Why Open‑Source Software Is Reshaping Industry Competition and Innovation

3.1 Software Industry Follows Traditional Industry Development Patterns

In the first thirty years of computer history IBM faced only one lightweight competitor, Digital Equipment Corporation (DEC). IBM's mainframes were too expensive for small companies and schools, creating demand for cheaper, lower‑performance machines, which DEC supplied. The market was not saturated, allowing both firms to coexist.

During the era of mainframes and minicomputers, the computer industry, like previous technological revolutions, used vertical integration: chips, boards, whole machines, operating systems, and applications were all produced in‑house. IBM was even sued for monopoly in 1970 for controlling hardware, OS, and applications, a case that lasted twelve years.

In 1976 Steve Jobs, a college dropout, built the first commercial personal computer, the Apple I, in a garage. The rise of personal computers transformed the industry's structure from vertical integration to horizontal specialization and cooperation, marking the start of the information‑technology revolution. The PC’s affordability followed the pattern that each technological revolution’s core elements become cheaper and more accessible.

IBM observed the PC trend but assigned a small Florida team, rather than its elite Watson Labs, to develop a PC. The team used Intel’s 8088 CPU and contracted an independent software company for the software stack.

For the operating system, IBM first approached Digital Research (DR) but failed to agree on price. Microsoft’s Bill Gates bought a disk‑based OS (MS‑DOS) for $75,000, then sold it to IBM, keeping the source code and charging a $5 royalty per PC. Microsoft also provided a free BASIC interpreter to attract developers and create dependence on its platform.

In 1982 IBM settled an antitrust case with the U.S. Department of Justice, agreeing to allow competitors to develop. The PC’s components—CPU, disk, display, keyboard—were often sourced from third parties, while the OS remained Microsoft’s.

IBM initially thought profit came from hardware, not software, but the rise of compatible PCs eroded its margins, turning IBM into one of many PC manufacturers.

Antitrust pressures forced industries toward specialization, economies of scale, and higher efficiency, but also created a “Marshall conflict” where competition drives scale, which can lead to monopoly, reducing overall efficiency.

Historical examples show how industries evolve from fragmented small firms to large monopolies, prompting antitrust legislation such as the Sherman Act (1890) and subsequent break‑ups of monopolies like Standard Oil.

Software firms also face the Marshall conflict, seeking scale economies.

Microsoft’s dominance grew from 1981 onward with MS‑DOS on IBM PCs, reaching over 80% market share by Windows 95. To avoid a full monopoly, Microsoft bought Apple stock in 1997, kept Windows and Office as growth engines, and saw revenues rise from $1.8 billion (1991) to $23 billion (2000).

Microsoft’s Windows and IE were investigated for antitrust violations in 1996‑1998, leading to a 2000 ruling that ordered a breakup, which was later overturned. The case highlighted how software platforms can become essential infrastructure, akin to oil or railroads.

3.2 Software Industry Differs from Traditional Industry

Moore’s Law predicts exponential performance growth of IT products. Unlike traditional industries, the IT sector exhibits high fixed costs, low marginal costs, and strong network externalities, leading to market structures where a single firm can dominate (the 70‑20‑10 rule).

Traditional sectors like oil, automotive, finance, and retail rarely have a single dominant firm; market shares stay below 20%. In IT, high fixed costs and low marginal costs enable a firm to capture a large user base, creating a positive feedback loop.

Two key reasons enable this:

High fixed cost, low marginal cost: manufacturing costs are a tiny fraction of total cost; copying software is nearly free.

Network externalities: the value of a product increases with the number of users, leading to “winner‑takes‑all” dynamics.

Network effects were first described in 1974 and later formalized as “path dependence,” where early adoption locks in standards and creates self‑reinforcing advantages.

Software’s direct network externalities arise from user communication within the same system; indirect effects stem from the complementarity between operating systems and applications.

These dynamics make it difficult for antitrust measures to break software monopolies, as scale economies and network effects quickly re‑establish dominance.

3.3 Rationale for Open‑Source Software

In knowledge‑intensive industries with strong network effects, private property rights grant software firms near‑monopoly power, raising costs for consumers and hindering technological progress.

Open‑source licensing reduces these barriers: users can freely obtain, modify, and redistribute code, lowering switching costs and encouraging competition.

The information‑technology revolution creates a new economy where knowledge is the primary production factor, and transaction costs for private IP become prohibitive. Open‑source public‑property models better align with these economic conditions, reducing costs, improving resource utilization, and fostering innovation.

3.4 Changes Brought by Open‑Source Software

3.4.1 Changes in the Software Industry’s Competitive Landscape

Open‑source software can transform monopolistic markets into oligopolies or competitive markets, prevent collusion among dominant firms, and promote product differentiation.

Key mechanisms:

Open source lowers innovation costs, allowing multiple versions to coexist.

Proprietary software’s high development costs limit competition to a single firm.

Open‑source advantages include lower price, broader functionality, and the ability to meet diverse user needs, especially in enterprise and embedded markets.

Market Entry Competition

Entry barriers in software include structural factors (scale economies, technology) and strategic actions (predatory pricing, exclusive contracts). Network externalities and high switching costs further raise barriers.

Technical Innovation Competition

Software innovation involves high fixed R&D costs, high risk, and complexity. Open‑source communities reduce costs through shared resources, lower transaction costs, and avoid duplicated effort.

Business‑Model Innovation Competition

Open‑source commercialisation combines research and development with community contributions. Common models include professional services, dual licensing, re‑licensing, and advertising‑supported software.

Examples: Red Hat’s subscription model, MySQL’s dual‑license, Apple’s macOS (BSD‑based) re‑licensing.

Strategic Shifts of Proprietary Vendors

From the 1980s to 2010s, proprietary firms focused on product competition; since the cloud era, they have shifted toward cooperation and service‑based models. Microsoft’s evolution—from anti‑open‑source tactics to embracing Linux contributions, Azure, and GitHub acquisition—illustrates this transition.

Impact on Competition

Open‑source drives lower prices, higher sales volumes, reduced producer surplus for monopolists, and increased consumer surplus. It also forces proprietary firms to lower prices and improve offerings.

3.4.2 Interaction Strategies Between Different Industry Players

Component competition in IT means that operating systems, applications, and hardware are interdependent. Open‑source changes the dynamics by enabling new partnerships, cross‑licensing, and collaborative standards.

Examples include Wintel alliances, Intel’s cooperation with Linux vendors, and Microsoft’s support for AMD.

3.4.3 Open‑Source Accelerates Regional Technology Spillovers

Since the 1980s, the information‑technology revolution has reshaped capitalism into “information capitalism,” where knowledge assets dominate. Open‑source software facilitates technology transfer to developing regions, helping close the digital divide.