The Economics of API Ecosystems and Modular Innovation

APIs, or Application Programming Interfaces, allow programs to share data in a standardized format.  This allows a wide range of software to share information and provide information to users from a wide variety of sources.  For example, multiple apps can draw information from a common source using APIs, allowing millions of consumers to get data from a centralized source, such as a government agency.

APIs Explained

Forty years ago, most software was single-use and not interconnected with other programs.  Consumers almost always had desktop computers that were not connected to the precursor of today’s Internet, and used one program at a time.  Thus, each program could be radically different and utilize unique code.  By the early 2000s, however, most middle class consumers were moving online and using multiple programs at once.  Data now needed to be shareable to prevent mass inconvenience.

APIs emerged in the 1980s as consumers began exploring the precursor of the Internet, often known as USENET.  A way for computers to access data from a range of other computers and programs was needed, especially to allow for messaging.  APIs became a necessity in the next decade as web development took off and websites became important tools for commerce, research, and communication.  In the 2000s, the Internet was no longer confined to hobbyists and technocrats.  To make more revenue, tech companies needed APIs to allow Internet users across the world, on vastly different platforms, to be able to seamlessly use their websites.  For example, Amazon needed for consumers in Mexico or Argentina to be able to use the same online features as users in the U.S. and Britain.

Modular Innovation and the Network Effect

If you want to make money, your goods and services must be accessible to a large market.  This fact has spurred modular innovation, where different “modules” of services can be seamlessly attached to existing software and web designs.  Web developers cannot make features that are too unique, or they will not integrate with existing capabilities on websites and apps.  New modules need to be accessible to users on desktops, laptops, and smartphones without providing an aggravating experience.

Economics of Modular Innovation

Most new services created for online users are extensions of larger software that has existed for a while, such as adding a new feature to iPhone’s text messaging app.  These extensions are quicker and more cost-effective for tech companies to create, allowing for greater efficiency.  While this may lack the pizazz of the “world building” software creation of the 1980s and early 1990s, it allows for users to make quick updates and enjoy new features without going through an expensive and complex process.

Individual modules also increased efficiency by allowing creators to access to process data regarding their use more easily than for entire software.  A new module could be added to an existing program and analyzed thoroughly for effectiveness, while an entirely new program would be difficult to analyze.  Due to modules’ greater ease of development and analysis, they can quickly be made more user-friendly and effective, increasing user productivity and allowing for economic gains.  For example, businesses that receive modular updates to existing software will receive better and faster updates for these modules than for entire software, allowing improvements to be seen in months instead of years.

Economics of Modularity and Network Effects

New modules to existing software are designed to be accessible to a wide variety of systems, creating network effects as businesses and consumers purchase modules that have widespread interoperability with other programs.  Expansion packs for software and apps may even be advertised as widely accessible with most operating systems, ranging from desktop systems to smartphone systems.  Making modules widely interoperable both increases the likelihood of widespread revenue, thanks to purchasers from a variety of software users, and increases efficiency gains across those systems.

For consumers and businesses, accessibility is vital.  If only users of the exact same software, hardware, and operating systems can utilize your software, you risk becoming isolated.  By adding modular updates that are widely accessible to other software, all Internet users can increase their connectivity with others, both for personal and professional gain.  Thus, modular innovation, through the network effect, has drastically improved the macro economy by allowing seamless commerce, research, communications, and media.

Modular Innovation and Barriers to Entry

One one hand, the shift of software development from entire, standalone programs to modular updates has reduced barriers to entry by allowing smaller teams of developers and programmers to create workable, revenue-generating products.  A startup firm may develop an update that provides meaningful benefit to a major piece of software, which the startup can then sell to the larger company.  This allows for innovation spillovers - many groups can get in on the innovation! 

On the other hand, however, large software companies may seek to block smaller firms and individual developers from building add-on modules for their products.  To get in the software development game, startups must therefore enter agreements with tech oligopolists.  These agreements may be considered oppressive and require the vast majority of any revenue created by modular add-ons to go to the oligopolist instead of the creators.  Additionally, the oligopolists may decree that the add-on only be accessible through their software purchasing portal rather than independently online.

Macroeconomic Effects of APIs and Modular Innovation

Thanks to modular innovation, improvements in software can be realized in a fraction of the time compared to the early 1990s, when users had to upload entirely new programs from disks.  This has allowed for increased efficiency in data analysis for researchers, automation procedures for businesses, and commercial transactions for buyers and sellers.  Users can purchase only the add-ons they need for their activities, benefiting consumers and leading to less resistance to purchasing new tech.  New modules are seen as complementary goods of existing modules, enhancing demand and leading to greater consumption.

Allowing consumers and businesses to download modules of what they specifically need has improved the macro economy by increasing overall productivity; users no longer avoid technological improvements as “bloatware” that provides only a fraction of the total purchase price in usable features. APIs allow the desired modules to work seamlessly with others all across the Internet and different operating systems, reducing lags and opening up the ability to communicate and trade with those on other continents.