The Host’s Dilemma: Voluntary Forfeiture in Platform Markets for Informational Goods

Jonathan BarnettUSC School of Law

March 5, 2010

Main Propositions

1. Easy proposition: Open organizational models for information production are not new.

2. A little harder proposition: Open organizational models for information production are not really open.

3. A somewhat harder proposition: The welfare implications of open models for information production are ambiguous, even for users.

Caricatures of Open Innovation

• (Some academic) Lawyers; (Many) Policy Advocates: Open source is revolutionary and really good. Let’s subsidize open “anything”.

• Economists: Open source appears to deviate from rational choice behavior. Let’s figure it out . . . Reputation effects; warm glow; intrinsic utility.

• Management scholars: Open source is the innovation engine of the future. Here’s a link to my book.

Open Innovation Is Neither New Nor Exceptional

• Bell Labs (AT&T): “Open” licensing (nominal royalty subject to cross-licensing), plus complementary know-how transfers

• Research disclosures, sometimes at “academic”-level volume and quality (IBM Technical Disclosure Bulletin; AT&T; IBM; Xerox)

• Open Software Foundation (1988): Not-for-profit organization founded by AT&T rivals to standardize Unix operating system.

• Microsoft: API disclosure with no revenue sharing. Result: > 70,000 applications for Windows (cf. 12,000 applications for Mac).

• Free software: Adobe Reader, Internet Explorer, Google, etc.

Transaction Paths in ICT Platform Markets

End-UsersEnd-Users

Developer-Users

Developer-Users

Platform: Software, Hardware, Operating System

Host’s Dilemma (I)

• Platform only has value over non-mediated transactions if it achieves scale, which implies network effects. Host must credibly commit to achieve scale.

• Users must make nonsalvageable learning and adaptation investments to use the platform or any other platform. Host must credibly commit against hold-up behavior after achieving scale.

• Hold-up opportunities are abundant. – Change price for access– Change level of access– Withdraw or constrain support– Planned obsolescence

• So long as host expropriates value < switching costs, users will capitulate. By anticipation, users decline to adopt (or “underadopt”).

Windows Releases (Desktop Systems)Release Release Date Type

Windows 1.0/1.01 Nov. 1985 16-bit

Windows 2.0 Dec.1987 16-bit

Windows 3.0 May 1990 16-bit

Windows 3.1 Apr. 1992 16-bit

Windows 95 Aug. 1995 16 & 32-bit

Windows 98 June 1998 16 & 32-bit

Windows 98 SE May 1999 16 & 32-bit

Windows 2000 Prof. & Server Feb. 2000 32-bit

Windows Me Sept. 2000 32 & 64-bit

Windows XP Home & Professional Oct. 2001 32-bit

Windows XP Media Center Edition 2003 Dec. 2003 32-bit

Windows XP Media Center Edition 2005 Oct. 2004 32-bit

Windows XP Professional x64 Edition Apr. 2005 64-bit

Windows Vista (Business Versions) Nov. 2006 32 & 64-bit

Windows Vista (Desktop Versions) Jan. 2007 32 & 64-bit

Windows 7 Oct. 2009 32 & 64-bit

Host’s Dilemma (II)

• Platform is a theoretically durable good. But host maximizes long-term profits by constraining durability through upgrades and extensions.

• In multi-period setting, reputation effects constrain hold-up behavior as platform achieves scale. But reputation is not a complete solution if host can not credibly commit against end-period behavior.

• Result: Host’s dilemma persists at every release. This is true even assuming (i) end-user myopia, and/or (ii) developer myopia.

Non-Exclusive Imperfect Solutions

• Contract: Not all forms of hold up are perfectly contractible (not anticipated or not verifiable). E.g.: extent/quality of support or backwards compatibility.

• Integration: – Not all users can be integrated (e.g., end-users) – Integration costs can be exorbitant

• Forfeiture:– Set price below short-term profit maximizing price– Disclosure of trade secrets (e.g., source code, specifications)– Disclaim control rights or transfer ownership over platform

Forfeiture/Control Tradeoff

• Complete forfeiture resolves the credible commitment problem. But it destroys any direct funding stream.

• Long-term profit maximization requires that the host select some intermediate combination of incomplete forfeiture and incomplete control over the consumption bundle.

• Control can be asserted in three non-exclusive ways:1. Assert control over some portion of the platform2. Assert control over platform with respect to some users3. Give away platform and assert control over complementary

goods

Old Models: Closed to Semi-Open• The Mainframe Model (IBM):

– Customized software “given away” with hardware and support– Hardware usually leased

• The Unix Model (AT&T): – OS developed at Bell Labs– Widely licensed at nominal fee until AT&T breakup (1983)– Funded by implicit user tax through AT&T monopoly

• The Windows Model (Microsoft):– OS licensed broadly to OEMs (Dell, etc.)– Widely releases APIs and beta versions to third-party developers

• The Mac Model (Apple):– OS preinstalled as part of hardware; not available for license– Limited cultivation of third-party developers

Old Software Model: Semi-Closed

Platform Holder (OS)

