Should Governments Specify Licence Conditions?

I have been made aware of a meme passing around Government purchasing circles to the effect that Government ought not to be dictating licence terms in the course of procurement.  This has two variants, a strong variant that Government ought not be specifying, for example, a class of licence that ought to apply to the procurement and a less strong variant to the effect that Government ought not be specifying particular licence terms. Of course, the underlying aim of this meme is that if a Government can’t dictate licence terms then it can’t require open source.

To argue these positions requires a complete lack of understanding of the role that a licence plays in an acquisition.  I will take software as an example, but any procurement involving a licence would serve as well.   When anyone “acquires” a piece of software they, primarily, acquire two things.  The first, is a copy of the software being acquired.  The second is a licence in relation to that software.  Neither is useful without the other.  A copy, even legitimately acquired, can’t be used* without a licence and a licence can’t be exercised without a copy.   However, of these two components – the licence and the copy, the licence is by far the more important because it demarcates the whole of the uses to which the copy can be put.  If your licence is good enough, you can dispense with the provision of a copy because you can acquire the copy from elsewhere.   The acquisition of the licence, and the terms of the licence are the greater part of the substance of the procurement.

To take a practical example, if I were to buy a copy of Office from Microsoft I can choose from Office Home and Student 2013 or Office Home and Business 2013.   Microsoft provides a comparison chart which discloses that the main difference between these two packages is that the first can only be used for “Home Use” while the second can be used for “Home or Business Use”.  Now, the purpose for which I might use Microsoft Office is not a function of the copy of the software I acquire.  It is wholly derived from the licence terms which apply to that copy.  To argue that the Government is not able to specify the characteristics of a licence is to literally prohibit Government from discriminating between a licence which permits only home use (which would be useless to the Government) and one which permits use in the course of business.

For a public servant to even entertain the possibility of a broad based limitation on specifying licence characteristics would be to demonstrate a total failure to understand the subject matter.  The licence is the substance of any software acquisition.  To not be able to specify licence characteristics is equivalent to not being able to include technical specifications in any other sort of acquisition.  It is a nonsense.

The only time where specifying a licence ought to be prohibited is where the licence terms effect an exclusionary dealing.  So, if the licence terms permitted use only by persons who had signed up for some form of online service being offered by a third party, that would be anticompetitive because it would require bidder’s  customers to be funneled through to the a third party.  Open source licences do not have these dependencies.

* technically, some uses may be permitted if they do not involve an infringement.  However, the scope of things which count as an infringement these days is so broad that in any practical scenario the use of software will involve performing an activity which would, in the absence of a licence, infringe copyright.

The Invisible Closed Source Overhead – 1

Brendan Scott, June 2008

Groundwork

Many people focus on the “hard” costs of software acquisition and maintenance such as licence fees and implementation costs. However, the adoption of a closed source solution has a number of hidden costs which are rarely properly accounted for. Many of these costs arise because of the extreme lack of flexibility in closed source licences and they are likely, at least in some cases, to be far more significant than the hard costs. In this series of posts we will work our way through the closed source acquisition and maintenance path and have a look at some of the more obvious ones.

Underlying Reasons – Natural Monopoly

Software is a natural monopoly (because it has a high fixed cost and low marginal cost to produce). As such there is a tendency for the market to become increasingly concentrated, first within a particular product line (such as databases, operating systems or word processing software), then across groups of product lines (typically because of the creation of artificial cross product dependencies).

Underlying Reasons – Good Enough for Most

Professor Pamela Samuelson and Mr Mitch Kapor have run a lecture series at UC Berkeley on open source (which, by the way is worth a listen). In one of their lectures they give the example of the university sector in the United States having particular requirements for their accounting, requirements which are not met by the closed source software industry. Indeed, the gap between their requirements and the capability of close source solutions is so great that Universities have banded together to create their own (open source) accounting software – at substantial expense. Ordinarily you would expect that Universities would have enough market power to get additional functionality into closed source solutions – but they don’t. Remarkably, the US University sector is not important enough to influence the direction of closed source software vendors on features of their accounting software. This is not an isolated case.

