When Kirby Slack went looking for enterprise resource planning (ERP) software to help his company schedule its production runs of dental implants and artificial fingernails, he found his options limited. AMCO, the 29-employee Conshohocken (Pa.) family company of which Slack is both part owner and head of technology, has annual revenues of only $5 million. So it couldn't afford a million-dollar ERP package from a big supplier such as SAP (SAP) or PeopleSoft (PSFT) -- or even the six-figure deals it could get from mid-tier software companies.
So last December, Slack turned to an upstart software company in Norfolk, Va., by the name of OpenMFG. It makes ERP packages designed for the 300,000 manufacturers in America with sales of $50 million or less. OpenMFG's prices start at $15,000 for up to 15 users and include full support plus regular software upgrades.
OpenMFG can charge less, in part, because it builds its applications on top of two pieces of customizable open-source software that are available free on the Web -- the Linux operating system and the PostgresSQL database. The only parts of its product that OpenMFG has built from scratch -- the proprietary components -- are the manufacturing planning modules, financial packages, and other top-level business functions.
LICENSE-FREE. Slack didn't worry for a second that software so critical to his business was built on an open-source foundation. "I didn't even know [PostgresSQL] was in there, and frankly I don't care, as long as it works," he says. He was aware, however, that he didn't have to buy a database license from Oracle (ORCL), IBM (IBM), or Sybase (SY) on top of what he's already paying OpenMFG. "Our customers love that," says Ned Lilly, OpenMFG's CEO and a prominent figure in the open-source community.
OpenMFG is in the vanguard of a new wave of entrepreneurs who are trying to push open-source software beyond its roots in operating systems, which simply control the basic functions of a computer, to the much broader world of applications -- programs that tell a computer how to think, calculate, and manage. Many chief information officers have been reluctant to go this far, even though they've embraced Linux now that it's sold by the likes of IBM, Hewlett-Packard (HPQ), and Oracle.
The CIO's reluctance could fade away over the next few years, however, as more companies like OpenMFG spring up to sell open-source databases, desktop software, and Web-application servers. This trend is building momentum slowly for now, but once it catches on such traditional sellers of application software as Oracle, IBM, BEA (BEA), and Microsoft (MSFT) could find themselves struggling to justify their hefty prices.
"INEVITABLE MIGRATION." In a sense, the systems integrators that often implement big software installations have already set the table for low-cost, open-source applications: Increasingly, these service companies "give away" software -- or at least include its cost in long-term maintenance and outsourcing contracts. This trend has started to devalue some varieties of software in customers' eyes.
Now, the big software companies face the challenge of "what looks to be an inevitable migration toward [pricing based on] services" instead of on the software itself, says John Parkinson, the chief technology officer for the Americas of consultant Cap Gemini Ernst & Young. "In that equation, the role of the software becomes much less important -- and you can't charge a lot for things that people don't think is important," Parkinson adds.
The open-source trend is being driven by, among others, IBM -- the third-largest software producer in the world. Rather than bloody itself in tough battles against Sun Microsystems (SUNW) to supply operating systems for high-end servers and against Microsoft for lower-end installations on Intel machines, IBM decided to embrace Linux as a way to commoditize the operating-systems business and focus more on its own prime interest in providing tech services.
MIXED BLESSING. This strategy has worked brilliantly for Big Blue, which reaped $1 billion last year in revenue from sales of Linux software, hardware, and services. And IBM has fought Microsoft to a standstill in the battle to win midsize business customers, as well as nabbing customers tired of paying big bucks for Sun's expensive bundled packages.
Adapted for applications software, the same strategy could threaten such players as Sybase, Oracle, and BEA, which get the majority of their revenues from sales of software products. "By encouraging the commodity effect, you burn the field behind you and commoditize the entire market," notes Martin Fink, general manager for HP's Linux services division. If that starts to happen, these players might have to redefine themselves more as service companies than software providers -- something they probably could do, given their extensive sales and marketing infrastructures. "You can look at this phenomenon as a threat or as a blessing," says Fink.
One possible threat: It will be hard to replace the 50% to 80% gross margins of the software business with the 20% or less gross margins typical for software-service companies. Last year, for instance, WorldCom spent close to six figures to install software that let employees connected to a corporate network or the Internet easily tap into and use back-end software such as databases or financial applications.
FLEX TIME. Then in December, 2002, senior software engineer Jerry Shifrin simply abandoned that proprietary software for JBOSS, an open-source Web application server used by McDonald's, Dow Jones, and the U.S. State Dept., among others. For support, he hired JBOSS Group, a 14-employee consulting shop in Atlanta that includes many of the programmers who wrote JBOSS. "The real saving is that we can deploy without having to worry about how many licenses we have bought," says Shifrin.
That's a key advantage, since procuring proprietary software licenses at any large corporation is a time-consuming hassle involving numerous decision makers. In contrast, Shifrin can test and install open-source code with no license concerns. "We're happy to pay for support, but having the freedom and flexibility to deploy as we need is enormous," he says.
For now, these are isolated examples in a business that remains dominated by the sellers of proprietary software suites. Scott Handy, IBM's director of worldwide Linux solutions, says he isn't too worried about JBOSS, because it doesn't support many of the applications customers want to use.
Dave Dargo, vice-president of Oracle's Linux division, says he doesn't see open-source databases as a real threat to Oracle's bread and butter because customers fear that they could lose critical data with a no-name brand. "If an operating system crashes, you reboot the machine," says Dargo. "If your database corrupts your data, you're kind of lost. It's one of the areas where people (read: bosses) don't accept failure."
NEW PROFIT MODEL. Even companies that are pushing open source into the application mainstream concede that natural barriers exist. Generally, the more specialized the program, the harder it is for an open-source rival to gain the credibility and critical mass needed to succeed -- if only because the skills to create the software often are as proprietary as the program itself. "It's a smaller and more selective group of people who know the math that underlies capacity planning used in ERP software," says OpenMFG's Lilly.
Beyond that, open-source software has achieved its current popularity in good part because of the endorsements of major companies that have no interest in creating competition for themselves in the applications business -- and without whose support it will be hard to build credibility. OpenMFG's Lilly himself previously headed an open-source, database-software company that failed in part because of customer concerns over support issues.
Such obstacles aside, though, the lure of open-source software will only grow stronger as Linux matures. And it's certainly conceivable that the software profit model will continue to tilt more toward payment for services instead of software licenses. Once that happens, software companies will have less incentive to protect their traditional products at all costs. Then, a world of applications built on open-source programs will finally thrive. By Alex Salkever in New York