Linux vs. Windows: A Comparison of Application and Platform Innovation Incentives for Open Source and Proprietary Software Platforms

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1 NELLC NELLC Legl Scholrship Repository New York University Lw nd Economics Working Ppers New York University School of Lw --5 Linux vs. Windows: A Comprison of Appliction nd Pltform Innovtion Incentives for pen Source nd Proprietry Softwre Pltforms Nichols Economides Stern School of Business, economides@stern.nyu.edu Evngelos Ktsmks Business School, Fordhm University, ktsmks@fordhm.edu Follow this nd dditionl works t: Prt of the Antitrust nd Trde Regultion Commons Recommended Cittion Economides, Nichols nd Ktsmks, Evngelos, "Linux vs. Windows: A Comprison of Appliction nd Pltform Innovtion Incentives for pen Source nd Proprietry Softwre Pltforms" 5). New York University Lw nd Economics Working Ppers. Pper 3. This Article is rought to you for free nd open ccess y the New York University School of Lw t NELLC Legl Scholrship Repository. It hs een ccepted for inclusion in New York University Lw nd Economics Working Ppers y n uthorized dministrtor of NELLC Legl Scholrship Repository. For more informtion, plese contct trcy.thompson@nellco.org.

2 NET Institute* Working Pper #5-7 ctoer 5 Linux vs. Windows: A comprison of ppliction nd pltform innovtion incentives for open source nd proprietry softwre pltforms Nichols Economides Stern School of Business, NYU nd Evngelos Ktsmks Fordhm University * The Networks, Electronic Commerce, nd Telecommunictions NET ) Institute, is non-profit institution devoted to reserch on network industries, electronic commerce, telecommunictions, the Internet, virtul networks comprised of computers tht shre the sme technicl stndrd or operting system, nd on network issues in generl.

3 Linux vs. Windows: A comprison of ppliction nd pltform innovtion incentives for open source nd proprietry softwre pltforms + By Nichols Economides * nd Evngelos Ktsmks ** Revised Septemer 5 Astrct The pper nlyzes nd compres the investment incentives of pltform nd ppliction developers for Linux nd Windows. We find tht the level of investment in pplictions is lrger when the operting system is open source rther thn proprietry. The comprison of the levels of investment in the operting systems depends, mong others, on reputtion effects nd the numer of developers. The pper lso develops short cse study compring Windows nd Linux nd identifies new directions for open source softwre reserch. Keywords: open source softwre, operting systems, technology pltforms, Linux, innovtion incentives JEL clssifiction: L, L86, L3 + We thnk the editors Jurgen Bitzer nd Philip Schroder for useful comments nd suggestions. The uthors contriuted eqully nd the nmes pper in lpheticl order. * Stern School of Business, N.Y.U., 44 West 4th Street, New York, NY, tel: , neconomi@stern.nyu.edu, nd Executive Director, NET Institute, ** Grdute School of Business, Fordhm University, 3 West 6th St, New York, NY 3, tel: , fx: , ktsmks@fordhm.edu

4 . Introduction pen source softwre is n emerging type of softwre tht my fundmentlly ffect the usiness nd economic fetures of the softwre industry. Linux, n open source operting system, hs een the prominent exmple of the potentil of the open source movement, competing ginst Microsoft Windows, the incument operting system. This pper nlyzes the incentives to invest in ppliction softwre nd n operting system under two different softwre ecosystems: one sed on n open source operting system, such s Linux, nd the other sed on proprietry operting system, such s Microsoft Windows. We uild model extending Economides nd Ktsmks 5) to compre the innovtion incentives of ppliction developers nd operting system developers for Linux nd Windows. In our model, firms nd developers invest to improve the qulity of the pltform or the ppliction nd expnd the demnd y users of these softwre products. When the operting system is proprietry, the pltform provider nd the ppliction provider invest only in their own product to mximize their profit. When the operting system is open source, there is no pltform provider firm, ut the users invest in the pltform to mximize their user surplus nd their development reputtion, which depends on the success of the pltform mesured y its doption. This modeling pproch is justified y other open source reserch tht conceptulizes the users s developers Frnke nd Von Hippel 3, Von Hippel 5). Another innovtion of our model is tht it considers the strtegic interction etween the pltform developers investment incentives nd the ppliction developers incentives. We show tht this interction is importnt nd shouldn t e ignored in pulic policy. The existing dete of how innovtion is ffected y open vs. proprietry pltforms e.g. Lessig )) tends to focus only on the innovtion incentives of ppliction providers, ignoring the reltionship of these incentives with the incentives of the pltform provider.

