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Profitability under an open versus a closed system

Author: Kende, Michael INSEAD Area: Economics and Political Science Series: Working Paper ; 92/49/EPS Publisher: Fontainebleau : INSEAD, 1992.Language: EnglishDescription: 32 p.Type of document: INSEAD Working Paper Online Access: Click here Abstract: This paper explores the conditions under which the profits of a system developer are greater or less under a closed system versus an open system. In this context a closed system is defined to be one in which a system manufacturer produces and sells both the main component and peripherals, and an open system is one in which the system manufacturer sells only the main component and allows the producer to price discriminate by using the peripherals as a tied good. A manufacturer who opens its system loses profits on the peripherals, but is compensated by increased profits on sales of the main component due to the greater competition in peripherals. The results show that an open system is likely to be more profitable: the more elastic demand is for the system; the more differentiated are the peripherals; and the greater is the share of the main component in the total system budget of the consumer. The results are illustrated using examples of different IBM computer systems.
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This paper explores the conditions under which the profits of a system developer are greater or less under a closed system versus an open system. In this context a closed system is defined to be one in which a system manufacturer produces and sells both the main component and peripherals, and an open system is one in which the system manufacturer sells only the main component and allows the producer to price discriminate by using the peripherals as a tied good. A manufacturer who opens its system loses profits on the peripherals, but is compensated by increased profits on sales of the main component due to the greater competition in peripherals. The results show that an open system is likely to be more profitable: the more elastic demand is for the system; the more differentiated are the peripherals; and the greater is the share of the main component in the total system budget of the consumer. The results are illustrated using examples of different IBM computer systems.

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