Piracy in Commercial vs. Open-Source Software Competition

This paper studies pricing strategies for a commercial software provider who faces competition from both a free-of-charge open-source software substitute and illegal copies of its own product. When network externalities are present, the commercial software provider may choose to set a price sufficiently low such that a critical mass of users is not attainable for the open-source product, which consequently reduces the value of open-source software. I coin this pricing strategy “network limit pricing”. Due to lack of network benefits, network limit pricing leads to increased quality differences between the commercial and open-source products, which consequently leads to a market dominated by the commercial software product. Software piracy strengthens the incentives of imposing network limit pricing. This is because piracy takes over parts of the open-source product's market share, and because the price decrease to network limit pricing is lower, which reduces the opportunity cost of imposing this pricing strategy