Open Source Software - Business Aspects

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See also: Open Source Business Models


Introduction: Open Source as a Business Model

Open source is not a business model, but can be integrated in successful market offers and business models.

Here are the main arguments of why this makes sense, by Tony Bailetti, in: How Open Source Strengthens Business Models


OS and Business Model Strength

OS can strengthen or weaken a business model. OS can strengthen a business model if its use:

  • persuades customers of the importance to get a job done, solve a problem, or fill a need
  • makes the offer more valuable on the elements that matter most to customers, channel partners and complementors relative to the best alternative offer
  • increases the likelihood that the revenue and profits from the offer will achieve company's targets
  • increases access or control over the key resources, processes and norms required to deliver value to customers, channel partners and complementors
  • increases the company's ability to protect its intellectual property for which customers are willing to pay


We provide some examples of how OS can strengthen business models. The examples are organized by variable and do not provide an exhaustive list of the many ways in which OS can increase business model strength.

1. Significance: community plays a major role in OS. The free exchange of ideas and code benefits everyone. When members of an OS community convince customers of the importance of getting a job,done, scores in the significance dimension increase and the offer's business model becomes stronger.

Various communities have convinced customers of the importance of avoiding vendor lock-in. This results in stronger business models for many offers that build on OS stacks. Similarly, the Xen community has convinced customers of the importance of server virtualization. This results in stronger business models for companies such as Cintrix and Virtual Computer that market offers which use a Xen-based client hypervisor as a tool.


2. Customer Value: OS assets such as open hardware, software, and content offer many elements that essentially deliver the same value to customers as that delivered by the best proprietary alternatives. Customers do purchase and benefit from proprietary software, hardware, and content. There is little benefit to a company that relies on OS in coming across to customers as being zealot-like. This may undermine the credibility of the company's customer value proposition. The objective is to identify the points of difference OS provides and that customers value. If OS delivers value elements that customers consider to be superior to those offered by proprietary alternatives, the offer's business model will be strengthened.

For example, with OS you see what you get. Customers can examine the source of the asset line by line. An OS asset that is widely distributed and frequently fixed can deliver significant value to customers. With OS, hundreds of professionals examine the asset's source to discover bugs and fix them quickly. Contrast this with commercial assets where customers may end up being at the mercy of suppliers of secretive and bug-filled proprietary products.

With OS, access to the source code accelerates the development of add-ons that enhance the asset's functionality.

With OS there are no license fees for development or runtime. For this reason, OS reduces ownership costs and increases flexibility as to where to operate the asset. Contrast this with proprietary alternatives where you must pay license fees and make decisions on where to run the asset based on licensing agreements.

With OS, customers do not need to upgrade their assets with other customers as they can stay at a previous version and add enhancements selectively. Moreover, with OS, customers do not have to wait for a supplier to provide the features they require as they can add these features themselves.

With OS, customers can monitor development and no longer have to depend on suppliers' promises of delivery dates. Frequently, these delivery dates are not met or the dates are met with assets that lack all the promised features.

With OS, all can beta test the next release of an asset without the restrictions associated with testing proprietary assets such as restrictions on time or the number of users. In OS, beta testing is not restricted to a few organizations and platforms as is the case of proprietary assets. Moreover, the results of tests are public. Contrast this with tests of many proprietary products where suppliers prevent customers from publishing test results and portray products in their best light.

In OS, both users and suppliers are stakeholders of OS assets as everyone must succeed. Contrast this with the adversarial relationships that frequently exist between suppliers of proprietary assets and their customers.

With OS, talented individuals who are not part of the core development team are more likely to contribute to user documentation. Contrast this with the development of documentation of many proprietary products where there is lack of communication between product developers and documentation writers.

OS provides more opportunities for developers to incorporate users' ideas into OS assets. Users are more likely to try OS assets and provide feedback based on its use.

With OS, development efficiency increases. OS enables: i) rapid learning of how products work; ii) greater collaboration; and iii) faster debugging.

When an organization adds features or functionality to an OS asset, a large number of smart people that the organization does not have to pay will help improve these features and functionality.

OS assets are released when the community feels it is ready. Contrast this with commercial alternatives which are released to meet revenue targets set by senior executives.

OS assets often support multiple compilers and do not lock customers into one supplier platform.


3. Partner Value: OS provides significant value to partners as many of the elements that differentiate OS from proprietary alternatives are also valued by partners.

