31 Jul 2012Working Paper Summaries

Investment Incentives in Proprietary and Open-Source Two-Sided Platforms

by Ramon Casadesus-Masanell and Gastón Llanes

While proprietary and open-source software have coexisted since the early days of the computing industry, competition between these two modes of development has intensified dramatically following the surge of the Internet in the mid-1990s. This paper provides a first step to better understand incentives to invest in proprietary and open platforms. Specifically, the authors examine a model of a proprietary and an open-source two-sided platform to study equilibrium investment in platform quality. Their analysis provides answers to three important questions: (1) How are the incentives to invest in platform quality affected by the degree of platform openness? (2) Which of these two modes of governance leads to investment closer to the social optimum? And (3), how are incentives to invest in platform quality moderated by competition between proprietary and open two-sided platforms? Comparing monopoly platforms reveals that for a given level of user and developer adoption, investment incentives are stronger in proprietary platforms. However, open platforms may receive larger investment because they may benefit from wider adoption, which raises the returns to quality investment. The authors also find that proprietary platforms may benefit from higher investment in competing open platforms when developers multi-home, a result that helps explain why a proprietary platform such as Microsoft has chosen to contribute to the development of Linux. Key concepts include:

Through access prices, a monopolistic proprietary platform can ensure that a particular level of investment in platform quality takes place regardless of how much users pay for applications.
Quality investment in open platforms may be larger than for proprietary platforms, due to larger user and developer entry. Therefore, open platforms may lead to investments in platform quality closer to social efficiency.
When developers multi-home, the proprietary platform may benefit from higher quality investment in a competing open-source platform. This result explains why proprietary firms may choose to contribute to the development of competing open-source platforms.

Author Abstract

We study incentives to invest in platform quality in proprietary and open-source platforms. A comparison of monopoly platforms reveals that for a given level of user and developer adoption, investment incentives are stronger in proprietary platforms. However, open platforms may receive larger investment because they may benefit from wider adoption, which raises the returns to quality investment. We also study a mixed duopoly model of competition and examine how the price structure and investment incentives of the proprietary platform are affected by quality investments in the open platform. We find that access prices may increase or decrease as a result of investment in the open platform, and the sign of the change may be different for user and developer access prices. We also find that the proprietary platform may benefit from higher investment in the open platform when developers multi-home. This result helps explain why a proprietary platform such as Microsoft has chosen to contribute to the development of Linux.