5 Beyond the nlysis of investment incentives, we lso present short cse study compring Windows vs. Linux long three dimensions: the client-side, nd server-side nd the interction etween the client-side nd the server-side. We emphsize tht the comprison etween Windows nd Linux is n issue of compring two competing softwre ecosystems, not just two products. The existing Windows ecosystem of the operting system, pplictions, ppliction developers, nd service providers is competing ginst n emerging ecosystem centered on the Linux operting system. The short cse study enles us to identify directions for future reserch on open source softwre. The min findings of our nlysis re the following. First, the level of investment in the ppliction is lrger when the operting system is open source rther thn proprietry when the two operting systems re of equl qulity. Second, the level of investment in the operting system depends on numer of fctors, such s the strength of the reputtion effects for the developers of the open source operting system, the rtio of developers within the totl user popultion of the open source operting system, the level of investment in the pplictions within ech ecosystem nd the cost of dopting the open source operting system. An increse of one the first two fctors leds to reltive increse of the investment in the open source operting system, while n increse of the fourth fctor leds to reltive increse of the investment in the proprietry operting system. The pper hs the following structure. Section reviews the relted literture. Section 3 discusses the cse study of Windows vs. Linux nd identifies some new reserch directions. Section 4, develops the model nd nlyzes the innovtion incentives in the two lterntive softwre ecosystems, the open source nd the proprietry one. The conclusions section follows. 3

6 . Relted Literture The economics literture on open source focuses minly on the individul incentives to prticipte in open source projects, the incentives of firms to dopt open source inititives, the usiness models of firms operting within the open source lndscpe, nd the competitive implictions of open source softwre Lerner nd Tirole 4), Rossi 4)). Johnson ) models the contriution to n open-source project s prolem of privte provision of pulic good nd nlyzes the effect of incresing the numer of developers. Lerner nd Tirole, ) discuss the incentives of individul progrmmers nd softwre firms to prticipte in open source projects. They rgue tht progrmmers re motivted y peer recognition nd delyed creer enefits such s eing hired y softwre firm, or getting ccess to funding for future softwre ventures. Mustonen 3) proposes model in which the prticiption of progrmmers in opensource projects is endogenous nd shows tht low implementtion cost of n opensource ppliction is crucil for its survivl when it competes with proprietry ppliction. Csdesus-Msnell nd Ghemwt 3) study dynmic setting of competition etween Windows nd Linux. Bitzer 4) nlyzes why some softwre firms support Linux depending on the heterogeneity etween Linux nd the firms commercil product. Economides nd Ktsmks 5) nlyze the strtegic differences etween proprietry nd n open-source technology pltform nd their competition. Mustonen 5) nlyzes when proprietry softwre firm my support the development of sustitute open source softwre. Comino nd Mnenti 5) ssume informed nd uninformed users out the existence of open-source pplictions, nd study the welfre implictions of pulic policies supporting open-source softwre. DiBonn 999), Rymond ) nd Fink 3) provide good prctitioner overviews of open source softwre. 4

7 Perhps the closest pper to this one is Bitzer nd Schroder 3), which lso nlyzes the innovtion performnce of open source nd proprietry softwre development. It shows tht competition etween open source nd proprietry products leds to n increse of the level of technology of oth products, s result of incresed investment. The focus of Bitzer nd Schroder 3) is on the effect of competition on innovtion, while the focus of our pper is on direct comprison of the innovtion in the two lterntive softwre ecosystems, which consist of ppliction nd operting system developers. 3. Cse Study: Linux vs. Windows This cse study of Linux vs. Windows distinguishes etween the operting systems mrket for end users of desktop operting system client) nd the mrket for server operting systems server). The most interesting ttle tody is t the server side. 3. Client-side Recent studies suggest tht the mrket-shre of Linux t the client-side is round 3% nd some expect to it rech 7% y 7. This slow growth cn e ttriuted to lck of ese of use, smll vriety of pplictions, prolems with drivers tht enle users to connect other devices to their computing systems. Linux hs een mostly n operting system for power-users who hve Unix-like skills, ut this my chnge since the opensource community is developing severl friendly user interfces such s KDE. Switching costs from the dominnt Windows operting system mke it difficult for the Linux mrket-shre to grow fst. Much depends on the reltive vilility of pplictions for Windows vs. Linux nd the switching costs from the Windows ecosystem to the Linux ecosystem. There re mny open source pplictions under See 5

