Sebastian von Engelhardt

The Economic Properties of Software

Software is a good with very special economic characteristics. Taking a general definition of software as its starting-point, this article  systematically elaborates the central qualities of the commodity which have implications for its production and cost structure, the demand, the contestability of software-markets, and the allocative efficiency. In this context it appears to be reasonable to subsume the various characteristics under the following generic terms: software as a means of data-processing, software as a system of commands or instructions, software as a recombinant system, software as a good which can only be used in discrete units, software as a complex system, and software as an intangible good. Evidently, software is characterized by a considerable number of economically relevant qualities—ranging from network effects to a subadditive cost function to nonrivalry. Particularly to emphasise is the fact that software fundamentally differs from other information goods: First, from a consumer’s perspective the readability and other aspects concerning how the information is presented, is irrelevant. Second, the average consumer/user is interested only in the funtionality of the algorithms but not in the underlying information.

The New (Commercial) Open Source: Does it Really Improve Social Welfare?

The number of open source (“OS”) software projects has grown exponentially for at least a decade. Unlike early open source projects, much of this growth has been funded by commercial firms that expect to earn a profit on their investment. Typically, firms do this by selling bundles that contain both OS software and proprietary goods (e.g. cell phones, applications programs) and services (custom software). We present a general two-stage Cournot model in which arbitrary numbers of competing OS and closed source (“CS”) firms decide how much software to create in Stage 1 and how many bundles to supply in Stage 2. We find that the amount of OS software delivered depends on (a) the degree of substitutability between proprietary products, (b) the number of OS and CS firms competing in the market, and (c) the savings available to OS firms from cost-sharing. However, code-sharing also guarantees that no OS firm can offer better software than any other OS firm. This suppresses quality competition between OS firms and restricts their output much as an agreement to suppress competition on quality would. Competition from CS firms weakens this quality-cartel effect, thus mixed industries often offer higher welfare. We find that Pure-OS (Pure-CS) markets are sometimes stable against CS (OS) entry so that the required OS/CS state never occurs. Even where mixed OS/CS industries do exist, moreover, the proportion of OS firms needed to stabilize the market against entry is almost always much larger than the target ratio required to optimize welfare. We examine various policy options for addressing this imbalance with tax policy, funding of OS development, and procurement preferences. We find that the first-best solution in our model is to tax OS firms and grant tax breaks to CS firms. Conversely, government policies that fund OS development or establish procurement preferences for OS software actually increase the gap between desired and actual OS/CS ratios still further. Despite this, funding OS development can still improve welfare by boosting total (private government) OS investment above the levels that a private cartel would deliver.

Industry self-governance: A new way to manage dangerous technologies

Advanced technologies for making chemical, biological, and nuclear weapons can be purchased from hundreds of companies around the world. But negotiating treaties to regulate this trade would take years‘and even then, many governments lack the will or resources to enforce them. Security experts often suggest that the United States could avoid these difficulties by encouraging industry to govern itself. Recent experience in the artificial DNA industry shows that this approach can yield large dividends. At the same time, officials need practical guidance about when private standards are possible and what government can do to promote them. The authors argue that private security standards work particularly well for industries in which manufacturers face massive fixed-cost investments, sell to large buyers, and face risk from intelligent adversaries. This profile fits most high-technology industries that security experts care about. The authors also discuss strategies that governments can use to promote, influence, and learn from private initiatives to regulate dangerous technologies.

Who Starts with Open Source? Institutional Choice of Start-Ups in the German ICT Sector

We analyze the characteristics of new businesses in the German ICT industry, distinguishing them based on their choice between two IPR regimes: open source software (OSS) or closed source software (CSS). The share of new firms with an OSS-based business model has increased considerably over the last several years. OSS-based firms tend to be smaller (in terms of staff and capital) and experience less shortages of capital. Only older cohorts of OSS-intensive start-ups had more difficulty than their CSS counterparts in convincing potential financiers of their viability, indicating that OSS business models are now well established. We find no evidence that the lower entry barriers for OSS firms are particularly attractive to start-ups with low human capital endowment or to necessity-motivated entrepreneurs.

Quality Competition or Quality Cooperation? License-Type and the Strategic Nature of Open Source vs. Closed Source Business Models

In the ICT sector, product-software is an important factor for the quality of the products (e.g. cell phones). In this context, open source software enables firms to avoid quality competition as they can cooperate on quality without an explicit contract. The economics of open source (OS) versus closed source (CS) business models are analyzed in a general two- stage model that combines aspects of non-cooperative R&D with the theory of differentiated oligopolies: In stage one, firms develop software, either as OS or CS, or as a an OS-CS-mix if the license allows. In stage two, firms bundle this with complementary products and compete a la Cournot. The model allows for horizontal product differentiation in stage two. The finding are: 1.) While CS-decisions are always strategic substitutes, OS-decisions can be strategic complements. Furthermore, CS is a strategic substitute to OS and vice versa. 2.) The type of OS-license plays a crucial role: only if the license prohibits a direct OS-CS code mix (like the GPL), then Nash-equilibria with firms producing OS code exist for all parameters. 3.) In the equilibrium of a mixed industry with restricted licenses, OS-firms offer lower quality than their CS-rivals.

Open Source Software, Closed Source Software or Both: Impacts on Industry Growth and the Role of Intellectual Property Rights

There is considerable debate regarding the use of intellectual property rights (IPR) to spur innovation in the software industry. In this paper we focus on the choice of intellectual property right regimes and industry growth. We begin by developing a growth optimal mixture of open source and closed source software. This optimal scenario is then used as a basis to examine the co-existence of open and closed source software within various institutional frameworks ranging from no protection, copyright to patent protection. Such an analysis is beneficial as it enables an objective comparison of the three scenarios under the assumption that both copyrights and patents serve the purpose for which they were designed. Our analysis, based on the existence or absence of spillovers, confirms that a co-existence is growth optimal for the industry. Further, we find that the move from no protection to copyright protection increases the maximum growth rate. However, despite assuming properly functioning patents, the benefits of moving from copyright to patent protection are less clear.

Wettbewerbspolitischer Handlungsbedarf bei der Verknüpfung von zweiseitigen Märkten im Internet: Der Fall Google

Abstract We discuss competition policy issues of vertical integration in internetbased two-sided markets against the background of the Google antitrust allegations. Network effects and economics of scale often lead to dominating companies, which are integrated over several markets. This implies efficiency gains but creates barriers to entry. Where entrants can appropriate dynamic effects accumulated by incumbents, barriers to entry are lowered but this reduces incumbents’ incentives to invest. Reducing multi homing and increasing switching costs is anti-competitive behaviour. Manipulating search results may leverage market power, but there is no theory on the ‚information power‘ of search engines. The concept of ‚search neutrality‘ is not convincing.