Proprietary Software, Free and Open-Source Software, and Piracy: An Economic Analysis : A theoretical approach to competition between free and non-free software in the presence of unauthorised copying and network externalities

Abstract

This thesis aims to analyse the impact of software piracy on competition between a non-free proprietary type of software and a free/open-source type of software.

In pursuing this, I use a model inspired by Besley et al. (2010) originally applied to describe voting behaviour in political elections. In the benchmark model with no piracy there are two types of software: one free (e.g. open-source) and one non-free type (i.e. proprietary). I show that under certain conditions the proprietary software type may strategically take advantage of network externalities by reducing the price in order to prevent users from choosing the free type of software. In this way the proprietary software developer may avoid that the free software type generates sufficient network externalities in order to create high demand for the free software type. However, such a strategy may involve a large price reduction. Therefore, the profit maximising strategy may rather be to set the price higher so that both types of software generate sufficient network externalities to exist side by side.

When users have the option of obtaining an unauthorised copy of the proprietary type of software (i.e. piracy), the optimal pricing scheme may change relative to the no-piracy benchmark. I find that when piracy is present, it is more often optimal to keep the free type of software out of competition by strategically taking advantage of network externalities. This is because the threat from piracy may force a price reduction which also affects the demand of free software. In addition, piracy takes market share directly from the free type of software. Hence, market dominance of the proprietary type of software arise more easily when piracy is present.

Furthermore, I provide empirical evidence that suggests that Linux (i.e. free and open-source software) usage is negatively affected by the extent of software piracy.

The main conclusions of this thesis are that piracy affects demand for free/open-source software negatively, and that piracy may contribute to market dominance by the non-free proprietary software type when network externalities are present. This is because piracy mitigates the competitive advantage of free software (the price) in competition with non-free software. In addition, the pricing strategy towards competition from free software may change when piracy is present. Despite the market dominance that may occur from piracy, the model gives no implications that piracy may increase profits.