Two-Sided Competition of Proprietary vs. Open Source Technology Platforms and the Implications for the Software Industry

NYU, Law and Economics Research Paper No. 05-20

NET Institute Working Paper No. 05-06

36 Pages Posted: 20 Oct 2005

See all articles by Nicholas Economides

Nicholas Economides

New York University - Leonard N. Stern School of Business - Department of Economics

Evangelos Katsamakas

Gabelli School of Business, Fordham University

Date Written: October 2005

Abstract

Technology platforms, such as Microsoft Windows, are the hubs of technology industries. 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 applications 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 applications, and the platform access fee for applications may be below marginal cost, and we characterize demand conditions that lead to this. The proprietary applications sector of an industry based on an open source platform may be more profitable than the total profits of a proprietary platform industry. When users have a strong preference for application variety, the total profits of the proprietary industry are larger than the total profits of an industry based on an open source platform. The variety of applications is larger when the platform is open source. When a system based on an open source platform with an independent proprietary application competes with a proprietary system, the proprietary system is likely to dominate the open source platform industry both in terms of market share and profitability. This may explain the dominance of Microsoft in the market for PC operating systems.

Keywords: networks, network effects, network externalities, complements, systems, open source software, technology platforms, software industry structure

JEL Classification: L12, L13, C63, D42, D43

Suggested Citation

Economides, Nicholas and Katsamakas, Evangelos, Two-Sided Competition of Proprietary vs. Open Source Technology Platforms and the Implications for the Software Industry (October 2005). NYU, Law and Economics Research Paper No. 05-20, NET Institute Working Paper No. 05-06, Available at SSRN: https://ssrn.com/abstract=613601 or http://dx.doi.org/10.2139/ssrn.613601

Nicholas Economides (Contact Author)

New York University - Leonard N. Stern School of Business - Department of Economics ( email )

44 West 4th Street
New York, NY 10012
United States
212-998-0864 (Phone)
212-995-4218 (Fax)

HOME PAGE: http://www.stern.nyu.edu/networks/

Evangelos Katsamakas

Gabelli School of Business, Fordham University ( email )

140 West 62nd Street
New York, NY 10023
United States

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