APIs+ support

Independent Developers OEMs/

Users

OS

$

$

Software Applications

New Software Model I: Community (Pure Open Source)

CoreContributors

Users

Bug reports, patches

Code releases subject to license at no fee

Obstacles

1. No support/warranty

2. “Forking” (multiple versions)

3. Privatization (depending on “reciprocity” term)

User-Contributors

New Software Model II: “Community Lite”(Hybrid Open Source)

Foundation Entity

Core Contributors

User-Contributors

Proprietary Sponsors

“Distributions”; Services; Hardware

Users

$$Reports, patches

Code subject to license at no fee$

Selected Open Source Foundations

Application (market share)

Foundation Governance Structure

Linuxkernel (8%server market)

LinuxFoundation

Membership entity. Classes based on increasing dues with increasing representation rights on board. Max. 2 reps/member.

“Ubuntu” Linuxdistribution

UbuntuFoundation

No members. Self-appointing Community Council. Public commitment to zero royalty.

GNOME GUIdesktop

GNOME Foundation

Advisory Board with representatives from sponsor entities. Members are exceptional contributors as determined by Board. 40% cap on board representation by single entity.

FirefoxBrowser (20%)

MozillaFoundation

No members. Self-appointing board. No corporate representation. Derives 88% of funding from Google “royalty” contract.

Apacheserver application (47%)

ApacheFoundation

Individual members (300). Self-appointing board; almost no corporate representation.

Linux Platform (OS Kernel)

Linux Foundation (subject to Board of 15 sponsor plus 2 independent reps)

Core Contributors

Sponsors/Members:IBMNovell IntelRed HatOracleFujitsuHPBank of AmericaHitachi NetAppAMDNECTexas InstrumentsMotorola

$500K/yr/p.c

$

Staff (>50% total)

Contributors-Users

UsersCode

Reports, etc.

>1/3 code changes, >1/2 signoffs

Distributions; other goods and services

$

Patent Invention Network

Patents

Leading Sponsors of Linux

Sponsor Level of Involvement Related Products

IBM Sponsor >$500K/yr. $1B commitment announced in 1999. 10,000 Linux-related positions. Responsible for 6% of code changes and 5.3% of signoffs.

Linux-compatible hardware (servers), middleware, client applications; related consulting services.

Intel Sponsor >$500K/yr. Responsible for 6% of code changes and 6.4% of signoffs.

General microprocessor; Linux-based operating system platform for mobile devices.

Red Hat Sponsor >$100K/yr. Responsible for 12% of code changes; 36.4% of signoffs.

Red Hat Enterprise Linux distribution; related support and warranty services. Top seller of supported Linux operating systems.

Novell Sponsor >$500K/yr. Responsible for 6% of code changes and 8.2% of signoffs.

SUSE Linux Enterprise distribution; related support and warranty services. Second leading seller of supported Linux operating systems.

New Software Model III: Market Altruism (Sun Microsystems)

2005: Releases Solaris operating system source code; establishes independent OpenSolaris Governing Board, which sets forth Open Solaris Constitution

Sun Inc.

Hardware, Supported Software

(Paying) Users

OS Code subject to no-fee license

Governing Board, subject to Charter, Constitution

“Core Contributors” (Members)

Approved Community Groups

Nominate members

Non-Profit Strategies in the Mobile OS Wars

1. Nokia (Symbian OS) (47% worldwide smartphones): • 1998: Symbian established by Nokia, Motorola and Ericsson to

hold acquired Psion OS.• 2008: Nokia pays $410M for OS and transfers it to non-profit

Symbian Foundation• Feb 2010: Foundation “open sources” OS.• Foundation founders: AT&T, Fujitsu, Nokia, NTT Docomo,

Qualcomm, Samsung, Sony Ericsson, TI, Vodafone

2. Competing Initiatives– Google (Android OS): Open Handset Alliance, sponsored by

Google and various chip, telecom and handset providers.

– Linux Mobile OS: LiMo Foundation, sponsored by various telecom and handset providers.

– Intel/Nokia (MeeGo OS): Linux Foundation hosts open source software platform for mobile devices, developed by Intel, Nokia

Organizational Competition: Mobile OS Market

Operating System Foundation/Parent Global market share (2009)

Symbian Symbian Foundation (open source) 47%

Blackberry RIM 20%

Apple iPhone Apple 13.7%

Windows Mobile Microsoft 12.4%

Android Open Handset Alliance (open source) 2.8%

MeeGo Intel, Nokia (open source) --

LiMo LiMo Foundation (qualified open source) --

Palm WebOS Palm --

Main Points; Implication

• Both for-profit and not-for-profit entities regularly forfeit knowledge assets in order to resolve the “host’s dilemma” and elicit user adoption.

• Voluntary forfeiture is a strategic, not ideological, choice. Relaxing access at any point in the consumption bundle requires access restrictions at some other point.

• Welfare implications of “open” over “closed” are indeterminate a priori. Open platforms may be welfare-neutral, welfare-improving or welfare-detrimental relative to closed platforms.