Economics of Open Source
by Sebastian Benthall
Hat tip to Paul Ramsey for the link to this blog post by Stephen O’Grady, “The Economics of Open Source: Why the Billion Dollar Barrier is Irrelevant.”
O’Grady argues that despite protests from those who haven’t seen the billion-dollar-value FOSS company of their dreams, open source business is doing great.
The question, remember, isn’t whether businesses and developers are consuming and producing open source software. They are, in droves. Nor are there questions as to whether or not the software can be sold successfully on a commercial basis: it is, every day. The only remaining questions really regarding the economics of open source are whether they can duplicate the margins of their proprietary predecessors, and frankly I think most customers hope they don’t.
This brings up an understated point about the economics of open source: that the proprietary software production model is a monopolistic model and hence bad for technology consumers. The high margins of proprietary software companies are due in part to monopolistic rents. The non-competitiveness of the proprietary software market leads to bloated, inefficiently created, and poorly supported software.
Another, related economic issue is the challenge of open source business, which O’Grady sums up like so:
Part of the challenge for open source software vendors, of course, is the fundamental difference between open source software and proprietary alternatives, not to mention other tangible goods: the primary asset to be sold is (generally) freely available.
I think this is a poor characterization of the problem. The problem is not that the asset to be sold is freely available. That would assume that software is the asset to be sold. But if an asset is “anything … capable of being owned or controlled to produce value and that is held to have positive economic value,” then free software can’t be the asset.
So what has to be primary asset for open source software vendors? The time of software experts who can do development or support.
At this point the analysis gets confused, because there are two issues at stake. Would-be open source billionaire entrepreneurs become disappointed that consulting and support around open source doesn’t scale as well as their proprietary software forebears. But this reaction is accentuated by another, independent problem: the free-rider problem around developer and support services.
Open source software vendors are in the business of shedding off public goods in the form of (improvements to) freely available software. This is why make sense for an open source vendor like OpenGeo to consider itself a social enterprise: it “does good” merely by operating.
But it also means that these services are going to be under-valued in the market because it is so difficult to capture the consumer demand for a software improvement as revenue.
How much does each user of a free software project value this new feature? Ok, sum that. That’s how much the open source vendor should be able to raise, in principle, for developing that feature–if there is only one potential supplier.
Proprietary software companies are able to capture this demand for the software improvements through the mechanism of selling the software itself. Free software developers won’t be able to raise as much–because they compete with each other as suppliers (which is good for society!)–but there is still a much bigger market there than is currently tapped into.
The kind of advance that will fuel open source business moving forward is mechanisms that allow for the capturing of this latent consumer demand.
The most literal case of this “crowdsourced microfunding,” a model that is greeted with mockery whenever I talk about it to people with industry experience, but which has recently had a preliminary success story: Diaspora’s skyrocketing funding via Kickstarter. Kickstarter, as opposed to other collaborative funding sites that have come and gone like Fundable.org, looks like it has some additional incentive structures built in that eliminate some of the Nash equilibria in the collaborative funding game in which not enough actors participate. (New York Times coverage and mass resentment towards Big Brother don’t hurt either.)
But there are other models for solving this problem as well. For GeoNode, the World Bank’s CAPRA initiative is seeking out partners to build a global community of funders to be in partnership with the developer community.
If this model works and is replicable, the potential impact on the software business world could be immense. Strategic cooperation between major funders would allow them to efficiently channel funding towards development while regulating against free-riders among themselves. The result would be a highly efficient market for software development–more efficient than either the proprietary software market or the free-rider-ridden free software market.
These speculations are consistent with O’Grady’s analysis: none of this leads to a billion-dollar corporation. But it does lead to a thriving economy of smaller scale consultancies, valued fairly according to their expertise, generating a torrent of free software available for all. Isn’t that the best outcome of all?
Digifesto 
Yuck.
“Open source software vendors are in the business of shedding off public goods in the form of (improvements to) freely available software. This is why make sense for an open source vendor like OpenGeo to consider itself a social enterprise: it “does good” merely by operating.”
I am suspicious of any claim like this. The form of it is familiar — it seems identical (in form) to “any entity that helps to grows the economy is doing a public service.”
I disagree entirely.
Increased production of (non public) goods (which grows the economy) doesn’t (at least not necessarily) cause greater economic equality.
Increased production of public goods necessarily does.
Er, meant to reply to this, not to myself. See below.
Increased production of a public good does not necessarily cause greater economic equality.
Increased production of a public good ought to lower the market price for that good.
A lower market price for that good benefits the buyers of that good. To a lesser[*] degree, it benefits the potential buyers of that good.
That’s as far as you can assume without further detail. A lower market price for that good *could* increase economic equality — if the increased *use* of that good necessarily increases economic equality, if the money saved by buyers of that good necessarily went toward increasing economic equality (rather than on, say, higher profits) — but it doesn’t *have* to.
[*] Because use of software requires significant capital investment besides the initial purchase: server costs, administration and maintenance costs, knowledge and time costs. The existing buyers have already made those investments, or already have the capability for those investments. With new buyers you can’t make that assumption.
I think this is an important fact about software, and makes me doubt whether it makes sense to assume all open source software is a public good: it is only self-evidently non-excludable if you ignore these factors. It is possible to imagine an open source software project that attains perfect excludability by having a high barrier of entry in those hidden costs with, say, poor documentation, difficult installers, obfuscated code, and demanding platform requirements; by hiring full-time all qualified developers as soon as they become qualified; and by selling service contracts.
This might not be a realistic or reasonable though experiment .. but I think it suffices to demonstrate a *theoretically* non-public-good-open-source-software. And plenty of real open source software projects fit *enough* of those criteria to question their non-excludability in *practice*.
I think your point about the use of ‘public software’ (can we call it that) is a good one. However, I maintain my point:
Increased production of a public good ought to lower the market price for that good.
More specifically, it should do it in a non-excludable way. So the reduction of market price in that good is “global” in an important sense.
This results in greater economic equality in this narrow sense (the one intended): that it increases purchasing power across the board increases, with effects distributed similarly to the way a progressive tax distributes its effects. (Lowering market prices, ceteris paribus, matters more to the poor than to the rich.)
So, to address your points more specifically:
I think there are equality effects of ‘public software’ even without stipulations on how it is used, because of the price reduction.
I should mention that this price reduction should effect not only the good itself, but also derivative goods and services. So while obviously not every consumer is going to use (for example) a GeoServer installation, it makes goods and service that depend on efficient data management (and there are a lot of them) cheaper (in a progressive way) if everyone can access that technology at a lower cost.
[open source software] is only self-evidently non-excludable if you ignore these factors.
I think that this is a question of the good in question.
If the good is “the source code”–and the other factors are related goods and services–then its still going to be a public good. (The digital divide is my main worry here…)
If you are talking about some other good or service of which the source code is merely a part, then sure.
However, I think its worth noting that public availability of the source code lowers the cost of creating unobfuscated code, documentation, better installers, etc.
So, while I don’t think your thought experiment is unreasonable, I think the case you raise would be an unstable one. If some company does what you describe, I’d guess there’d be economic pressure to fork the project and clean it up. (I don’t feel like I’ve got a lock down on this line of reasoning though.)