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Innovation through Optimal Licensing
MIT Center for eBusinessNov 3, 2005
Marshall Van AlstyneBoston University & MIT
Geoffrey ParkerTulane University
Sponsored by NSF IIS-0338662
© 2005 Van Alstyne
Agenda
• Motivation & Examples 10• Redefining network effects 15
– Non-mathematical intuition & biz logic• Formal Model 10
– Claims & proofs• Stimulating innovation 25
Topic Time
© 2005 Van Alstyne
US Constitution – Article 1, Section 8, Clause 8 :
Congress shall have power to promote the progress of science and useful arts, by securing for limited times to authors and inventors the exclusive right to their respective writings and discoveries.
© 2005 Van Alstyne
The Debate
Longer is Better Free / Open is Better
• Infinitely long but narrow patents– Gilbert & Shapiro ‘90
• Infinitely renewable ©– Landes & Posner ’03
• Even “perfect” control better for incentives– Wagner ‘03
• Capturing sequential innovation– Green & Scotchmer ‘95
• Fundamental right of access– Stallman ‘92
• Tragedy of the “AntiCommons”– Heller & Eisenberg ’98
• Collective production– Benkler ’02– Hippel & Krogh ’03
• Open Science (enablement)– David ‘04
© 2005 Van Alstyne
Motivating Issues• OSS licenses destroy economic incentives to
innovate.
– Even Raymond admits that such licenses only permit indirect business models like sale of services.
• To build on a code base, a developer needs access and permission. Hold-up and monopsony curb innovation.
• Neither patent nor copyright law adequately solve the problems of full disclosure & enablement for software.
© 2005 Van Alstyne
Tension exists between ownership & access.
True for all kinds of platform goods.
© 2005 Van Alstyne
Incentives to develop software
U.S.
U.K.
Germany
Japan FranceItaly
BrazilKoreaRussiaChina0
10
20
30
40
50
0.2 0.4 0.6 0.8 1
Piracy Rate
Softw
are
Rev
enue
pe
r cap
ita ($
)
Source: Software & Information Industry Association
© 2005 Van Alstyne
Reusable Art
Sarah Boxer “Chomp if you like Art” 12-27-04 NYT
Piet Mondrian. Broadway Boogie Woogie. 1942–43. Oil on canvas, 50 x 50"(127 x 127 cm)
© 2005 Van Alstyne
Reusable Art
Bacchus & Ariadne by Titian
© 2005 Van Alstyne
Reusable Maps
1897 Rand McNally map © 2002 Cartography Associates, David Rumsey Collection, used with permission.
© 2005 Van Alstyne
Reusable Music• Music based on the same
beat– Pitbull: Culo– Elephant Man:
Youngbloods– Twista: Jook Gal (Remix)– Nina Sky: Move Your Body
Girl
• Creative Commons– David Byrne– Chuck D– Zap Mama– Thievery Corporation
© 2005 Van Alstyne
Mash-Ups• I'm awed by the power of
the people: the hackers, the experimenters, the strangers who help strangers in the online cellphone forums. If the cellphone companies were smart, they'd realize that these customers are their allies, not their enemies.
Source: NYT 10/20/05 – “Journey to a Thousand Maps Begins With an Open Code”
David Pogue NYT 10/27/05
© 2005 Van Alstyne
Question: What are “network externalities?”
Hint: they matter for platform growth and development…
© 2005 Van Alstyne
Reinterpreting Network Externalities
FAX
• “Network Externalities”are demand economies of scale.
• They imply at least some level of interaction as when I email you, or you FAX or IM me.
Phone E-Mail
IM
© 2005 Van Alstyne
Reinterpreting Network Externalities
• Where is the interaction when your neighbor rents “Lord of the Rings”?
• In fact, his rental may mean you have to wait!
