Open-source companies' developer dilemma

Open source offers a fantastic way to reach developers and users of one's technology. Ironically, however, the very group most inclined to adopt open source is the least likely to pay for it.

Therefore, to make an open-source business thrive in enterprise software, vendors must learn to distinguish between developer-users and IT operations-buyers. As I'll explain, however, open-source companies may need to guard against becoming too successful in order to preserve their exit opportunities.

It is, of course, quite possible to make money in open source. Lots of it. Red Hat, for example, is approaching $1 billion in annual revenue. MySQL had generated more than $90 million in sales the year it was acquired by Sun Microsystems for $1 billion.

That's real money.

It doesn't, however, come from the developers that download open-source code. Developers, in former MySQL CEO Marten Mickos' words, "spend time to save money."

Hardly the ideal customer.

Developers download software, which a great way to initial a buying conversation but a terrible way to finish it. Open-source companies talk about selling support, but this is a losing proposition. Developers, after all, are highly likely to support themselves through online forums or other means. They don't pay for software, and they don't buy support. Not most of them, anyway.

This is one reason that pure-play support models simply don't scale in open source. They focus on the exact wrong audience.

Sure, there's a honeymoon period for new open-source companies that launch support offerings around established community-led projects. Some developers buy support, either through personal need or corporate requirements. After that initial rush for support, however, it's a tough slog selling support to developers. It's like selling ice to Eskimos.

This brings us back to a real dilemma in open-source companies: how to monetize popularity (i.e., downloads).

Developers are the most efficient way to spread adoption of one's product but perhaps the least efficient way to monetize it. To get paid, vendors must learn to separate IT developers from IT operations, and build offerings for both.

Red Hat is a classic example. People think that Red Hat sells support. It doesn't. Not really.

The primary reason enterprises buy a Red Hat Enterprise Linux (RHEL) subscription isn't for Linux support, and certainly isn't for the bits: you can get the bits free from CentOS, and support comes heavily discounted from Oracle.

No, the reason companies purchase a RHEL subscription comes down to certification that RHEL works with a wide variety of hardware and software, as well as with the Red Hat Network, which delivers updates to an enterprise's RHEL servers.

In other words, IT operations pay Red Hat to help manage their Linux servers in production. The money is in operations.

Red Hat isn't alone. Look at JBoss. The company started minting money, once it licensed Hyperic's software to build the JBoss Operations Network.

SpringSource took it one step further and actually bought Hyperic, the company, as the foundation for its Build-Run-Manage message, a message founded in selling to IT operations, not developers. (Rob Bearden, chief operating officer at SpringSource, was deeply involved in both decisions and remains one of the smartest people in the industry on building open-source businesses. If there's any wisdom in this post, it is his.)

For new open-source companies grappling with how to supercharge sales, the answer is operations. It may not be a systems-monitoring tool like Hyperic or Zenoss, but it likely is about systems management, as operations need and pays for it.

There you have it: the secret to your billion-dollar open-source opportunity. Except for one niggling fact: despite the value of IT operations to make sales, it's really developers who create the most company value, from an asset perspective. SpringSource's sales didn't justify its $420 million valuation. Its developer base did. Developers have strategic value, in terms of IT operations and creating tactical value.

In fact, SpringSource's valuation might well have gone down, had it been making more money, just as TechCrunch's Michael Arrington astutely argues could happen with Twitter. Sales provide a measurable, tangible valuation. Developer traction creates an amorphous, strategic value.

Hence, while IT operations is the crux of making sales in open source, it might well be that open-source companies should focus on community development and avoid making too much money so that they can maintain a healthy valuation. But not too healthy: there isn't an incredible amount of IT vendors that can swallow $1 billion acquisitions, the IPO era seems to be over.

Is this the new open-source entrepreneur's dilemma?

Follow me on Twitter @mjasay.

[KeithCu]

I would type up a response, but as you wouldn't engage like Michael Arrington does on his blog, I don't see the point.