8 development, nd the open source-community hs recognized the strtegic importnce of mking their pplictions similr to the Windows pplictions to lower user switching costs. Mny open source pplictions such s penffice, the Mozill Firefox rowser etc) re lso comptile with Windows. These pplictions lthough they increse the recognition of the open source community, they strengthen the Windows ecosystem, therefore my hurt Linux in its competition with Windows in the short-term. However, the existence of these open source pplictions my reduce the switching cost to Linux in the long-term. At the sme time, there re mny proprietry pplictions tht re offered over the Linux operting system. Therefore, we do not see pure open source ecosystem competing with pure proprietry ecosystem, ut two ecosystems oth sed on mix of open source nd proprietry pplictions. Understnding the strtegic implictions of these mixed ecosystems is n interesting question for future reserch. 3. Server-side At the server side, IDC predicts doule-digit growth of Linux doption 3 nd tht Linux server shipments will rech 5.7 percent of totl shipments in 8. Linux is ecoming minstrem nd the Linux-sed pckged softwre mrket is expected to exceed $4 y eweek reports IDC sees doule digit growth continuing for Linux, Dec. 8 4 t 4 See 6

9 The totl cost of ownership TC) of Linux my e higher presently. 5 The migrtion from Windows environments to Linux is more costly thn the migrtion from Unix to Linux, since Linux is Unix-like operting system. Therefore significnt switching cost is protecting Windows. Both Windows nd Linux re currently gining mrket shre t the expense of proprietry Unix systems including the Sun versions of Unix), which tend to e closed nd expensive running on expensive hrdwre. The Linux ecosystem is developing fst in terms of numer, vriety nd qulity of pplictions nd vilility of support nd other complementry services. However, it is expected tht firms tht offer competing proprietry solutions will respond in vriety of wys, including the reduction of prices nd higher investment in their products. For exmple, Microsoft seems committed to reduce the security issues fced y Windows. Uncertinty out potentil litigtion risks due to uncler property rights nd confusing open source licenses lso hurts Linux. Sponsoring of Linux y ig IT compnies such s IBM nd HP is ffecting positively Linux ecuse it ffects the expecttions of customers out the prospects of the pltform. These firms re sponsoring Linux y developing or porting their enterprise pplictions to Linux such s IBM Wesphere), prticipting ctively in open source projects nd inititives nd sometimes leding open source projects, nnouncing pulicly their support nd their positive expecttions out Linux. Sponsoring of Linux y Europen nd Asin governments lso strengthens Linux. 5 See Ynkee independently pits Windows TC vs. Linux TC, Microsoft Wtch, Mrch 4 4, 7

10 Security prolems nd risks re hurting Windows. An independent study hs shown tht Linux kernel hs.7 security flws per, lines of code, compred to verge - flws of proprietry softwre. 6 Firms hve the option to compile their own for free Linux distriution, y undling the free Linux kernel with select utilities, ut there re severl competing commercil Linux distriutions such s Red Ht, SuSe etc). Therefore there is competition within the Linux pltform itself, esides the competition etween Linux nd Windows. There is need for more reserch to nlyze tht competition nd understnd the strtegies of competing Linux distriutors. There is n ongoing process of stndrdiztion 7 cross the different distriutions ensuring tht Linux ppliction cn run on ll distriutions. However, it is uncertin how successful this process will e in the future nd whether the risk of forking to incomptile distriutions will mterilize. The risk of forking is ffecting negtively the expecttions of potentil dopters nd the costs of ppliction developers for Linux, who my need to develop different versions of their pplictions for different Linux distriutions. The existing literture tends to focus on the development side nd not on the demnd side. It is uncler how nd where firms choose to dopt Linux nd open source pplictions. This my depend on the existing IT infrstructure, cpilities nd employee IT skills of firm, the size nd the industry of the firm. nly firms with sustntil IT cpilities nd resources my switch erly. Most firms re likely to hve mix of Linux nd Windows infrstructure evolving over time. For exmple Linux tends 6 See Linux kernel review shows fr fewer flws, eweek, Dec 4 4, t 7 Linux Stndrds Bse LSB), see 8

