users
value content variety.
Second, many studies have shown that heavy users of p2p file sharing networks are more prone
to purchase content online.
2
Our framework not only suggests that there is no contradiction in this
observed behavior, but also sheds light on the factors that explain the demand for online content
in the presence of a p2p network.
Third, we show that the firm has an additional incentive to charge high prices, compared to what
a standard model of vertical differentiation would predict. When prices are high, more consumers
prefer to download from the p2p network. As a consequence, congestion increases and the value of
the p2p network decreases, increasing the attractiveness of the firm’s product.
Finally, researchers and industry analysts have long questioned the existence of applications
that drive broadband demand (“killer apps”).
3
Our model shows that file sharing networks strictly
benefit from improvements in broadband capacity, creating value for all participants.
4
A study
performed by Internet research firm CacheLogic in 2005 revealed that over 60% of total Internet
traffic belonged to p2p file sharing applications.
5
This suggests that file sharing is indeed a driver
for broadband demand. We believe that our results should be of interest to all participants in
1
Note that an online store could be set up to distribute content through p2p, rather than through a client-server
model. Motivated by iTunes’ success, however, we assume that the firm not only has centralized governance but
that it also distributes through a client-server model that provides content instantly. We show that the use of a
client-server architecture for distribution is a critical source of advantage for the firm.
2
See, for example, ‘Downloading myths challenged,’ BBC News.com, July 27, 2005.
3
See Crandall and Alleman [14].
4
See Parker [32].
5
See Johnson et al. [25].
3

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TL;DR: In this paper, the invariance proposition of public goods and the optimal tax treatment of charitable giving are discussed. And the authors show that impure altruism is more consistent with observed patterns of giving than the conventional pure altruism approach, and has policy implications that may differ widely from those of the conventional models.
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  • ...…approaches to modeling the decision to contribute: the self-interested approach of Bergstrom et al. (1986) where individuals are concerned about the total supply of public goods, and the “warm-glow” approach of Andreoni (1990) where individuals “feel good” when they privately provide public goods....

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Frequently Asked Questions (1)
Q1. What are the contributions in this paper?

The authors study competitive interaction between two alternative models of digital content distribution over the Internet: peer-to-peer ( p2p ) file sharing and centralized client-server distribution. The authors present microfoundations for a stylized model of p2p file sharing where all peers are endowed with standard preferences and show that the endogenous structure of the network is conducive to sharing by a significant number of peers, even if sharing is costlier than freeriding. The authors build on this model of p2p to analyze the optimal strategy of a profit-maximizing firm, such as Apple, that offers content available at positive prices. The authors characterize the size of the p2p network as a function of the firm ’ s pricing strategy, and show that the firm may be better off setting high prices, allowing the network to survive, and that the p2p network may work more efficiently in the presence of the firm than in its absence. ∗We thank the Coeditor and three anonymous Referees for suggestions that helped improve the paper substantially. The second author conducted this research at the Universitat Autònoma de Barcelona and Harvard University.