The model considers an MNC having its origin in the Developed Country (DC) with the following options for production to initiate production in an LDC:
(1) It can produce entirely in the DC market and export thefinished product to the LDC with a per unit positive transport cost.
(2) It can fragment the production process in two stages between the DC and the LDC. In thefirst stage, production of the core material takes place in the DC.
In the second stage assembling of the core material takes place in the LDC.6 (3) It can undertake the entire production in the LDC by opening up the entire
manufacturing and assembling unit with FDI.
In the second option the embodied technology and in the last option disem-bodied technology is transferred. In both the cases diffusion of technology results in the possibility of entry of the fakefirm. The fake firm is capable of producing an identical replica of the original product. The probability of entry of the fake firm will, however, depend on the IPR protection exercised by the local government and the level of anti-copying investment undertaken by the MNC. The local LDC government as a monitoring authority will extract a penalty from the fakefirm if detected. Now depending upon the government’s IPR protection rate the MNC adopts two strategies, namely complete copy protection and accommodating strategy. In the paper, complete copy protection investment (CP strategy) is a
6A common example of this type of production is in the case of Coca Cola—one of world’s leading beverage suppliers. The MNC prepares the concentrate in the United States which is then exported to different countries where the bottling units are located.
technology determined cost which prevents copying completely.7This is in contrast to anti-copying investment (AC strategy)8which makes the task of copying dif fi-cult.9In the former case the MNC takes an investment that completely prohibits the entry of fakefirm and in the second case even with anti-copying investment fake firm enters the market and the game ends with the MNC acting as a price leader in a duopoly situation. The sequential game moves in the following manner. In thefirst stage of the game LDC government chooses IPR protection rate. Given this rate, MNC decides the mode of entry where the options are export, fragmented pro-duction, or FDI production. Under fragmentation and complete FDI production technology diffusion may cause the entry of fakefirm in the market. Hence under these two cases MNC incurs a copy protection investment. Depending upon local government’s IPR protection rate it adopts either a complete copy protection strategy or accommodating strategy. In case of accommodating strategy, the IPR protection rate and investment undertaken by the MNC determines the entry of fake firm in the market. If the fake firm enters, the MNC acts as a price leader in the duopoly set up. In case of complete copy protection strategy the MNC acts as a monopolist (Fig.1).
Given the game tree, the game is solved using the backward induction method.
Atfirst the price game is solved. If the fake firm enters, MNC acts as the price leader and the fakefirm follows, otherwise a monopoly price solution is obtained.
Given the prices, the fake firm takes his entry decision which depends on the anti-copying investment of MNC and the monitoring rate exercised by the local government. Depending on the behavior of fakefirm the MNC decides about its anti-copying investment for each entry mode. It compares its profit under the
7Empirical evidences show that copy protection are available in a number of different types like digital licensing, digital watermarks, etc., for various forms of digital media, and are commonly referred to as Digital Rights Management Systems or DRMs. They describe a wide range of technical measures that are licensed for controlling, measuring, and enabling use of copyright protected digital content for different purposes. Technical Protection Measures (TPM) are the most often used, as they are for copy protection of digital content.
In case of software, copy protection is implemented in several forms either on the physical media that comes with the media or within the software itself. Many programs try to control piracy through product keys which are a unique string of numbers that a user must enter to register the product. Many game CDs and some audio CDs contain copy protection that prevents the disc from being copied or even played on other systems. http://www.ehow.com/how_6820532_detectcd-copy-protection.html, http://en.wikipedia.org/wiki/Digital_rights_management. Accessed on 09.
02.15.
8The AC strategy considers measures adopted by companies to make the task of copying harder or difficult. In this respect we must mention existence of ‘Indian Music Industry’ an association of all leading Indian recording companies. The companies have to pay a membership fee to become member of this association. This association undertakes anti-copying raids to deter piracy.http://
indianmi.org/. Accessed on 09.2.2015.
Apart from this anti-copying investment may be done by encrypting commercial discs to make copying them a little more difficult.http://www.howtogeek.com/161498/. Accessed on 09.2.2015.
9On the basis of empirical evidences the paper considers CP and AC strategies are the two completely distinct strategies to combat piracy.
different strategies to decide the optimal entry mode which essentially depends on the monitoring rate chosen by the LDC government. Finally given the MNCs choice the LDC government chooses its optimal monitoring rate.
2.2 The General Assumptions
The model assumes that the product is sold and consumed solely in the LDC. In addition, the product under consideration is such that its production is fragmented in two parts. In thefirst part, the production of the core material takes place. In the second part, assembling or finishing of the core material takes place. The LDC government chooses a monitoring rate g, where cost of monitoring C(g) is increasing and convex in g. Further it is assumed that complete monitoring by the government is costly Lt
g!1CðgÞ ! 1.
Government chooses IPR Protection Rate
MNC Export
Fragment
FDI
Enter
Enter Do not
Enter
Do not Enter
D
D
CP AC
CP
Pirate
Pirate
In all cases where pirate does not enter a monopoly outcome (M) is observed.
D denotes an outcome of price leadership game with the MNC as the price leader.
M
M
M
AC
M
M
Fig. 1 The game tree
The MNC is facing a linear demand function given as:
q¼ a P: ð1Þ
where q is the quantity demanded, P is the price of thefinal product, and a is the market size parameter.
Given the general assumptions the three options for entry by MNC in LDC market are Export, Fragmentation, and FDI in LDC. The model assumes that for the last two entry modes the possibility of technology diffusion exists and a fakefirm can enter the market. The model assumes that probability of copying of the original product by the fake firm is higher in FDI where complete transfer of technology takes place than in case of fragmentation where only embodied technology is transferred.
Given these assumptions the behavior of MNC and fakefirm for different entry mode is analyzed in Sect.3.