Innovation, Openness, and Platform Control

Abstract

Suppose that a firm in charge of a business ecosystem is a firm in charge of a microeconomy. To achieve the highest growth rate, how open should that economy be? To encourage third-party developers, how long should their intellectual property interests last? We develop a sequential innovation model that addresses the trade-offs inherent in these two decisions: (i) Closing the platform increases the sponsor’s ability to charge for access, while opening the platform increases developer ability to build upon it. (ii) The longer third-party developers retain rights to their innovations, the higher the royalties they and the sponsor earn, but the sooner those developers’ rights expire, the sooner their innovations become a public good upon which other developers can build. Our model allows us to characterize the optimal levels of openness and of intellectual property (IP) duration in a platform ecosystem. We use standard Cobb–Douglas production technologies to derive our results. These findings can inform innovation strategy, choice of organizational form, IP non-compete decisions, and regulatory policy.

Keywords: Open Innovation, Sequential Innovation, Two-Sided Markets, Two Sided Networks, Platforms, Patent Length, Network Effects, Externalities, R&D Spillovers, Bundling, Vertical Integration, Standard Setting Organizations

JEL Classification: L00, L11, L5, O3, O31, O32