11 to ecome dominnt in We serving pplictions, comined with Apche, the dominnt we server ppliction tht is open source. 8 Prominent Internet compnies such s Google nd Amzon rely hevily on Linux. There is need for oth empiricl nd nlyticl work on the conditions under which firms dopt Linux nd open source, nd how this doption ehvior ffects the competition etween the two ecosystems. 3.3 Interction of Server-side nd Client-side There is lso significnt reltionship etween the client/desktop side nd the server side within n enterprise IT infrstructure. Since Microsoft is expected to hve dominnce t the client operting systems mrket nd mny pplictions) for long time this my give it n dvntge t the server mrket too. Alterntively, s Linux increses its presence t the server mrket, this my encourge its doption t the client mrket s well. The recent Europen Union court decision, requiring Microsoft to pulish some proprietry protocols tht define the interction of clients nd servers, my mke it esier to introduce Linux clients in networks tht depend on Windows servers The Model This section provides rief overview of the technology pltforms model of Economides nd Ktsmks 5) nd extends tht model to nlyze the investment incentives of different pltforms. 8 Apche s mrket-shre is lrger thn 68%, Microsoft s IIS mrket-shre is round % nd the difference etween the two is incresing over time; see We server survey, Netcrft, Jn 5, t 9 See Microsoft s secret codes, Wll Street Journl, Dec, 4. 9

12 The model consists of two softwre ecosystems, the first sed on proprietry pltform nd the second sed on n open source pltform. The softwre ecosystem sed on the proprietry pltform consists of one pltform firm selling the pltform A operting system), nd n independent ppliction developer selling B ppliction softwre). The pltform firm sells the pltform to the users t price p. The independent ppliction provider sells the ppliction to the users t price p. The ppliction provider pys lso n ccess fee s to the pltform firm. The fee s is set y the pltform firm nd it cn e negtive when effectively the operting system firm susidizes the ppliction developer. The demnd function of the pltform A is q p dp, nd the demnd of the ppliction B is q p dp, where prmeter d mesures the complementrity etween the pltform nd the ppliction. We ssume tht, > d, i.e., the own-price effect of ech product domintes the cross-price effect. The profit function of the pltform firm is π p q + sq, equl to the pltform profit from users plus the pltform profit from the ppliction ccess fees. The profit function of the ppliction provider is π p - s)q. The mrginl cost of production is zero for oth the pltform nd the ppliction, ecuse oth re softwre products esy to reproduce. The firms set prices in two-stge gme. In stge one, the pltform sets the ccess fee s pid y the ppliction provider. In stge two, the pltform nd the ppliction provider set the user prices p, p simultneously. The softwre ecosystem sed on n open source pltform consists of usersdevelopers tht help develop the open source pltform A, which is dopted y users for free, nd n independent ppliction provider firm tht develops nd sells the ppliction BB t price q u p. The demnd for the pltform A is c dp, nd the demnd for the ppliction is B is q p dc. Under open source, the profit function of the operting system is zero nd the profit function of the ppliction provider u

13 is π p q exogenous doption cost cu.. We lso ssume tht open source pltform users my fce n dditionl At equilirium, when the operting system is proprietry, the operting system nd ppliction profits excluding investment costs re + d ) d ) d ) + d ) π, 4 d ) 8 + d ) 8 + d ) π, respectively. Alterntively, when the operting system is open source, equilirium profits re π, + d π, 4 d ) nd the comined consumer surplus from the operting systems nd pplictions mrkets is CS + 3d ) 8d 8 d ) + 4. The following section extends this sic frmework y introducing new modeling fetures nd ssumptions tht enle us to nlyze nd compre the innovtion incentives in the two ecosystems. Innovtion Incentives Before the operting systems nd the pplictions re offered to users s defined ove, the softwre firms nd individul developers my invest in incresing i As noted in the cse study section 3), there is evidence tht the totl cost of ownership TC) of Linux is possily higher thn the TC of Windows, t lest s for now.

