Digital piracy: Price-quality competition between legal firms and P2P network hosts

•This paper models the competition between a legal retailer and P2P host sites.•The analysis explicitly incorporates the advertising income of P2P network host sites.•P2P network host investment is greater in partially served markets.•Legal firms are profitable despite competition with P2P network hosts.•Retail firms decrease prices if horizontal product differentiation decreases.

This paper examines competition between firms that produce legal information goods and host sites that index P2P links. Specifically, we develop a simple model in which a legal firm determines price for its information good and a P2P host site decides on its investment to improve the quality and accessibility of the information goods linked to its site for free download. In the analysis, users choose between goods that are both horizontally and vertically differentiated. We show conditions under which the profitability of legal firms may or may not be negatively affected by the presence of a P2P network. In addition, we demonstrate the resilience of P2P host sites to distribute digital goods. Our approach extends earlier studies in the literature to further allow for price-quality competition between legal firms and P2P network hosts.