The economics of Microsoft's kill switch

Would you sacrifice $10 million in sales to prevent $1 billion in software piracy? How about $100 million? How many customers would you annoy?

Interesting questions with no hard and fast answers. Those are the types of questions Microsoft (the figures above are only there for illustration purposes) has to ponder with its Windows Genuine Advantage and Office Genuine Advantage plans. A behind back-the-envelope calculation illustrates why it makes sense for Microsoft to risk irking techies with its piracy battle.

For the record, there is no magic formula for determining how many customers Microsoft can afford to lose if it really bombs with its efforts to put a kill switch on Vista and Office. I've been checking with as many business professors as I can find to no avail. What we do know: The losses due to software piracy are large. The Business Software Alliance reports that the U.S. lost $6.9 billion to software piracy in 2005.

Now let's assume that Microsoft's losses to piracy are 20%, or $1.38 billion, of that big figure. That's a lot of dough on the other end of scale. To balance that equation Microsoft's kill switch program would have to be such an annoyance that $1.38 billion in sales would walk out the door. That's not likely given the headache required to totally ditch Windows or Office.

Microsoft doesn't disclose its losses due to piracy. It did say this in a regulatory filing Oct. 26:

"We may not be able to protect our intellectual property rights against piracy, infringement of our patents by third parties, or declining legal protection for intellectual property. We defend our intellectual property rights and combat unlicensed copying and use of software and intellectual property rights through a variety of techniques. Preventing unauthorized use or infringement of our rights is difficult. Piracy of our products represents a loss of revenue to us. While this adversely affects U.S. revenue, the impact on revenue from outside the United States is more significant, particularly in countries where laws are less protective of intellectual property rights. Similarly, the absence of harmonized patent laws makes it more difficult to ensure consistent respect for patent rights. Future legal changes could make this even more challenging. Reductions in the legal protection for software intellectual property rights or compliance with additional intellectual property obligations impacting the rights of software developers could both adversely affect revenue."

Bottom line: The losses due to piracy are a little more than a rounding error to Microsoft. Will Microsoft's anti-piracy policy have some well publicized hiccups? You bet. But those hiccups will actually have to cost Microsoft money--equivalent to its software piracy losses--for the software giant to make a change. What would you do to protect your product?

In the meantime, it's unclear what form Microsoft's program will ultimately take. As long as Microsoft has a remediation program for large corporate customers snared in a kill switch snafu the software giant should come out ahead.