14 effectively incresing the qulity of the softwre product) expnding the demnd of the operting system nd the pplictions. We show tht the incentives to invest differ cross operting systems, nd we chrcterize the reltive strength of these incentives. When the operting system is proprietry, we ssume tht ) ech firm invests in its product to mximize its profit; nd ) neither the users nor the ppliction providers invest in the pltform, ecuse the pltform is closed. For exmple the qulity of Microsoft Windows depends lmost exclusively on Microsoft s investment in this operting system. When the operting system is open source, we ssume tht there re D users tht re D developers, nd define the proportion of such users s δ <. The developers q invest in the open source pltform so tht tht they mximize the user/consumer surplus CS from the open source pltform plus their reputtion vlue q ) R, where R.) is n incresing function of the doption of the open source pltform. The intuition is tht high doption of the open pltform is signl of success nd ll the developers tht prticipted expect some future enefits from tht for exmple future jo opportunities). Indeed the development of Linux, depends crucilly on investment of time nd effort of individul developers who lso use Linux s n operting system to run the pplictions they use Rymond ). We ssume tht the ppliction provider invests in the ppliction, nd it my invest on the pltform too. The gme now hs n investment stge tht precedes the two pricing stges descried t the eginning of section 4. We ssume tht the investment hs fixed cost reflecting the high fixed cost nd low vrile cost structure of softwre development. We ssume tht, y investing in product operting system or ppliction), the sponsor is le to push outwrds increse) the demnd for the product, here mesured y the prmeter i.

15 3 The firm incurs fixed cost indicted y the incresing nd convex investment function C i ). Assuming concvity of the profit functions, optiml choice of investment for profit mximiztion when the operting system is proprietry requires: perting System: ) ) ) C d d C π, ) Appliction: ) ) ) 8 ) C d d C + + π. ) The developer utility mximiztion nd ppliction firm profit mximiztion conditions when the operting system is open-source re: per. Syst.: C q R d d C q R CS ) ) ) ) + + δ δ δ, 3) Appliction: C C ) ) π. 4) We cn now prove the following proposition compring investment incentives in operting systems nd pplictions in the two ecosystems, s descried y equtions )- 4). Proposition. ) Provided tht the cost function for softwre development is the sme for open source nd proprietry developers nd tht the open source operting system is offered for free, investment in the ppliction is higher when the operting system is open source, i.e.,. <

16 ) Investment in the open-source operting system is lrger thn investment in the proprietry operting system if there re strong reputtion effects from prticiption in open source development, nd/or significnt prt of the open source users re developers nd the difference in ppliction investments is not lrge. Conversely, investment in proprietry S is smller when there re wek reputtion effects from prticiption in open source development, nd/or only smll prt of the open source users re developers nd the difference in ppliction investment levels is lrge. Proof: First, compre the mximiztion conditions of the pplictions, equtions ) nd 4). Since it follows tht + d ) < 8 + d ) < for ll, nd the cost function is convex in,. Now compre the mximiztion conditions of the operting systems. Becuse the cost function is convex, the investment in the open source operting system is lrger if nd only if R d ) δ + d + > δ δ 5). First, ssume tht the mrginl vlue of reputtion is zero for the open source developers. Then if δ nd δ, since d >, it follows tht 5) is flse, therefore < therefore. If δ > nd is not lrge, i.e., if δ < then 5) is true, nd. Alterntively, since the mrginl vlue of reputtion is positive, < ) strong enough reputtion effect such tht δ + d δ < δ d R is sufficient to fulfill 5) nd result in. < 4

