Michael Kende

Profitability under an Open versus a Closed System

This paper explores the conditions under which a monopolist selling a system consisting of a main component and differentiated secondary components can increase profits by allowing competition in the aftermarket for the secondary components. Opening the system in this fashion can increase profits by giving consumers an added incentive to incur the setup cost of purchasing the main component. This paper extends the second-sourcing literature by showing the explicit effects of various parameters of demand on the decision to open the system. The results show that an open system is likely to be more profitable than a closed one when demand for the system is more elastic, when secondary-component variety is more valued, and when the share of the main component in the total system budget of the consumer is high.