If this sector isn’t influential enough, what hope does an ordinary organisation have? Any implementation which is designed to be sold on a per unit basis (regardless of the unit – eg copy, seat, site, user etc) means it must be designed to maximise sales of that unit. Here the 80-20 rule comes into play, with the vendor coding features to attract a large chunk of the market for the lowest cost. That is, in order to maximise profits a closed source vendor must aim for a product which is “good enough for most”.

While the market is young there may be niche players who will provide products into that tail 20% that is not properly served (or that there might be multiple different products each covering a different 80%). However, this market structure is unstable because software is a natural monopoly (as described above). As products begin to win market share they crowd out competitors starting with the competing 80%-ers and then to niche players.

If your organisation has specific feature requirements it is likely not only that closed source solutions will not meet your needs, but also that you will be unable to influence the vendor to implement features to meet your needs. Even offering to pay the development costs will not necessarily influence a vendor to implement the feature because this would burden their code with additional modules which would need to be maintained going forward and the vendor maybe unwilling to take on this maintenance burden.

In short, for those who fall into “the many” category, they will be reasonably well served by their closed source vendor. However those in “the few” (roughly 20% according to the 80-20 rule) won’t be. I will use the terms The Many and The Few for convenience in the balance of these posts.

Tragically Closed

Closed source vendors are typically reluctant to interoperate with others, especially if they vendor is well positioned in the market. Indeed, a vendor’s support for interoperability is inversely proportional to their market share – when they have small market share they need their software to be able to work with other people’s software, since by assumption most people have other people’s software. As the vendor’s market share grows interoperability transforms into intraoperability – the ability to operate with other components in the vendor’s software portfolio. Indeed, vendors with large market share will even argue that intraoperability and interoperability are the same thing, since that vendor controls the market, (they argue) intraoperatibility is all that a customer needs de facto.

As the market share grows offering interoperability is only assisting the growth of the market share of the smaller players in the market, so beyond a certain market share, vendors have a disincentive to interoperability and that disincentive grows as the market share grows. In the extreme examples, for someone with no market share to enter the market their first sale must interoperate with the existing software so they support interoperability. Equally, for someone with 100% market share, support of interoperability necessarily means that they lose some part of the market.

It follows from the fact that software is a natural monopoly that, over time, because the natural tendency of a closed source market is to market concentration, there is also a natural tendency towards lack of interoperability. So, even if you invest in a closed source product which supports or promotes interoperability today, you will likely be in trouble in five or ten years’ time. By then, either the product will have emerged as a market leader and therefore no longer supports interoperability or they will have fallen by the wayside and the actual market leader will be trying hard to lock out the product that you have in fact invested in. Moreover, there is now a move among some closed source vendors to trade interoperability against patent rents, thus increasing the cost of interoperability. Therefore long term interoperability prospects for any closed source solution are poor (I have used the heading “tragically” closed here in Hardin’s sense – that the long run closure of the system follows almost inexorably from the nature of the industry ).

The lack of interoperability is an enormous problem because interoperability is a precondition to competition. When software lacks interoperability it is a symptom that there is no competition in the market. As competition in a market decreases not only do the costs of products in the market become artificially inflated, but the quality and diversity of the products simultaneously decreases. Lack of interoperability means that a customer cannot avail themselves of self help to implement features that they want in a product or remove dis-features (1) (2) from a product. As we mentioned above, unless your requirements are shared by a substantial proportion of the target market, you will be unlikely to be able to have specific features implemented – even if you are willing to pay the cost of implementation.

A result of this Tragic Closure is that closed source software tends to be monolithic rather than modular.

In part 2 we look at some costs of acquisition.

The Tragedy of the Anti-Commons

or Why Government FLOSS Purchasing Policy is Misapplied

Summary

Misapplication of “value for money” requirements when purchasing software results in poor value for money – Government purchasing policies for software tend to support the creation of monopolies.

Government purchasing has effects on the price paid by citizens for the product purchased. In some cases purchasing produces volume which permits scale discounts and therefore a net benefit to citizens who also purchase the product. However, in the case of lock in software* Government purchasing can create a monopoly in the software which leads to increased costs for citizen purchasers and a net detriment for society as a whole. It is not appropriate for value for money policies to be assessed on a per acquisition basis when software is being acquired. Doing so will almost certainly create net costs for the community when considered in the aggregate.