Some value elements are unique to partners. For example, to founders of startups, venture capitalists (VCs) are important partners. VCs are institutions and high net worth individuals who bring managerial and technical expertise as well as capital to companies with high growth potential. VCs like OS because they can spend more money in global go-to-market strategies instead of research and development (R&D). For startups, OS can significantly reduce time-to-cash for the startup and increase the return on investment for capital suppliers.

The governance, IT infrastructure and norms of OS make it easier for partners to collaborate. OS provides an out-of-the box approach that supports collaboration across partner organizations and individuals and harnesses global innovation to meet customers' needs. For example, OS can enable two companies that use the same OS asset as the means to two very different ends to partner.

OS assets are readily available to existing partners and can be easily distributed to new partners. OS ubiquity increases the value of OS to partners.


4. Profit: when a supplier uses OS, the likelihood that the profit targets for its offer will be achieved increases. A supplier that uses OS may have more control over its costs and better assessment of market size and sources of revenue.

OS makes the development and sales costs of a supplier more predictable. The supplier does not have to worry about changes in the prices of commercial alternatives. Moreover, OS reduces the cost of finding customers, promoters and distributors for the suppliers' offers, and the cost of shaping the message promoters will pass on to their friends.

A supplier can readily find on the Internet those individuals and organizations that promote the OS upon which their offers rely. These individuals and organizations are important to the supplier for two reasons. First, they are potential customers. Second, they can recommend the supplier's offers to others who may benefit from the offer.

If a supplier's growth is a function of the number of its net promoters, OS can significantly increase the growth of the supplier's revenue and reduce its cost of sales.


5. Leverage: a company that uses OS can increase control or access to the resources and processes it requires to deliver value to customers, the company and other relevant stakeholders. For example, the use of OS can increase the number of talented individuals that a company can access to develop its offers.A company can observe the behaviour of contributors to OS projects and approach the most talented individuals to work in company projects as full- or part-time employees or as contractors.

A company can gain access to a well defined customer base that is anchored around the OS projects upon which the company's offers rely.

A company can use OS to reduce the barriers to enter a market that is dominated by proprietary vendors.

A company can lever OS communities to reduce the number of unfair comments from detractors of its offers. Members of the OS community are more effective at arguing against unfair public comments about a company's offer than company employees. They are diligent on countering the fear, uncertainty, and doubt (FUD) that may be spread by competing proprietary alternatives.

OS is available to anyone. This places companies, large and small, on equal footing. However, a company can become involved in the governance of the OS community and influence project direction. To strengthen its offer's business model, a company needs to exert more control over the OS project than other companies.


6. Intellectual Property: OS enables a company to compete based on the points of difference for which its customers are willing to pay and collaborate with other companies on the development of assets for which customers are not willing to pay. This enables companies to concentrate their resources in creating intellectual property. The greater the number of customers that wish to pay for the intellectual property a company owns, the stronger the offer's business model.

An example of this is Apple's use of the user interface of Mac OSX as the differentiator. This user interface is built on top of Darwin, an OS computer operating system." (http://www.osbr.ca/ojs/index.php/osbr/article/view/825/798)



Discussion 2

Why Companies Contribute

Andrew Morton:

"Companies contribute engineering resources to open source projects for two strategic reasons:

- Firstly: resource pooling. Maintaining an entire OS is expensive, but with open source you get to pool development resources with the other users of the product while retaining many of the benefits of an in-house development project.

- And the second main reason why companies contribute to open source is to avoid vendor lockin. One way to obtain your low-level software is to simply license it from another IT vendor, and the cost of this could well be similar to the cost of using and contributing to an open source equivalent. But with open source you get full access to all the technology, you get access to the products key developers and you get full rights to modify the product if you need to do so and you get good visibility into the product's roadmap. In fact, you can to some extent control that roadmap if you're prepared to put appropriate resourcing into it.

So the one-sentence summary of open source from a technology businessperson's point of view would be: a source of legacy infrastructure software whose development is cost-optimised via resource pooling and which naturally provides protection against vendor lock-in." (http://www.groklaw.net/article.php?story=20041122035814276)


Can you make money?

To open source or not to open source by Adam L. Beberg:

"Assuming that you are a company considering open source for your own code, then the bottom line is revenue. If the software can't make money, you can't pay the bills, and everyone will need a new day job. The choice to open source has many implications to revenue, so the implications need to be considered as primary reasons for or against open source.

