Divide and Conquer: Competing with Free Technology Under Network Effects

Abstract

W e study how a commercial firm competes with a free open source product. The market consists of two customer segments with different preferences and is characterized by positive network effects. The commercial firm makes product and pricing decisions to maximize its profit. The open source developers make product decisions to maximize the weighted sum of the segments' consumer surplus, in addition to their intrinsic motivation. The more importance open source developers attach to consumer surplus, the more effort they put into developing software features. Even if consumers do not end up adopting the open source product, it can act as a credible threat to the commercial firm, forcing the firm to lower its prices. If the open source developers' intrinsic motivation is high enough, they will develop software regardless of eventual market dynamics. If the open source product is available first, all participants are better off when the commercial and open source products are compatible. However, if the commercial firm can enter the market first, it can increase its profits and gain market share by being incompatible with its open source competitor, even if customers can later switch at zero cost. This first-mover advantage does not arise because users are "locked in," but because the commercial firm deploys a "divide and conquer" strategy to attract early adopters and exploit late adopters. To capitalize on its first-mover advantage, the commercial firm must increase its development investment to improve its product features.

Strategies to Fight Ad-Sponsored Rivals

“…Casadesus-Masanell and Ghemawat (2006), Economides and Katsamakas (2006) and Lee and Mendelson (2008) for example, study duopoly models in which a profit-maximizing competitor interacts with an open source competitor. Casadesus-Masanell and Yoffie (2007) study competitive interactions between two complementors, Microsoft and Intel, with asymmetries in their objectives functions stemming from technology-software vs. hardware, and Casadesus-Masanell and Hervas-Drane (2009) analyze competitive interactions between a free peer-to-peer file sharing network and a profit-maximizing firm that sells the same content at positive price and that distributes digital files through an efficient client-server architecture.…”

Open source ERP business model framework

“…In this regard, OSS and proprietary software complete in many areas of the software market [11]. According to Lee and Mendelson [32], the optimal strategies of these two industries depend on both product timing and compatibility. Network effects (the ability to link work to other organizations, as in supply chains) make compatibility a key competitive factor.…”

The adoption of open source software in business models

“…The rise of FLOSS has forced the software industry to both lower prices and invest more in product innovation [1], thus playing a vital role in transforming the industry. Businesses, however, are still struggling to incorporate FLOSS into their overall strategy and perceiving the impact this has in the various elements constituting their commercial ventures.…”