A Tale of Two Widgets

Consider the case where the government must buy one of two types of widget (called Widgets A and B respectively). Assume also that both widgets are more or less equivalent. Not only do both widgets meet the government’s needs, but they would also both meet the needs of most general purchasers of widgets. Assume further that the government price for Widget A is about half that of Widget B. At this point take out your taxpayers hat and place it squarely on your head and think about which widget you’d like the government to buy. That is, would you prefer the government to take more of your money and spend it on Widget B or would you prefer it to spend your money on the cheaper Widget A?

It was the Best of Times

Did you choose Widget A? Surely, based on what I’ve told you, that must be right! You’d think government would need to be mad, bad or corrupt to purchase Widget B in those circumstances. Not surprisingly this purchasing preference is reflected in government procurement policies. For example:

• The Commonwealth Procurement Guidelines require Australian Federal Agencies to secure value for money in procurements. This is stated to be a “core principle”.
• The UK policy on OSS states that contracts will be awarded on a value for money basis (at page 4).

Let’s assume now that the Government does purchase Widget A and take the scenario further to analyse some of the assumptions we made in arriving at the purchasing decision. What if Widget A is used to lay roads? What if Widget A is not interoperable?

What if Widget A has been specifically designed so that if it is used to lay a road, then to drive on the road a car must also be fitted with Widget A? (Assume, for the sake of fairness, that Widget B also requires a car to be fitted with Widget B). Would you still be happy for the government to buy Widget A? Maybe you would – Widget A costs half of Widget B. Presumably you’ll be no worse off. You will need to buy one of the two Widgets and you’ve already paid half** the price of Widget B when the government used your taxes to buy Widget A, if you have to pay half the price of Widget B again, you’re square with the price of buying Widget B – in fact you’re better than square because if the government had bought Widget B you’d pay the full price for it with your taxes and you’d have to pay the full price for it in order to drive your car.

It was the Worst of Times

There is a but – and it is unrelated to the characterstics of Widget A and Widget B, their functions, design and operation. That “but” is the availability of Widget A and how it can be priced. Assume that Widget B is made by lots of different people and there is fierce price competition in relation to it. Assume also that Widget A is only available from a single vendor. The vendor of Widget A (Vendor A) is able to set different prices for Widget A in different markets (the vendors of Widget B are not able to do so, because of the assumed competition in the market). Vendor A can choose to set a very low price for Widget A for Government purchasers, knowing that governments build a lot of roads. They can then choose to set a higher price for other purchasers – the prices given above were prices for government purchasers (not for chumps like you and me). Want to drive on a government road? Sorry, that’ll be 10 times the price of Widget B.*** Now, any way you cut it you are out of pocket. Assuming most roads are laid by the government, over time Widget B will be pushed out of the market or at very least relegated to small niches.

Intermediate Conclusion

We can conclude from the above that it is not possible to make a judgment as to value in isolation. Something which seems to be good value in a particular purchase scenario can lead to extremely poor value from public expenditure.

What’s the Problem

Government procurement can both create and reinforce a monopoly in goods and services which it is acquiring. Anecdotal evidence suggests that bureaucrats look at “value for money” type formulae and assess it against the cost to Government on a purchase-by-purchase basis. This approach is fine in respect of goods and services which are easily substitutable (such as hammers, screws, cars etc). In respect of goods which are specifically designed to prevent substitutability – eg devices which are not designed to be interoperable it is an extremely hazardous approach. If those goods also tend to be a natural monopoly (such as software in general, but particularly that which is designed not to be interoperable) this approach is absolutely the wrong one. The reasons should be obvious:

• the vendor of the product can almost always underprice competitive offerings – even when competitors are loss leading;
• the Government, bound by its bureaucrat’s incorrect understanding of the value for money policy is required to purchase the monopolist’s product;
• over time network effects enable the monopolist to crowd out competitive offerings;
• the vendor, now a monopolist, can charge what it likes to the rest of the community safe in the knowledge that, because of the preponderant use by Government others have no choice but to acquire the product;
• ironically, over time the monopolist will even be able to charge the Government more because of the its huge installed base and the previous elimination of competition.

