Open to Your Rival: Competition between Open Source and Proprietary Software under Indirect Network Effects

Abstract

With the popularity of open source software (OSS) as an alternative to proprietary software (PS), proprietary-software firms such as IBM and Microsoft started to embrace this new paradigm during the past decades. We analyze how firms choose the software development strategy between OSS and PS, by constructing a duopoly model in which consumers sequentially purchase software and complementary services in a market that exhibits an indirect network effect. We show that a PS firm may benefit from the presence of an OSS firm, and the software market can be dominated by a single OSS if the indirect network effect is weak and the cost saving effect of OSS is negligible. We also show that the market can support two OSS if the cost saving effect of OSS is sizeable, and two PS if firms can provide fully compatible services to competitor’s PS. Building upon the existing works that investigate the competition between PS and OSS, this study improves our understanding of the role of OSS in firm’s software development strategy and market equilibrium.