Competitive Strategy for Open Source Software Vineet Kumar (Harvard Business School) Brett R. Gordon (Columbia University) Kannan Srinivasan (Carnegie.

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