© 2005 Van Alstyne
A “2-sided” network externality crosses markets from consumers
to developers or developers to consumers
© 2005 Van Alstyne
Product Category Mkt 1 Product Intermediary Mkt 2 Product
Portable Documents Document reader* Adobe Document Writer
Credit Cards Consumer credit* Issuing bank Merchant Processing
Operating Systems Complementary Applications
Microsoft, Apple, Sun Systems Developer Toolkits*
Plug-Ins Applications Software Microsoft, Adobe Systems Developer Toolkits*
Ladies’ Nights Men’s Admission Bars, Restaurants Women’s Admission*
TV Format Color UHF, VHF, HDTV*
Sony, Phillips, RCA Broadcast Equipment
Advertisements Content* Magazines, TV, Radio Advertisers
Computer games Game Engine/ Player Games Publishers Level Editors*
Auctions Buyers* E-bay, Christie’s, Sotheby’s
Sellers
Streaming Audio/Video Content* RealPlayer, Microsoft, Apple
Servers
* Indicates which market is discounted, free or subsidized. Source: Parker & Van Alstyne 2002
Readily identifiable platform markets
© 2005 Van Alstyne
Consider profits in two marketsMarket Two
(Acrobat Distiller)Market One
(Acrobat Reader)
Pric
e
Pric
e
q1
p1
q2
p2
QuantityQuantity
Initially, there are profits to be made in both markets.
Consider profits in two marketsMarket One
(Acrobat Reader)Market Two
(Acrobat Distiller)
Pric
e
Pric
e
Quantityq2
p2
Quantityq1
p1
Initially, there are profits to be made in both markets.
© 2005 Van Alstyne
But subsidizing market one can increasedemand and profits in market two morethan the loss in market one.
© 2005 Van Alstyne
Why this can also create profits
V4V3
Indu
stry
Pro
fitPlatform Value
V1 V2 V3V4
Pric
e
q1
p1
V1
V2
Quantity
© 2005 Van Alstyne
Question: So how do you stimulate innovation on your
platform?One answer: manage your
platform standards, specs & IP to promote it…
© 2005 Van Alstyne
Consider a Flexible License
• A default contract offered to anyone.• Original author opens portions platform to public,
keeping a key complement proprietary.• Offers open source style license but forces
disclosure on derivative works after T years.• Inventor profits from
– sales of complementary good– New versions: 5%x1e9 > 95%x1e6
© 2005 Van Alstyne
OSS ClassificationType Free Redist Unlimited
UseSrc.
Avail.Src.Mod.
PublicCheckIn
Viral
Commercial
Trial SW x
Shareware x x
Royalty Free Bin. x x x
Royalty Free Lib. x x x x
Open Src (BSD) x x x x x
Open Src (Apache) x x x x x x
Open Src (Linux/GNU) x x x x x x x
Source: Vinod Valloppillil / The Halloween Document
© 2005 Van Alstyne
Most licenses are boundary solutions
σσ
tt
GPL
BSDMS EULA
New
100
1API• Let σ∈[0,1] be the
measure of openness.
• Let t∈[0,1] be the time to release derivative works.
© 2005 Van Alstyne
Coding on the shoulders of giants…
VA
NU
But can’t charge for fraction σ given away.
Platform authors can charge for VA.
(1-σ)VA
+∆U
Opening the code promotes adoption and opportunities for adaptation.
+∆U Opening the code promotes adoption and opportunities for adaptation.
VD2
+∆U
Repeat...
VD1
Developers add value.
© 2005 Van Alstyne
VA
NU
How can we model the feedback from Developers → Consumers → Developers …?
+∆U
(1-σ)VA
Tatonnement:
õûVa ! eduõûVa ! eudeduõûVa ! edueudeduõûVa ! :::
Defines Cauchy sequences: M D = 1à edueud
õûVa M U = 1à edueud
eduõûVa
© 2005 Van Alstyne
Model Parameters
Va = Intrinsic platform Value (from original author)
û = Shared platform value, openness
t = Time until derivative works become open
Ò = Open platform resources (0 until original author contributes)
N u; N d = Native Users and Developers with no network externalities
M u; M d = Network Multipliers from Users and Developers respectively
î = Discount factor (just simpler form of )eà r t
p = Price charged during proprietary period
k = Reuse or Konversion rate of open resources in new production
© 2005 Van Alstyne
• Consumer & Developer participation
• Free/Open Platform Evolution
qut = N u + M uÒt
qdt = N d + M dÒt
Ò1 = ûVa
Ò2 = Ò1 + qd1õÒ1(1 à eà r t)
© 2005 Van Alstyne
Model Timing
0 1 2
Developers respond toσ and t. Consumers choose
consumption levels.
Dvprs create newworks using t = 1 code.Consmrs choose again.
Platform authorChooses σ and t.
