Software Piracy: The Direct Threat to Enterprise Value
By any measure, software piracy is a huge problem. While the USD142 billion or more it costs producers and distributors per annum is widely reported, the biggest losers may in fact be the enterprise users of pirated software, or Stolen IT, themselves. As it turns out, they may be risking a far larger amount of their own collective enterprise value than they are costing the owners of Stolen IT through their infringing conduct, given that the fair value of any customer and technology-related intangible asset can and should be reduced, through discounting for risk, for any association with Stolen IT.
Highlighting this can and should open a new and necessary front in the global campaign against software piracy, as enterprise owners and managers come to realise that the amounts ‘saved’ by using Stolen IT are much less than the enterprise value being risked and lost, right now, through their actions. Using Stolen IT represents a direct, and potentially devastating, risk to enterprise fair value that can and should be communicated to business. If it is, enterprise economic self interest may very well triumph where appeals to respect the intellectual property rights of software producers and distributors, supported by appropriate measures and sanctions, have so far failed to reduce, much less eliminate, the scourge of software piracy.
The direct risk to enterprise value that the use of Stolen IT represents is clear and compelling enough, once understood, to have a real impact. It can and should be communicated to, and clearly understood by, enterprises as part of the broader effort to combat software piracy.
Software Piracy as a Threat to Enterprise Value
Intangible assets represent a significant, and increasing, majority share of enterprise value. By one measure, the share of enterprise value accorded to intangible assets, within S&P companies, increased from 38 percent to 85 percent between just 1982 and 1998 .
Assisted by the increasingly positive obligations imposed under a harmonising set of International Accounting Standards (IASs), there is a growing requirement to identify enterprise intangible assets that are legally separable from goodwill, and to give these acquisition ready values that must also be regularly tested for impairment.
IAS38 – Intangible Assets – for instance, specifies how to measure the carrying amount of intangible assets and requires certain disclosures regarding these. With IFRS3 – Business Combinations – which imposes positive obligations, such as the mandatory reporting of acquired asset values and the regular testing of these for impairment, the enterprise owners of intangible assets, including those that support key income and revenue streams, must increasingly ensure the integrity of these, as all the while, the trend towards increasing disclosure in intangible asset valuation reporting makes it more and more likely that the use of Stolen IT in the context of the valuation of these key assets will be discovered.
Intangible assets include not just legal intangibles (or IPs such as patents and trade marks), but also a growing list of “customer and technology related intangibles”, which are often built around or on core systems, databases and applications. The fair value of any enterprise income or revenues linked to these must be reported in NPV (Net Present Value) terms and discounted for risk as part of the valuation process.
As part of the risk assessment, obvious risks such as threats to future revenue posed by technological obsolescence are considered. As a valuer I should, and would, also consider legal, regulatory and compliance risks, and part of the enquiry around establishing these would oblige me to consider any situation involving rights to use any third party software. The discovery of incomplete rights to use, much less direct evidence of software piracy or Stolen IT, would be reflected, by the valuer, in the discounting for risk of the fair value of any relevant future economic benefits, such as revenue streams, that might reasonably be expected to flow to the enterprise.
The use of unlicensed, under licensed, or Stolen third party software or IT in the context of these intangible assets can therefore have a significant negative impact on the reportable fair value of these key enterprise intangible assets and the overall revenue streams that they support. The risks of software piracy become, immediately, far greater than balancing avoided payments to vendors against penalties imposed if caught; and go to, and threaten, an enterprise’s very core fair value.
Communicating this risk represents a new ‘front’ in the anti-piracy campaign. With valuers obliged, under prevailing valuation standards and processes, to reflect the risks of using unlicensed and pirate/counterfeit software in the discounting of enterprise intangible asset value, this gives rise to a situation in which the use of pirate/counterfeit software becomes not just morally wrong, but also extremely dangerous, and a situation truly worth avoiding. A rational, rather than moral, deterrent therefore exists for discouraging this type of conduct.
The Way Forward
Whilst the broader efforts to target software piracy, are absolutely warranted, this can and must be supported by the encouragement of a wider risk-based IT/IP compliance culture based, at least in part, on the communication, and acceptance, of the direct enterprise valuation risks and impacts of using Stolen IT/IP.
This would open a new (internal) enterprise front in the campaign to fight software piracy, where compliance is usefully driven by the need to avoid unacceptable risks to their own business value, rather than simply not costing the software industry at least USD142 billion per year through such conduct; a fantastic number that most enterprises, whether they should or not (morally) simply cannot, as the increasing incidence and costs of piracy demonstrate, be prevailed upon to help reduce without a healthy measure of enterprise self interest being introduced.
Raising awareness of the threat to enterprise fair value that software piracy represents should be a key to combatting software piracy. A culture of IP compliance should be encouraged by vendors, such that enterprises, with vendor encouragement and support as part of the development of a wide and effective IP compliance culture, become aware of the risks of using Stolen IT/IP and co-develop an IP culture and management process to guard against it, in a joint compliance effort.
With the threat to fair value as a motivation, IT/IP compliance can and should be a mutual core objective for vendors and businesses; with enterprises obliged to achieve this as part of their own IP management processes, rather than through compliance audits. Not just a moral choice or consideration, software piracy would be something essential to avoid, in the interests of asserting, and preserving from risk, the very core value of the enterprise; an awareness that will only complement and support the formal UCA framework.
Internal due diligence and compliance can, and properly conducted certainly would, identify where unlicensed, under-licensed, much less blatantly pirated, software is deployed in the context of income-related customer and marketing intangible assets, and both vendors and enterprises would be motivated to remove such threats to their respective businesses and enterprise value.
Such a recognition of mutual interest can, and will, create and sustain an effective IT/IP culture and compliance regime, based on an appreciation of the risk to enterprise value that software piracy represents; considerations that will underline the shared risk that Stolen IT/IP represents to both the owners, and misusers, of it.
In a situation where the losses to software owners and distributors, while enormous and unacceptable, may actually be less than the economic cost, through the devastating threat to fair value, that the use of Stolen IT/IP imposes on enterprises
themselves, the recognition of the mutual interest that vendors/distributors, and users, of it have in stamping out software piracy is essential to achieving victory in the fight against it.
Industry can, and will, succeed in combating the scourge of software piracy by adding, to the UCA legislative base that has been built to oppose it, a clear and unequivocal appreciation of the dire threat to the enterprise fair value, of the owners and users of Stolen IT/IP, that it represents.
Dr Sanders is a practising solicitor in NSW (Australia) where he was admitted to practice, as a Barrister and Solicitor, in 1999. He can be contacted via email@example.com.