DP12901 Open source hardware as a profit-maximizing strategy of downstream firms

Author(s): Alfonso Gambardella, Eric von Hippel
Publication Date: April 2018
Keyword(s): Competitive Advantage, Competitive Strategy, Corporate Strategy, Open Innovation, Technology Strategy
JEL(s): L21, M21, O32
Programme Areas: Industrial Organization
Link to this Page: www.cepr.org/active/publications/discussion_papers/dp.php?dpno=12901

This paper characterizes and explores a corporate strategy in which downstream firms collaborate to develop open substitute designs for proprietary hardware they would otherwise purchase from upstream suppliers. This strategy centrally involves customers themselves distributing design costs over multiple customers – a strategy that is routine to producers selling to multiple customers, but which has been impractical for coalitions of customers until fairly recently. Today customers find it increasingly feasible to co-design products they may all purchase due to two technological trends. First, CAD-CAM and other design technologies are lowering downstream firms' costs to develop designs for purchased hardware inputs. Second, better communication technologies are lowering the costs of doing such projects collaboratively, even among large groups of downstream customer firms. Customer firms collaborating to develop a design for a hardware input they all purchase could in principle choose to protect their design as a club good. However, opening up collaboratively-created designs to free riders can increase the profits of the contributing firms for several reasons that we explore and model. Important among these is that free revealing draws free riders away from purchases of proprietary software or hardware to customer-developed free substitutes. This reduces the markets of upstream suppliers of competing proprietary inputs. Free riders also, in the case of hardware only, contribute to reducing the average manufacturing costs of the open hardware by increasing purchase volumes and so creating increased economies of scale. Resulting reduced unit purchase costs benefit customers contributing to the free design as well as free riders.