Network externalities, incumbent's advantage and the degree of openness of open source software start-ups

This paper proposes a formal model that analyzes the degree of openness chosen by start-ups when entering the software industry. In line with the literature, we label as degree of openness the extent to which software start-ups mix open source (OS) and proprietary solutions in the portfolio of software products they offer to their customers. We relate the choice of the degree of openness to two key characteristics of the market segments in which software start-ups operate, i.e. the strength of the network externalities and the competitive advantage of the incumbent. Specifically, by modelling (price) competition between an incumbent and an entrant in two ways, i.e. the entrant is price-setter or price-taker, we derive the necessary condition(s) in terms of the strength of network externalities for observing the adoption of a hybrid business model by the entrant (i.e. a business model that comprises the offering of both proprietary and OS solutions). Then, we highlight that, if a hybrid business model is the choice, the degree of openness chosen in equilibrium increases along with both the strength of the network externalities and the competitive advantage of the incumbent. This result holds indifferently whether the software start-up is modelled as a price-setter or a price-taker.