If you do open source, revenue purely from the software is all but eliminated. This leaves only publishing (sticking the software in a pretty box), tech support when the user gets stuck, and consulting for people that need help setting up your software as sources of revenue. Unless your product is many megabytes, hard to use, and hard to set up, then these may not be enough to cover development and marketing costs.

Open source does give you some advantages that offset the inability to sell the software: bug hunting, reliability, and community. Since the source is out there, if there is a bug, anyone can hunt it down and then send the fix back in to be incorporated into the master copy. With all of this bug-stomping, your software will end up being very stable and reliable; this is offset by all the semi-functional "neat stuff" that users will want to add.

While the open source community can be a large source of programming talent, do not open source your software because you expect them to solve your problems for you. You will still have to do all of the design, initial development, maintenance, and product documentation. The desire for programmers to fix any bug that doesn't directly affect them or to add a feature that they don't personally want is very low. Any sufficiently hard bug to track down will result in a bug report, not a patch. User-submitted "features" will tend to be neat things that they and a few other people may use, but all core functionality will still need to be developed by your programming team." (http://www.softpanorama.org/OSS/webliography.shtml)


Privileged Areas of Application

To open source or not to open source by Adam L. Beberg:


"Legacy applications that are no longer a part of current products being sold are an excellent area for open source, assuming that no third-party software is incorporated into the product. Old applications that are no longer cost effective to maintain or support can be made open source as a way to abandon the product, while not abandoning the users (as users who feel abandoned typically become ex-customers in a very short time). This way, the users who cannot migrate to newer products get the source and can use it to fix or modify things to suit their needs, while your entire development staff can move on to current projects.

The specifications to hardware and device driver code is another obvious place where publishing more information will benefit the product. In the past many vendors withheld the specification on how to work with their hardware fearing it would give competitors an advantage. The only real effect this had was preventing many users from having the option of buying their hardware. Writing device driver code is a development cost that is only made up by selling more of the hardware. Publish everything you can about it, and even help to get drivers written for the various open source operating systems. This will help you sell more hardware to anyone who wants it.

Any product that is aimed at establishing a standard protocol or API needs to be open source. If the source is available, then the adoption of any protocol or API will be much faster, and the programmers who use it will be far more comfortable with it. Many modern protocols and attempts at standards that were not open source failed before anyone even noticed they existed. In these cases the software itself does not represent the value; the things it enables does. Often, the amount of revenue from consulting, training, and licensing from the additional developers will completely dwarf any revenue that would have been gained by keeping the code proprietary. Many large Fortune 500 companies make 100 times more revenue on their consulting and support contracts than they do on their hardware and software sales. The key to this case is that the protocol, API, or hardware is worthless until a developer takes it and uses it to create value for the user.

Open source can be used as a powerful attack and defense mechanism while competing with rivals. If a rival's application has no need for support or consulting to use it, and an open source version of that application can be created and released, then the revenue from the closed application will be removed. This is very similar to the old method of discounting a product until a competitor is driven out of business, or salting the earth in a war. On the other hand, if you can develop your application as open source, then a rival will have no way to attack you in a similar way." (http://www.softpanorama.org/OSS/webliography.shtml)



Who Benefits from Open Source software

From Dirk Riehle at http://www.riehle.org/computer-science/research/2007/computer-2007-article.html


1.

Large system integrators, or solution providers, stand to gain the most from open source software because they increase profits through direct cost savings and the ability to reach more customers through improved pricing flexibility. Every dollar a system integrator saves on license costs paid to a software firm is a dollar gained that the customer might spend on services.

If it were up to the system integrators, all software would be free (unless they had a major stake in a particular component). Then, all software license revenue would become services revenue. To this end, I believe that system integrators prefer community open source over commercial open source. Only community open source software prevents vendor lock-in.

A system integrator can increase its profits if it reduces the software cost. By reducing software cost, it can move down the demand curve and sell to more customers.

Closed source software is the main obstacle to doing this: It cuts into profits on an individual sale and reduces overall pricing flexibility. Hence, system integrators have a high interest in turning closed source software markets into software markets with at least one viable community open source product.

Before the advent of open source software, entering an established and well-defended market was a risky proposition. With increasingly well-understood open source processes, setting up an open source project competing with an established closed source market leader's product is much less risky and carries a significantly higher chance of success than before. But it's not just a specific system integrator that will want to do that. It's pretty much everyone who isn't the closed source market leader." (http://www.riehle.org/computer-science/research/2007/computer-2007-article.html)


2.

From an Independent software vendors perspective:

Community open source ensures that prices for software support are subject to market forces rather than one owning corporation. Community open source is a strategic weapon for system integrators to squeeze out proprietary as well as commercial open source software vendors.