© 2005 Van Alstyne
This provides flexible BizModels
• Direct consumer sales– Office Suites (word processing,
spreadsheet, presentation)– Graphics packages (Photoshop,
Illustrator, ...)– DB & Statistical tools (Access,
Oracle, Stata, …)
• Indirect growth in sales– Operating System APIs– Office Suite plug-ins– 3rd party DB & Stat add-on
packages
• Indirect developer royalties– Game cartridges– Streaming media– Flash & PDF distiller
ùa = qu1(Va à Ò1) + :::
ùa = ::: + î (qu2 à qu1)(Va à Ò1) + :::
ùa = ::: + þp1qd1qu1 + î þp2qd2qu2
© 2005 Van Alstyne
When Openness “Wins”
Innovation Test:
M uVa(1 + N dkî (1 à î )) > = N u
For any given user base , there exist user side network effects platform values , or developer value added , that justify opening the code .
N u M uVa N dkî (1 à î )
û > 0
Optimum absent Innovation:
ûã = 21 à M uVa
Nu
Even if there is no innovation with reuse , user side network effects are sufficient to justify opening the code .û > 0
k = 0
© 2005 Van Alstyne
License Welfare ComparisonsOpen BSD and GPL licenses create greater total welfare. But unless the royalty rate exceeds a key threshold, an author prefers EULA
BSD is better if developers are profit motivated. GPL is better if developers are freedom motivated.
The flexible license always meets or exceeds both corner solutions, doing especially well if there is a mix of motives .
License Total WelfareAuthor ProfitauVNEULA
BSD
GPL
auVN
)( 22auuuaud VNMNkVNM +φ )1)(1( audauau VNkMVMVN ++
)1( auau VMVN +0
© 2005 Van Alstyne
Profits & Social Welfare Can Rise
Profits
Social welfare
• Social welfare and profits both show clear optimal values.• t can dynamically adjust to industry clockspeed.• Implies a hybrid can be better for profits and welfare.
© 2005 Van Alstyne
Why not subcontract in lieu of opening code?
Benefit Cost
• No sacrifice of (1-σ) code• Can open all own code to developers• Can contract for developer sharing
• Users can’t see, modify, or redistribute code
In the absence of network effects, subcontracting always dominates
But, in the presence of incentives, there is always some level ofnetwork effects that makes an open license more profitable.
© 2005 Van Alstyne
So Why Don’t Developers “Do The Right Thing” Naturally?
The answer is a prisoner’s dilemma.
arising endogenously from:1. Larger reusable code base complements development.2. Private desire to charge lengthens t.
This implies that contracts must enforce disclosure and some governance structure is better than anarchy
HoardDeveloper B
(πHH, πHH)
Free
(πHF, πFH)
(πFH, πHF) (πFF, πFF)
Hoard
Free
πHH > πFH πHF > πFF
Deve
loper
A
© 2005 Van Alstyne
Issue 1
Problem: OSS licenses destroy economic incentives to innovate.
Proposal: Return sufficient pricing power to developers to restore incentives. At a minimum, benefits to developers should cover direct expenses and opportunity costs.
© 2005 Van Alstyne
Issue 2
Problem: To build on a base of code, a developer needs not only access, but also permission. Hold-up and the monopsonyproblem reduce innovation incentives.
Proposal: As with GPL, offer a default contract that allows innovators the freedom to act upon their ideas.
© 2005 Van Alstyne
Issue 3
Problem: Certain licenses create opportunities to fork the code base. Consequences include VA Linux, Red Hat Linux, Free BSD, OpenBSD, Net BSD and Mac OSX.
Proposal: Require developers to license enhancements back to author who commits to withhold them from common code base until expiration of the proprietary period.
© 2005 Van Alstyne
Issue 6
Problem: Technology markets compete on components vssystems. But monolithic sellers lack “best-of-breed” parts while fragmented sellers suffer from multi-party bargaining.
Proposal: Commencement of the free period permits near zero cost transfer of enabling technology throughout developer pool. Best enhancements enter the code base with trivial bargaining cost distortion.
© 2005 Van Alstyne
Conclusions• Consider a license that positions your
intellectual property as a platform upon which diverse sources can build.
• Access to source code affects who can innovate but incentives affect who will innovate.
• Proprietary systems benefit from becoming more like OSS while OSS benefit from becoming more proprietary.
