What Can Firms Do in the Face of Model Distillation?

Model distillation has become a major concern in the rapidly growing generative AI discourse. In its simplest form, distillation is the phenomenon where smaller firms can use data distilled from transcripts of conversations with powerful proprietary closed-weight models to train their own models, thus achieving reasonably high model quality but at much lower costs. Besides the legitimate safety and security concerns associated with distillation, another major issue is how it can also distort marketplace outcomes. This motivates us to initiate an exploration of the problem from an economic theory lens. We consider a setting with two players: an incumbent and a distilling competitor and characterize how the incumbent's model characteristics drive the incentives around how much the competitor should distill. We also consider the impact of distillation on key market outcomes like user-side surplus and the incumbent's utility. Our key contribution, however, is to study interventions for preventing or limiting distillation attacks. In this context, we study two settings: i) when it is possible, with a certain probability (which grows in the extent of distillation conducted), to detect an attack on the incumbent's model; and ii) when a distillation attack cannot be reliably detected. In the first setting, we show that penalty-based regulations can be very effective in completely deterring distillation, although it can have potentially adverse effects on market competition and user surplus. In the latter setting, we show that the incumbent can use self-distillation as a mitigation strategy. Importantly, the effectiveness of self-distillation depends on how cost-efficiently the incumbent can deploy a new self-distilled model on the market. On the positive side, self-distillation can preserve market competition thus protecting user surplus to some extent.