There is a new interest emerging in the venture capital community, and that is to fund startups aiming to capitalize on the growing popularity of free and open source software (FOSS), such as the Linux operating system and the Apache Web server. J-Boss, Inc., for example, was incorporated in 2004 to sell technical services for the open source JBoss application server and other Java-based middleware. It recently received more than $10 million in venture funding from Matrix Partners, Accel Partners, and Intel Capital. Red Hat (Nasdaq symbol RHAT) has been the poster child of public FOSS companies because it has managed to achieve and hold a market value of several billion dollars. It initially declared $126 million in revenues for the fiscal year ending in February 2004 along with net profits of $14 million, before announcing in July 2004 that it will restate financial results for the past three years to recognize subscription revenues more conservatively. The Red Hat case, as well as a forthcoming book from MIT Press (for which I wrote a foreword), have prompted me to collect my thoughts on the potential of FOSS both as a source of software technology for users and a potential arena for entrepreneurs [2]. In general, I find FOSS fascinating to think about from multiple angles, but I also see the movement as raising unwarranted excitement among users as well as entrepreneurs and investors.
One of the common concerns for entrepreneurs and investors are potential "business models" that enable for-profit firms to take advantage of free or open source software. Clearly, there are several seemingly viable commercial opportunities, even though FOSS, in many ways, is the ultimate "commoditization" of at least some parts of the products business, such as infrastructure software. The major business opportunities seem to be in selling services (such as for system installation and integration, and technical support) and distributing convenient packages that include both free and open source software as well as some commercial utilities or applications. This is the strategy that Red Hat has followed.
As I have noted elsewhere, however, Red Hat lost some $276 million between 2000 and 2003 [1]. How it has recognized product revenues continues to be a problem. As a result, the jury is still out on whether we can consider Red Hat to have a successful business model and to be a successful investment for the long term. The same goes for JBoss, Inc. Of course, some companies will succeed as premier providers of FOSS products and support services. But it is very easy for competitors to jump into this space, so I doubt that many companies will succeed with either a pure distribution or services business model. I find more promising the "hybrid" approaches of companies such as IBM and Hewlett-Packard, which make money from services as well as proprietary products (hardware or software) that work with free and open source software products.
Of particular interest in the forthcoming MIT volume are articles not only on business models but also on the motivations of individuals and companies such as IBM and Hewlett-Packard to spend time on creating or improving a free "public good." Not surprisingly, the research indicates that many FOSS developers are motivated both by the creative challenge as well as self-interest, such as enhancing their reputations as programmers, and then taking advantage of this effect when searching for jobs. Because both for-profit and non-profit organizations pay many programmers to work on open source projects, we find there is also some overlapping between the free and open source and commercial software worlds.
The data suggests that open source does not offer an alternative to producing more than a fraction of the software needed to run the world.
As someone who has studied software development techniques for many years, I paid special attention to reports in the MIT volume on process issues in open source projects and data on a particular debate: whether open source development methods produce better software than proprietary methods. Most of the researchers conclude that the open source methods and tools resemble what we see in the commercial sector. Open source projects and programmers do not seem to produce higher quality code in terms of modularity or bugs: There is a broad range in quality of the code as well as of documentation and testing. Moreover, the research casts some doubt on a widely held belief (popularized by Eric Raymond) that open source produces better quality because so many "eyeballs" view the source code [3].
The data indicates that, even though there are a large number of open source projects around the world, numbering in the thousands, the vast majority of projects consist of only a few developers and maybe fewer users. In fact, a small number of programmers write most of the world’s open source code. We also learn from the MIT Press study that even Microsoft has acknowledged the value of providing access to its source code as a "feature" of some products such as Windows CE, but that some 95% of its users never actually choose to exercise this right.
The open source movement in its most recent form came about because a number of skilled programmers, led by Richard Stallman and Linus Torvalds, were frustrated by not being able to improve commercial software protected by the lack of available source code as well as by patents, copyrights, and restrictive licenses. They became determined to write better code that was generally free and available to anyone in source-code format to improve upon, as long as the authors made the improvements available to everyone else. Eric Raymond has famously described the open source style of development as similar to a "bazaar," in contrast to top-down, hierarchical design philosophies similar to how the Europeans built cathedrals in the middle ages [3].
There is sufficient evidence in the history of the mainframe computer industry going back to the 1950s, as well as in various government-sponsored projects in the U.S., and the development of Unix, originally invented at Bell Labs, that making some software a free and "public good" encourages innovation. But, on the business side, most companies operate to make money and need some guarantee that they can make a return on investment by protecting their intellectual property. Most people need an income to feed themselves and their families. To suggest that all software should be free and freely available makes no sense.
In terms of development style, we should recognize that top-down cathedral styles of architecture and product development are useful in certain circumstances. The great churches of Europe are impressive achievements and did not emerge from the semiorganized chaos of medieval bazaars. On the other hand, as my own research on software development has shown, most software projects are best done with an iterative style of development. At least some software is also well suited to being written by programmers for other programmers in an open source mode. Increasing numbers of the rest of us can take advantage of this public good when "programmer products" like Linux, Apache, and Send Mail become more widely used or easier to use.
The most extreme advocates of free and open source software like to predict that proprietary software companies such as Microsoft, Oracle, and SAP will collapse because their approaches to intellectual property and software development are quickly becoming obsolete. But this is wishful thinking—not unlike Karl Marx’s prediction in the 19th century that capitalist states would collapse. The material in [2] does not support such an extreme view. Nor does the research suggest that such an outcome would be desirable for the software industry or for software users. Profit is a great motivation for people to do well and to do good things. To be sure, monopolies can be very irritating and hinder innovation; and open source is an important counter-strategy and mechanism for distributing innovation. But the data suggests that open source does not offer an alternative to producing more than a fraction of the software needed to run the world.
My conclusion is that we will continue to see a comingling of free, open source, and proprietary software products. Open source will force some products companies to drop their prices or drop out of commercial viability, but other niche products and companies will continue to appear. The business of selling software products will live on, along with free and open source programs. As for business models, most open source users are sufficiently sophisticated that they don’t need much help, though this situation will change as more users adopt FOSS programs. More importantly, it is very difficult for companies to differentiate themselves over the long term if all they offer are services for widely available technologies, with no proprietary product or technology knowledge. For this last reason, I think that entrepreneurs and venture capitalists are fooling themselves to believe that open source can be a great business opportunity for all but a few elite companies.
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