Licensing Decisions and Competition for Integration and Services in Open Source Software

By Terrence August Hyoduk Shin Tunay I. Tunca
July12009| Working Paper No. 3123

Open source software is becoming increasingly prominent, and the economic structure of open source development is changing. In recent years, firms that are motivated by revenues from software services markets have become primary contributors to open source development. In this paper, we explore firms’ economic incentives to foster open source software initiatives in lieu of proprietary ones and the role of services in software development and value generation. We present an economic model that jointly analyzes software originators and subsequent contributors’ investments in software development as well as pricing of software and services under competition. We find that, despite benefits the originator obtains from an external contributor in improving software quality under an open source strategy, increased contributor development efficiency may encourage the originator to choose a proprietary strategy. Due to strategic interaction between the originator and contributors, in certain cases, an increase in originator development efficiency can lead to increased contributor profits, while an increase in contributor development efficiency can reduce social welfare. Under an open source regime, increased service costs can increase both originator and contributor profits. Further, increased service costs can result in the software originator’s choosing an open source strategy and increase welfare, implying that taxes on service revenues imposed by a regulator may in certain cases prove beneficial. Exploring open source license selection, we identify conditions that determine an originator’s choice of license restrictiveness. We show that more restrictive licenses may increase development investments and software quality, but providing government subsidies for less restrictive licenses can improve welfare.