Open-Source Software: Who Needs Intellectual Property?

Article excerpt

The market for open-source software - uncopyrighted, freely reproducible computer programs - is not well understood by economists. A central source of surprise is that innovation can thrive in a market without traditional inteUectual property (IP). But as we argued in a 2005 unpublished paper, "Perfectly Competitive Innovation," as a matter of theory there is no reason to believe that monopoly power through IP is needed for innovation. The market for open-source software is the poster child for this perspective.

First, understand that the market for open-source software is a classic example of a competitive market. It is characterized by the voluntary renunciation of copyright and patent. Buyers are entitled to make their own copies, modified or not, and seU them. "Free software" in this context means "free as in freedom, not free as in beer." There is also voluntary renunciation of trade secrecy: the original creator publishes the source code - the "blueprint" for producing the software - along with the software itself. Some open-source software has the further requirement that as a condition of use, buyers make their modification available under the same terms. The open-source movement has been called everything from a virus to socialism - so it may or may not be surprising to hear it called a model of a fully competitive market. Yet that is what it is, as much so as the market for wheat. AU purchasers of software can compete with the seUer and one another, and often they do.

Given that there are fixed costs of producing software and (it is commonly thought) competition drives profits to zero, how does this market function? How are the fixed costs covered? In the absence of profits from monopoly power, the source of income used to pay fixed costs is competitive returns. We wiU investigate three issues here. First, what is the source of the competitive returns that pay the biUs of software developers? Second, is the market a real market? That is, do software producers in fact get adequate compensation for the fixed costs of their efforts? Or is open-source software, as is sometimes alleged, simply an elaborate altruistic charity? Finally, we ask how significant the open-source software market is. Is it a thriving source of innovation, or just a free-rider off the innovations of more traditional closed-source IP-protected software, making cheap imitations that never would have been produced in the first place absent monopoly power?

The evidence (and the common sense of anyone involved with open-source software) shows that the source of competitive returns that pay the bills of software developers is the complementary sale of expertise. To earn a return through the sale of something, it must be something scarce. Copies of software may be scarce, but we shall see that the actual duplication of copies is sufficiently quick and inexpensive that only small returns can be obtained through the sale of copies. However, purchasers of copies of software programs also have a demand for services - ranging from support and consulting to customization. They naturally prefer to hire the creators of the programs, who in the process of writing the software have developed specialized expertise that is not so easily matched by imitators.

To understand the sources of competitive returns in this market, it is helpful to look at an example. A leading and profitable open-source software firm is Red Hat, a company that sells the computer operating system GNU/Linux, a modified and customized version of the underlying Linux system, with many features that can be optionaUy installed. Although the base system is in principle obtained by Red Hat for free, in fact it pays the developers. Alan Cox, one of the main kernel developers, works for Red Hat. The firm is also a contributor to the Open Source Development Labs, which employs Linus Torvalds, the developer of Linux. In addition Torvalds benefited from a substantial "gift" of stock options from Red Hat. …