17 The proposition suggests tht the investment in the ppliction is stronger when the operting system is open source. However, the comprison of investment levels in the operting system is miguous. When there re strong reputtion effects from prticiption in the development of the open source operting system, or significnt proportion of the users hve lso development skills, then the investment in the open source operting system is lso lrger thn the investment of firm controlling proprietry operting system. The proposition cptures oth the reputtion enefits nd the usge enefits of prticipnts in widely dopted open source projects. The ppliction provider for the open source operting system invests more thn the ppliction provider for the proprietry operting system, ecuse the first hs lrger mrginl profit for ll levels of investment. This is ecuse the open source operting system is dopted y users for free, enling the ppliction provider to set lrger price nd cpture lrger profit thn the ppliction provider for the proprietry operting system. The level of investment in the pplictions ffects the level of investment in the operting system, ecuse of the complementrity etween the ppliction nd the operting system. In prticulr, when the level of investment in the ppliction increses, the mrginl enefit of investing in the operting system decreses, s shown in equtions ) nd 3). Exogenous fctors tht reduce the doption of the open-source operting system, such s lrge doption cost c u, decrese the incentives of individul developers to invest in the open source operting system. Therefore, n independent ppliction provider my susidize the doption of the open source pltform not only to increse the sles of its ppliction, ut lso to increse the incentives of developers to invest in the operting system. 5

18 5. Conclusion We developed model to compre the incentives to invest in the operting system nd its pplictions oth under open source nd proprietry operting systems. We found tht the comprison of the levels of investment in the operting systems is miguous, ut the investment in pplictions is stronger when the operting system is open source. These results were developed under the ssumption tht the productivity of investment is the sme for proprietry nd n open source system. This is n issue where there is significnt disgreement, nd oth sides for profit softwre compnies nd open source developers) clim tht their productivity is higher. This clerly is n open reserch issue, ut the purposes of this pper chnge of the ssumption of the equl productivity of investment in oth environments will tend to chnge our result in fvor of the ecosystem tht is ssumed to hve higher productivity. For exmple, if it is ssumed tht the productivity of the open source development is lrger thn the productivity of proprietry softwre development, then C ) C ) < for ll nd, everything else eing equl, the reltive investment in the open source operting system increses; if it is ssumed tht productivity of proprietry softwre development is higher, the reltive investment in the proprietry operting system increses. An interesting extension of the current model would e the nlysis of the innovtion incentives in competitive setting nd the dynmics of innovtion. We lso developed short cse study of Linux vs. Windows. The discussion distinguished etween issues tht ffect the competition t the client-side, the server-side nd the interction etween the client-server sides. Besides the competition etween 6

19 Linux nd Windows, there is need for more reserch to nlyze nd understnd the strtegies of competing Linux distriutors. Also more reserch is needed in understnding the switching costs nd the open source doption strtegies of enterprises. Another importnt re is the interction etween client-side nd server-side softwre products nd how this interction ffects the competition in the softwre industry nd the success of open source. 7

20 References Bitzer, J. nd P. Schroder, 3. Competition nd innovtion in technology setting softwre duopoly. Discussion Pper 363, DIW Berlin. Bitzer, J., 4. Commercil vs. open source softwre: the role of product heterogeneity in competition. Economic Systems, 8, Csdesus, R. M. nd P. Ghemwt, 3. Dynmic mixed duopoly: model motivted y Linux vs. Windows. Hrvrd Business School Working Pper. Comino S. nd F. Mnenti, 5. Government policies supporting open source softwre for the mss mrket. Review of Industril rgniztion, 6), 7. Economides, N. nd Ktsmks, E., 5. Two-sided competition of proprietry vs. open-source technology pltforms. forthcoming, Mngement Science. Frnke, N., nd E. von Hippel, 3. Stisfying heterogeneous user needs vi innovtion toolkits: the cse of Apche security softwre. Reserch Policy, 37), Johnson, J. P.,. pen source softwre: Privte provision of pulic good. Journl of Economics & Mngement Strtegy 4): Lerner, J. nd J. Tirole,. The open source movement: Key reserch questions. Europen Economic Review 454-6): Lerner, J. nd J. Tirole,. Some simple economics of open source. Journl of Industril Economics 5):

21 Lerner, J. nd J. Tirole, 4. The economics of technology shring: open source nd eyond. NBER Working Pper 956. Lessig, L.,. The future of ides. Rndom House. Mustonen, M., 3. Copyleft - the economics of Linux nd other open source softwre. Informtion Economics nd Policy 5): 99-. Mustonen, M. 5), When does firm support sustitute open source progrmming Journl of Economics nd Mngement Strtegy 4): -39. Rymond, E.,. The Cthedrl nd the Bzr. 'Reilly Press. Rossi M., 4. Decoding the F/SS softwre puzzle. Working Pper, Universit di Sien. Von Hippel, E., 5. Democrtizing Innovtion. MIT Press. 9