Dynamics of Knowledge-Based Service Industry and Open Source∗

In this paper, we build a model of a knowledge-based service indus-try focusing on customer collaboration and its dynamic feedback on the stock of knowledge of a service firm. We apply our service-based approach to explain why firms that capitalize on software-related ser-vices may want to release their software as open source. More pre-cisely, we consider two variants of a general model. When the cus-tomer makes an ex ante investment that enhances her collaboration, we find that knowledge sharing (through open source, for instance) and/or market sharing can be a strategy that a dominant firm em-ploys to boost the investment. When the project size is exogenous but the customer chooses collaboration level after selecting a service firm, we find that open source may be an aggressive entry strategy and the dominant firm may either voluntarily choose open source to boost collaboration or be forced to embrace open source in order no