competitive strategy for open source software vineet kumar (harvard business school) brett r. gordon...
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Competitive Strategy for Open Source Software
Vineet Kumar (Harvard Business School)Brett R. Gordon (Columbia University)
Kannan Srinivasan (Carnegie Mellon University)
Presentation at Chicago Booth School of Business, March 2011
What is Open Source Software?
• Software for which source code are in the public domain
• Examples: Linux, OpenOffice, Firefox Browser, Android, etc.
• Anyone can view, modify, customize for personal use
• Contributions made by individuals and firms
• Different from free software (Adobe Reader, Skype, etc.)
Microsoft on Open Source
• Microsoft CEO Steve Ballmer on Linux:– “…a cancer that attaches itself in an intellectual
property sense to everything it touches.” (NYT, 2003)
Open Source Markets
Two types of open source market structures, depending on license
Private Features (BSD):– Open source features are freely available to anyone, including
firms without restrictions.– Commercial firms can reuse these features in their products
Shared Features (GPL):– Open source features are available for use.– Commercial firms who use these features in product must give
back ALL features to the public domain
The Software Industry and Open Source
Puzzles from theOpen Source Industry
• Why Do Developers Contribute to Open Source?– Numerous studies (more later)
• Why would COSS firms contribute to features knowing that their competitors can take advantage of these contributions?
• Are firms and/or consumers worse off from the “cancer” of free-riding?
• How can a market based on free-riding produce better quality products?– Industry observers note that some COSS products are of better
quality than traditional closed-source software products.
Related Research
• Product Development and Co-creation– Prahalad (2002), Ramaswamy & Gouillart (2010):
How should a firm enable and incentivize consumers to create products?
– Rowley et al (2007), Lorenzo et al (2007)
• Open source versus Closed source– Leppamaki & Mustonen (2009) : should a firm open source its
products?– Casadesus-Masanell & Ghemawat (2006) : Windows versus Linux
Little to no research on competitive strategy of COSS firms
Why Do Developers Contribute?
• Use value– Intrinsic motivation to create something useful for them
• Altruism– Want to help the world (through open source)
• Signaling– Want to prove programming skills and capabilities in order to
improve employment possibilities– We focus on this explanation
Open Source & Developers
Open Source & Developers
Why Do Developers Contribute?
Relevant literature on developer motivations to contribute:
– Hars & Ou (2002): survey of developers reports that a majority list career concerns as primary reason for contributing
– Roberts, Hann, & Slaughter (2006): extrinsic factors, such as job concerns, play largest role
– Fershtman and Gandal (2007): less restrictive and more commercially-oriented licenses result in more contributions
– Lerner and Tirole (2002): in a lit review, find most evidence consistent with signaling perspective
Model
• Duopoly market with firms 1 and 2– Based on vertical differentiation models (Shaked and Sutton 1982,
Moorthy 1988)
• Each firm develops one product
• Consumers have heterogeneous value for quality,
• Each consumer buy either one of the products or nothing
• Firms endogenously differentiate on quality in equilibrium
( ; ) , (0, )U q q p U M
Firms hire developers and determine product features and usability
Firms set prices in the product market
Market structure is exogenously determined
Consumers make purchase decisions
Firms decide how many features to copy from competitor(only for shared features)
Developers contribute to open
source to signal their skill-level
0 1 2 2S 3 4
Model Timeline
What is Software Quality?
