Open source software companies must move to the cloud and add proprietary code to their products to succeed. The current business model is doomed to fail.
This is the conclusion reached by Peter Levine, a partner at Silicon Valley venture capital firm Andreessen Horowitz. This venture capital firm has invested in Facebook, Skype, Twitter, and Box during their startup phases. Levine is also the former CEO of XenSource, a company that commercialized products based on the open source Xen hypervisor.
Levine says the traditional open source business model is flawed: some open source companies charge for maintenance, support, warranty, and guarantee for applications or operating systems that can be used for free, but they cannot generate enough revenue.
He said: “This means that open source companies have problems investing in innovation, which makes them rely on the open source community for innovation.”
Why is this a problem? After all, the community-based open source development model has proven itself capable of developing innovative and very useful software.
Revenue Limitations
Levine insists that the answer is that without sufficient funds, open source companies cannot use the open source code their products depend on to make their products have significant differentiation advantages. Because of this, potential customers do not have a strong motivation to buy their products, but continue to use the underlying code for free. This at least limits the amount of fees that open source companies hope to charge, thus limiting potential revenue. This is a vicious circle.
Levine said: “If we look at Red Hat’s market, 50% of potential customers may use Fedora (the free Linux distribution), and 50% of potential customers use Red Hat Enterprise Linux (the version that Red Hat provides support and maintenance for subscription customers). So, a large part of the potential market is taken away - why should people pay the ‘Red Hat tax’?”
Some people may think that this is actually a good thing for the company, because the free use of open source software brings competition to open source companies’ solutions based on the same code, ensuring that these solutions can be used at very reasonable prices.
But if open source companies cannot make money from their products effectively enough to invest in innovation, then potential enterprise customers cannot benefit from the results of that innovation, which is not good for customers.
Unfair Competitive Environment
The problem becomes more complex if you consider that open source companies’ products not only compete with the free software that is the foundation of the product. The actual situation is often like this: they also compete with similar products sold by proprietary software companies. And this competitive environment is often unfair because open source companies generate little revenue from subscription services, which means they cannot compete with the large sales and marketing budgets that competitors offering proprietary product solutions have.
This is important because although sales and marketing actions are expensive, they are also quite effective. Otherwise, many companies would not waste money on this.
So the result is that even if they sometimes have excellent solutions, open source companies do not get the expected sales because having the best product is not enough. It is equally important to convince customers to pay through clever marketing and persuasive sales work.
Tony Wasserman, a professor of software management practice at Carnegie Mellon University, summarized this problem as: if you are considering buying new software, “open source companies won’t take you out to play golf; in other words, their marketing and public relations level is not good.”
Levine said that as a result, open source companies simply cannot compete with proprietary software vendors under the same conditions. “If you look at Red Hat, MySQL, KVM… as long as proprietary software vendors are involved in the competition, their businesses are more popular than open source software vendors and generate much more revenue.”
Red Hat is usually portrayed as a model for open source companies, which can show the severity of this problem. The company provides operating systems and server virtualization systems, but its total revenue is only one-third of professional virtualization vendor VMware, and only one-fortieth of Microsoft.
Hybrid is the Future Trend
This is why Levine came to the following conclusion: the only way for open source companies to make money from open source software is to abandon the standard open source business model: selling support and maintenance services, but using open source software as a platform to build Software as a Service (SaaS) solutions on top of it.
Levine said: “I can use Fedora as a basis to run SaaS products, then build proprietary software on top of it, and sell services. In that case, the revenue source will be the SaaS product, not the open source product. I think we will start to see more and more SaaS solutions mixing open source software and proprietary software.”
He added that many SaaS companies are already using a combination of open source software and proprietary software to build their services, including Salesforce, Digital Ocean, and Github (Andreessen Horowitz invested in the latter two companies).
Levine also said that Facebook is the largest open source software company. He said: “I was shocked when I realized this, and Google is probably the second largest open source software company.”
Facebook developed open source software for the infrastructure that forms the basis of its social network, uses open source software, and then adds its own proprietary software to develop revenue-generating services. He added that Google has also developed a lot of open source infrastructure code, but its search and advertising software is proprietary.
While the existence of free downloadable software undoubtedly makes it more difficult for open source companies to make money from the same software by adding services such as support and maintenance, these low-cost alternatives also certainly make it more difficult for proprietary software vendors who are struggling to sell products to the same market.
That’s because these low-cost alternatives will inevitably squeeze the market space of proprietary software, even if proprietary software vendors have more revenue that can be used for innovation, product differentiation, and marketing.
This may help explain why some proprietary software companies are now moving their products to the cloud, or at least developing SaaS alternatives. Open source alternatives like LibreOffice basically replicate the functionality of mature products like Microsoft Office suite, but Microsoft’s cloud-based Office 365 product adds additional services on top of the basic Office functions, such as file storage, Active Directory integration, and mobile applications.
It will be much more difficult for anyone to copy, whether it is open source software or not. And this suggests that in the future, all software companies will move to the cloud and provide software as a service, not just open source companies.
Reprinted with permission: Developer Relations »
