When to Use the Open Business Model for Software Products under Network Effects?

Open business models, whereby incumbent software firms share their intellectual property (IP) with third parties, have been increasingly used in business practices (Parker and Alstyne 2013). For example, BitPay, the largest payment processor for bitcoin (a cryptocurrency), shares its IP (source code) so that other startups can develop similar bitcoin payment software apps to accelerate the adoption of bitcoin. Additional examples of companies using open business models in the software space include SAP (Ceccagnoli et al. 2012) and Salesforce. More industry examples using open business models in both the markets for information goods such as software and markets for physical goods such as t-shirts have been documented by Parker and Alstyne (2013) and in Lessig (2002). However, there are few formal studies on open business models (Parker and Alstyne 2013) that offer actionable guidance on when a firm should embrace an open business model compared with traditional closed (do-not-open) business models. In this paper, we address the following research question: Under network effects and competition, when should an incumbent software firm share its IP and its market with a potential third-party entrant? Using a game-theoretic model, we identify conditions under which the software maker should embrace the open business model and when it should not. One novel finding we uncover is an interesting back-and-forth switch pattern among optimal business models (open vs. closed) as the strength of network effects increases: when the quality of the software product of the third party competitor is below a threshold, as the strength of the network effects increases from low to medium, the incumbent software firm switches to an open business model. Surprisingly, as the strength of the network effects continues to increase, after a higher threshold, the incumbent software firm switches back to the closed business model. We discuss managerial implications and our program of work in the conclusion section.