• Features (F), or functionality: basic operations of software– e.g. support for budget functions in excel, a calculator built into a
word processor
• Usability (s): enables a user to effectively utilize the functionality available– e.g. user interface enhancements, online help, tech support and
service
• Recall that– Usability is always kept private– Features may have to be shared in the public domain
( , )q Q F s
Open Source Markets
Two types of open source market structures, depending on license
Private Features (BSD):– Open source features are freely available to anyone, including
firms without restrictions.– Commercial firms can reuse these features in their products
Shared Features (GPL):– Open source features are available for use.– Commercial firms who use these features in product must give
back ALL features to the public domain
1f1s 2f 2s
1s 1fFirm 1 chooses and
OSS0F
Initial OSS features available to all
Firm 1’s Product
Firm 2’s Product
2s 2fFirm 2 chooses and
1 1( , )Q F s 2 2( , )Q F s
Priv
ate
Feat
ures
1 0 1F F f 2 0 2F F f
Private Product Market
Shared Product Market
1f1s 2f 2sOSS0F
Initial OSS features available to all
1 2F F
Firm 1’s Product
Firm 2’s Product
Contribution
to OSS Cont
ributi
onto
OSS
Shar
ed F
eatu
res
1s 1fFirm 1 chooses and 2s 2f
Firm 2 chooses and
0 1 2F f f
1 1( , )Q F s 2 2( , )Q F s
Summary: Product Market• Duopoly market with firms 1 and 2
• Consumers are heterogeneous in taste in quality:
• Quality depends on the market type (P or S)
• In shared market, each firm also decide degree of copying
• Each consumer buy either one of the products or nothing
( ; ) , (0, )U q q p U M
Developer Market
Incentive Compatibility & Individual Rationality
IR for low-skilled developers does not need to be satisfied
Low-type
High-type
Developers expect wage
( , ( ))Le r w e( , ( ))He r w e
Firm 1 hires developers
Initial level of OSS
features available to all
Product Market
( )w e
OSS Features0
H LH LF f e f e
External markethires developersD
Firm 2 hires developers
Developers (High and Low)
Developer Signaling
• Spence (1973) models education as a signal of ability• Assumes a perfectly competitive market for
employers• We model an imperfectly competitive market for
developers• Signals have a “spillover” effect in two ways:
– Developer-Firm: Substitutability between developer contributions and firm contributions
– Firm-firm: Shared features market implies competitive spillovers
Firms hire developers and determine product features and usability
Firms set prices in the product market
Market structure is exogenously determined
Consumers make purchase decisions
Firms decide how many features to copy from competitor(only for shared features)
Developers contribute to open
source to signal their skill-level
0 1 2 2S 3 4
Model Timeline
Equilibrium Analysis
Solve the game by backward induction
• Stage 3+4: Pricing sub-game– Given product quality, firms simultaneously choose prices and
consumers make purchase decisions
• Stage 2: Given developer market outcome, firms determine product strategies and quality decisions– Firms determine how much to invest in features and usability
by hiring developers to create more features.– Usability is available through a competitive market where the
COSS firms are price takers
Pricing Game Equilibrium
• Prices are determined as function of quality• Common to both private features and shared
features markets
Product Strategy Equilibrium
• Complete free-riding in equilibrium in shared features market
• Full copying occurs
Developer Equilibrium Analysis
Solve the game by backward induction
• Stages 2+1: Developers and Firms• Firms determine how much to invest in features and usability by hiring
developers to create more features.• Developers of high and low types make contribution decisions
• Firms attempt to infer developer skill-level by observing contribution.• Low-skilled developers make different contributions than high-skilled
developers.• Signaling game yields multiple (infinite) equilibria
• Filter out unreasonable equilibria using Intuitive Criterion (Cho and Kreps, 1987)• Focus on Least Cost Separating Equilibrium
Analysis of Developer Market
Incentive Compatibility & Individual Rationality
IR for low-skilled developers does not need to be satisfied
0
R
High-skilled developers
Connecting Product & Developer Markets
• Demand for high-skilled developers:– COSS Firms and External Market
• Supply of high-skilled developers by signalingDetermine market wage by equating Excess demand (w) = demand(w) – supply(w) = 0
Wage Comparative Statics
• Equilibrium wage is determined from implicit equations
• “w” increases with market size M, cost of signaling and decreases with cost of usability
Puzzles from theOpen Source Industry
• Why would COSS firms contribute to features knowing that their competitors can take advantage of these contributions?
• Are firms and/or consumers worse off from the “cancer” of free-riding?
• How can a market based on free-riding produce better quality products?– Industry observers note that some COSS products are of better
quality than traditional closed-source software products.
Results
• Why would COSS firms contribute to features knowing that their competitors can take advantage of these contributions? – A larger base of features increases the value (to firms) to
differentiating even more on usability– Requires that features and usability are complements
• In the presence of free-riding behavior, can COSS firms make positive profits?– Yes, differentiating on usability and reducing the intensity
of competition in the developer market helps.
Results• Which market result in more available open source
features?– When market size is large, private features market results
in more open source features.
• Copying in shared features market – who copies from whom?– Both firms end up copying the maximum possible
features from each other
Results
• Who is hurt by the cancer of “free-riding”? – Consumers ALWAYS benefit from the shared
features market. (Both) firms may also benefit from the shared features setting if the market is large enough.
Extensions and Limitations
• Firms do not choose which license
• Multi-product firms that compete across markets with different licenses
• Allow firms to endogenously release software to open source
Thank You
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