The more mature a market for a specific software component, the higher the investment in the existing products, the higher the barrier to entering this market, the more established the existing players, and the more stable the price for the software component. A common scenario is "the 800-pound gorilla" firm that dominates a market and is surrounded by smaller players catering to market niches.

In such a market, the leading software vendor sets a price that maximizes its profits. Since the market is fairly transparent, the vendor can set just one pricing schedule, offering the product to different customers at the same price. (This is in contrast to the highly individual deals of large system integrators.) The result is frequently a flat price, as Figure 3b shows. Remarkably, the price of the proprietary closed source software doesn't directly depend on the actual cost incurred to develop, maintain, and provide the software.

The profit-maximizing price is largely independent of cost; the cost provides only a lower limit. Competition that drives prices closer to cost can't spring up easily due to the large initial investment a software product requires.

In a community open source situation, no such market-entry barriers exist. Given the right license, anyone can set up a company and start selling software. What the company will sell, of course, isn't the software itself, but its provision, maintenance, and support.

Because anyone can enter an attractive open source market, competition is fierce, and pricing will be based on markup over cost. If the markup is too high, new companies will enter the market; if it's too low, companies will leave the market. Moreover, the more mature the product, the lower the overall price.

Different firms will have different costs depending on their share of contributions to the open source project. However, with increasing project share, the company can charge higher prices because customers are likely to receive better service. The basic relationship remains unaffected: Price is markup over cost and varies depending on cost.

Customers love this situation because prices are substantially lower than in the closed source situation. System integrators love the situation even more because they can squeeze out proprietary closed source software." (http://www.riehle.org/computer-science/research/2007/computer-2007-article.html)


Deciding for community or commercial open source

From a corporate point of view, by Dirk Riehle at http://www.riehle.org/computer-science/research/2007/computer-2007-article.html


"The key differentiator between community open source and commercial open source is whether a community or a single entity like a corporation holds the power to make decisions about the project.

Commercial open source software is typically available for free to nonprofit users. Sometimes commercial use is free as well. Usually, companies make money by providing support services. Sometimes they make additional money by selling proprietary software enhancements.

Like community open source, commercial open source is available in source code form. Unlike community open source, however, one company controls commercial open source. This way, commercial open source software can gather some of the benefits of community open source: faster adoption, free and speedy user feedback, and possibly volunteers' code contributions. This approach is mostly a marketing strategy, however, because the company that owns the software still must do the development. Hence, the company must employ and pay the software's developers.

During the early days of an open source project, this is an advantage, as the company can provide clear direction and muster more resources than community open source projects typically can. As the project matures, this can turn into a disadvantage, as a competing community open source project might have more resources at hand in the form of volunteers.

The upside for the owning company is that little open source competition can spring up for its product. However, system integrators have a strong interest in providing alternatives to proprietary software, and this applies to commercial open source as well. Hence, this business model is likely to experience the same pressures as proprietary software." (http://www.riehle.org/computer-science/research/2007/computer-2007-article.html)


Low Innovation potential of Open Source

To open source or not to open source by Adam L. Beberg:

"One thing that open source is not generally known for is innovation. In general, the rate of innovation in the closed source world is far faster because the desire to stay ahead and stay in business has always been stronger than the desire to re-implement something that's already been done. Even the operating system gems of the open source world are just starting to gain the security and critical enterprise reliability features common in the high-end commercial systems 10 years ago.

All coders by nature like to do new and interesting things, but not necessarily things that are really new, just things which are new to them personally. A simple search for any common application will result in dozens of nearly identical open source projects to build it. Like an army, there are a few high-skill generals and masses of low-skill soldiers working their way up the ladder by working on projects like the ones that the generals worked on when they started out. Projects have high overlap, with low innovation.

If you have an application you need to build and there is an existing open source project to build it or something like it, then join that project or hire some of the main people in the project to work on it full time. The application can then move to the level where service, support, and consulting become sources of revenue. There is a long history of projects that started out as research or open source and turned into commercial ventures." (http://www.softpanorama.org/OSS/webliography.shtml)


More Information

Recommended Resources by Tony Bailetti:

  1. Open Source is not a Business Model
  2. Open Source Business Model is "Broken". Really?
  3. Open Source: The Model is Broken
  4. Licensing and Business Models
  5. What Vendors Really Mean by Open Source
  6. Clarifying Business Models: Origins, Present and Future of the Concept