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Two-sided competition of proprietary vs. open source technology platforms and the implications for the software industry

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Author Info
Nicholas Economides () (Stern School of Business, NYU)
Evangelos Katsamakas () (School of Business at Fordham University)

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Abstract

Technology platforms, such as Microsoft Windows, are the hubs of technology industries. The strategic behavior of a firm controlling a platform affects crucially industry evolution. We develop a framework to characterize the optimal two-sided pricing strategy of a platform firm, that is, the pricing strategy towards the direct users of the platform as well as towards firms offering components that are complementary to the platform. We compare industry structures based on a proprietary platform (such as Windows) with those based on an open-source platform (such as, Linux) and analyze the structure of competition and industry implications in terms of pricing, sales, profitability, and social welfare. We find that, when the platform is proprietary, the equilibrium prices for the platform, the application(s), and the platform access fee for applications can sometimes be below marginal cost, and we characterize demand conditions that lead to this. We find that the social welfare in the software industry may be higher when the platform is open source rather than proprietary and the cost of adopting the open source platform is small. The proprietary applications sector of an open source industry is more profitable than the total profits of a proprietary platform industry when the demand of the proprietary platform is not much stronger than the demand for the application(s) and the own-price effect of the platform is strong (demand for the platform is relatively elastic) while the own-price effect of the application is weak (demand for the application is relatively inelastic). When a system based on an open source platform with an independent proprietary application competes with a proprietary platform with an independent application, the open source system is typically dominant in terms of market share.

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Publisher Info
Paper provided by NET Institute in its series Working Papers with number 04-22.

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Length: 34 pages
Date of creation: Aug 2004
Date of revision: Aug 2004
Handle: RePEc:net:wpaper:0422

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Web page: http://www.NETinst.org/

For technical questions regarding this item, or to correct its listing, contact: (Nicholas Economides).

Related research
Keywords: networks; network effects; network externalities; complements; technology platforms; software industry structure; open source software;

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References listed on IDEAS
Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
  1. Joseph Farrell and Michael L. Katz., 2000. "Innovation, Rent Extraction, and Integration in Systems Markets," Economics Working Papers E00-286, University of California at Berkeley. [Downloadable!]
    Other versions:
  2. Rochet, Jean-Charles & Tirole, Jean, 2003. "Platform Competition in Two-Sided Markets," Open Access publications from University of Toulouse 1 Capitole http://neeo.univ-tlse1.fr, University of Toulouse 1 Capitole. [Downloadable!]
  3. Mikko Mustonen, 2005. "When Does a Firm Support Substitute Open Source Programming?," Journal of Economics & Management Strategy, Blackwell Publishing, vol. 14(1), pages 121-139, 03. [Downloadable!] (restricted)
  4. Jürgen Bitzer & Philipp J. H. Schröder, 2003. "Competition and Innovation in a Technology Setting Software Duopoly," Discussion Papers of DIW Berlin 363, DIW Berlin, German Institute for Economic Research. [Downloadable!]
  5. Mark Armstrong Author-Email: mark.armstrong@ucl.ac.uk, 2006. "Competition in Two-Sided Markets," RAND Journal of Economics, The RAND Corporation, vol. 37(3), pages 668-691, Autumn.
    Other versions:
  6. Rochet, Jean-Charles & Tirole, Jean, 2003. "Platform Competition in Two-Sided Markets," IDEI Working Papers 152, Institut d'Économie Industrielle (IDEI), Toulouse. [Downloadable!]
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  7. Lerner, Josh & Tirole, Jean, 2002. "Some Simple Economics of Open," Journal of Industrial Economics, Blackwell Publishing, vol. 50(2), pages 197-234, June. [Downloadable!] (restricted)
  8. Justin Pappas Johnson, 2002. "Open Source Software: Private Provision of a Public Good," Journal of Economics & Management Strategy, Blackwell Publishing, vol. 11(4), pages 637-662, December. [Downloadable!] (restricted)
  9. Economides, Nicholas & Salop, Steven C, 1992. "Competition and Integration among Complements, and Network Market Structure," Journal of Industrial Economics, Blackwell Publishing, vol. 40(1), pages 105-23, March. [Downloadable!] (restricted)
  10. Economides, Nicholas, 1989. "Desirability of Compatibility in the Absence of Network Externalities," American Economic Review, American Economic Association, vol. 79(5), pages 1165-81, December. [Downloadable!] (restricted)
  11. Jean-Charles Rochet & Jean Tirole, 2002. "Cooperation Among Competitors: Some Economics Of Payment Card Associations," RAND Journal of Economics, The RAND Corporation, vol. 33(4), pages 549-570, Winter.
  12. Katz, Michael L & Shapiro, Carl, 1994. "Systems Competition and Network Effects," Journal of Economic Perspectives, American Economic Association, vol. 8(2), pages 93-115, Spring. [Downloadable!] (restricted)
  13. Armstrong, M., 2006. "Competition in two-sided markets," Open Access publications from University College London http://eprints.ucl.ac.uk/, University College London. [Downloadable!]
  14. Carmen Matutes & Pierre Regibeau, 1988. ""Mix and Match": Product Compatibility without Network Externalities," RAND Journal of Economics, The RAND Corporation, vol. 19(2), pages 221-234, Summer. [Downloadable!] (restricted)
  15. Economides, Nicholas, 1996. "The economics of networks," International Journal of Industrial Organization, Elsevier, vol. 14(6), pages 673-699, October. [Downloadable!] (restricted)
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  16. Lerner, Josh & Tirole, Jean, 2001. "The open source movement: Key research questions," European Economic Review, Elsevier, vol. 45(4-6), pages 819-826, May. [Downloadable!] (restricted)
  17. Caillaud, Bernard & Jullien, Bruno, 2001. "Chicken and Egg: Competing Matchmakers," CEPR Discussion Papers 2885, C.E.P.R. Discussion Papers. [Downloadable!] (restricted)
  18. Josh Lerner & Jean Tirole, 2005. "The Economics of Technology Sharing: Open Source and Beyond," Journal of Economic Perspectives, American Economic Association, vol. 19(2), pages 99-120, Spring. [Downloadable!] (restricted)
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Full references

Cited by:
(explanations, Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.)

  1. Nicholas Economides & Joacim Tag, 2007. "Net Neutrality on the Internet: A Two-sided Market Analysis," Working Papers 07-27, New York University, Leonard N. Stern School of Business, Department of Economics. [Downloadable!]
    Other versions:
  2. Vitor Trindade & Johannes Moenius, 2007. "Networks, Standards and Intellectual Property Rights," Working Papers 0705, Department of Economics, University of Missouri. [Downloadable!]
  3. Juan D. Carrillo & Guofu Tan, 2006. "Platform Competition: The Role of Multi-homing and Complementors," Working Papers 06-30, NET Institute, revised Oct 2006. [Downloadable!]
  4. Nicholas Economides, 2007. ""Net Neutrality," Non-Discrimination and Digital Distribution of Content Through the Internet," Working Papers 07-9, New York University, Leonard N. Stern School of Business, Department of Economics. [Downloadable!]
    Other versions:
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