The Tragedy of the Anti-Commons

A prospective monopolist has a period of vulnerability before it has established the monopoly product in the market in which this strategy is risky (because it must carry the costs of underpricing). However, the tragic (ie fatalistic) nature of the process, coupled with the huge rewards to be had from playing the game makes it inevitable that sooner or later a monopoly will be established – it only requires one prospective monopolist to succeed for a monopoly to become entrenched. No number of failed attempts will prevent the next attempt and the winner take all nature of the scenario will continually draw in new prospective monopolists.

What is a Better Approach?

Government may have many roles in the procurement of goods and services but supporting, establishing and maintaining unregulated monopolies is not one of them.

While the value for money requirement is fundamentally correct, to elevate it to the status of gospel or taking it out of context is not. Value for money must be determined by reference to the price paid in the aggregate by the community for the Government’s acquisition, not to the price paid by Government or authority for the acquisition. This value for money assessment is further complicated by the fact that the assessment must necessarily:

• be an ongoing one. A purchase today has no immediate cost impacts on the rest of the community – those impacts are all in the future and some of them may be in medium or long term;
• involve a review of pre-existing Government acquisitions (as a previous (acceptable) acquisition may be unacceptable when taken in combination with a proposed acquisition); and
• involve a review of things other than the software – in particular whether the vendor is likely to be in a position to manipulate the market.

Of course, the complexity of issues to be addressed by a value for money assessment make it difficult to apply with any consistency or certainty. In relation to lock in software it may only be a feel good term with little real substance. Any doubt should be resolved against the creation of monopolies.

If the licence terms permit perpetual use of each copy and permit the Government to onsell each copy of the software acquired and to do so independently of any hardware acquired in conjunction with the software that would reduce some of the monopolistic impact of the arrangement. Unfortunately the structure of copyright law usually forbids this arrangement in practice and, in any event, would not eliminate all monopolistic effects.

Particular Example – Whole of Government Purchasing

Whole of Government acquisitions of lock in software provide especially poor value for money on this analysis. Such acquisitions provide a vast installation of the software across government and effectively create an environment in which incremental improvements are net costs rather than net savings. For example, if the software has been purchased for the whole of Department X, then using a cheaper product for some users will not result in any cost savings – on the contrary since there is an effective doubling up on the licensing to the small group it costs more to use cheaper software! Further they create an entrenched installed base which increases the costs in the next round of acquisition (because this installed base effectively dictates purchasing requirements in that acquisition round).

Particular Example – Key Resources

Government acquisitions of software for key services or resources also provide especially poor value for money on this analysis as well. In these cases the importance of the relevant project (for example, the provision of public information by a health body, broadcaster or library) creates a lock in because of the general need of the public to interact with that body. That need for interaction will create in the public a need to acquire the software in order to access the resource, with the consequent establishment of a monopoly. It is a dangerous vanity for public resources to adopt lock in technologies in the provision of information or services through public facing interfaces.

Note on Formats, Standards and Protocols

This discussion has focussed on software primarily because it is more familiar and is conceptually easier to understand. However, the arguments presented apply equally to the adoption of products which require the use of a particular data format, standard or protocol if that format, standard or protocol has the lock in characteristic. Indeed, ultimately the issue is not so much in the software which manipulates data but in the manner in which data is stored and exchanged. In many instances software (and particularly lock in software) has a direct mapping against a specific data format and can therefore be identified with that format. If no lock in data format is used, the negative effects of the acquisition of lock in software is greatly reduced.

Notes

* For the purposes of this paper “lock in software” refers to software for which: the licence for that software ties the licensee to the licensor or to any third party either implicitly; or the software is designed to effect such a tying and there is no capacity either at all or in practice for the licensee to avoid or remove that tying. Lock in software includes software: which is not interoperable (eg doesn’t save to a standard format in its default configuration) or not interoperable outside the product set for a specific vendor or set of vendors, for which there is only one manufacturing source (multiple sales channels don’t count) and that source of the software has a substantial degree of market power in the relevant software market. By definition, lock in software does not include software which meets the open source definition.

** Technically probably less than half. It’s only half if the Government must buy one widget per car on the road.

*** The price will be determined by the demand for Widget A and may not be (but also might exceed) 10x. If, as in the case of software, the law prevents on sale, Vendor A will also be able to price discriminate, by charging each individual consumer as much as they are willing to pay.

Finally, a “widget” in this context is a placeholder term for some object the subject of discussion.

[Note initially made available for review on 7 January 2008]