The open-source business model that relies solely on support and service revenue streams is failing to meet the expectations of investors
For anyone who hasn't been paying attention to the software industry lately, I have some bad news. The open-source business model is broken.
Companies have long hoped to make money from this freely available software by charging customers for support and add-on features. Some have succeeded. Many others have failed or will falter, and their ranks may swell as the economy worsens. This will require many to adopt a new mindset, viewing open source more as a means than an end in itself.
Change has been afoot for some time. Two years ago, Microsoft (MSFT) stunned the world by forming a partnership with Novell (NOVL), a company specializing in the open-source Linux operating system that competes with Windows. Before that, Microsoft Chief Executive Officer Steve Ballmer would have had us all believe that Linux and open source were un-American, cancers of the worst kind. Meanwhile the hard-core open-source faction screamed foul on Novell, claiming it was really an old-fashioned shakedown, with Microsoft promising not to sue companies that used Novell's "Redmond-approved" version of Linux.
Red Hat Adds Value
I was one of the few open-source CEOs to support that deal while at Open Source Development Labs, and I even joined Ballmer and Novell CEO Ron Hovsepian on stage that day. The deal made sense then and still does. It lets Novell provide important software that complements the core, or kernel, of the operating system and enables interoperability between Windows and Linux.
Red Hat (RHAT), arguably the most successful open-source company, has also found ways to add value beyond supporting the Linux kernel. It adds substantial layers of software on top of the kernel, a solid piece of software that needs little support, in order to provide additional value to its customers. If Red Hat relied on supporting the Linux kernel, it would go out of business simply because the code is so sound.
And therein lies the great paradox: Open-source code is generally great code, not requiring much support. So open-source companies that rely on support and service alone are not long for this world. The traditional open-source business model that relies solely on support and service revenue streams is failing to meet the expectations of investors.
No New Software Giants
Consider Sun MicroSystems' (JAVA) $1 billion acquisition of open-source database software vendor MySQL. With it came great code, but little revenue for the acquiring company. MySQL does provide the perceived value of choice and some open-source "cred" for Sun, but unless it adds significant value on top of the open-source project, I don't see how Sun will ever generate enough revenue to make this a profitable transaction.
Open source has simply become a means to an end—it lowers economies of scale for software and in doing so, is prompting more innovative business models. The software giants of yesteryear—Oracle (ORCL), Microsoft, and SAP (SAP), to name a few—will remain, but don't expect to see a new generation follow on their heels. Software is a commodity and the value a business can provide on top of that, beyond service, is where it gets interesting.
Now for the good news: We've learned that collaboration results in really good software that everybody can use. Collaboration begets lean development, lower costs, platform independence, and sustainability.
like sharing a pizza
While the open-source business model may be broken, the concepts behind open source will continue to bring new value to customers and strong returns to software company stakeholders.
But the value is in the collaboration, not in open source itself.
Think about it like going in with others on a pizza. Too often, businesses need to develop software with the same "ingredients" as everyone else, and this offers no competitive advantage. If everyone wants the same pizza, why not share the cost? And by the way, let's not just share the cost; let's make it together so we get it just right and know what we're getting.
This is where collaboration works best. Companies today are coming together to form "communities" of subject matter professionals—executives, business managers, doctors, or researchers—to define software that can be produced at much lower cost. The cliché that everyone wins may be corny, but it's true here. And hey, it's the way the best open-source projects always started.
But today, open source is the means. These "communities" of subject matter experts are using it to build their applications because it's open and low-cost, but in the end, it doesn't really matter if the final product is available via subscription, delivered as a service over the Web, or licensed under the General Public License that governs free software.
Unless open-source providers find new ways to add value for their customers, especially in this economic environment, the growth of their companies is at serious risk.
Acquisitions may still happen, but they will lack the multiples we saw with Sun and MySQL. The days of uttering the word "open source" to inflate valuations are over. But fortunately for the market, customers and vendors are together taking the best of it and building new kinds of software companies that are focused on collaboration.
Cohen is CEO of Collaborative Software Initiative, where he works with IT business and technology leaders to apply open-source methodologies to software development and business communities. He was formerly CEO at Open Source Development Labs.
Business Exchange related topics:
Open Source Software
Mergers and Acquisitions