[Matt Asay]

I do engage, but often don't read the comments because they tend to be high on vitriol, low on substance. But not yours. (I assume you were referring to my lack of response to your email? I've been in meetings from 7:00 am until 10:00 pm every day this week, and am now typing this on my flight home. It's not that I'm intentionally ignoring you. I've just been dead tired.)

[pentest]

Low on substance?

Much like the drivel you write Matt?

[jspaleta]

So Matt, is Alfresco making too much money to be a good acquisition target? Are you hinting that Alfresco isn't headed towards an IPO any longer?

[Matt Asay]

15 straight growth quarters with 1000 customers at a minimum deal size of $10K. You do the math. We're doing very well.

But yes, this is something that concerns me, because I personally (me: not my company) don't believe the IPO market will ever open up again. So, we can continue to grow our business, and will. But it's very possible that the new wave is to go the Quark/SAS/etc. route where you get big but stay private. Not sure.

I think to go public, if anyone will, you need $100M minimum and, well as we're doing, we're not there yet. So, no IPO this year. But if you have $1 billion I'd consider selling. ;-)

[jspaleta]

Doing very well...indeed you have made the claim on your twitter feed this month that you believe that Alfresco is the largest privately held open source company currently in play. So in the spirit of your post here....does being the biggest of the remaining privately held fish make Alfresco less desirable as an acquisition target compared to any of the smaller privately held fish?

[pentest]

Going public is a foolish thing to do.

[Matt Asay]

@jspaleta: I really don't know. It didn't stop MySQL from being acquired, or JBoss, or Zimbra, each of which had that distinction at the time of acquisition.

I think the main thing is to do one's best and let the market figure out what to do with that success. That's what we're doing: we're building a sustainable business, not a sustainable "for sale" sticker. :-)

I'm just glad to report that we're not the only ones doing well. Even in our area (ECM/WCM/collaboration), you have companies like KnowledgeTree doing very well, and Day seems to be reborn since Kevin Cochrane went there. Outside my market, Openbravo, Zenoss, etc. are all doing really well. This tells me that the market is healthy.

[fazalmajid]

I tend to disagree with your positions on commercial open source, but I found this a thoughtful and balanced article.

The solution is a freemium model where the boundary in functionality between the free and premium editions lies in things developers don't care about, but operations people do. Systems management is one, but there are others, like compliance, auditability, integration with enterprise identity management, compatibility with bloated enterprise standards like Java rather than sexier technology like Python or Ruby, and so on.

That said, enterprise IT departments have enjoyed significant levels of funding in the last 20 years or so (30% of all investment, by some measures), but the maturation of the enterprise IT market and the economic crisis means the gravy train is gone and I doubt it will come back. There are no new drivers like Y2K or SOX/HIPAA for future investment. Never underestimate the sloth, incompetence and inertia of the typical corporate IT department, of course, but even there the pressure to do more with less will be felt. The good news for Alfresco is that you will be among the last of the commercial vendors to feel it, the likes of Documentum, Vignette or Interwoven will be hit first.

[Matt Asay]

A good comment, and I agree with you on freemium. Actually, i should have written that into my post: freemium (in terms of features beyond those that you or I noted) is another way to capture dollars, though it's not necessarily a way to appeal to operations people, per se. It's simply a way to create some short-term, artificial scarcity for your product to coax a purchase. (In our case, we give perpetual rights to the software so once someone is in the door, they can leave whenever they like, and always have the right to modify source code.)

Thanks for your comment.

[odubtaig]

"IT operations pay Red Hat to help manage their Linux servers in production"

Isn't that the definition of a support service? I guess it's the difference between basic software support and a comprehensive IT support package but it's still support. I can see the point you're trying to make, that Red Hat are the direct source for the software while CentOS/Oracle are just cloning software while having no control over the development process but that doesn't make what Red Hat do something other than support.

What it does do is make it support worth paying for when you can ask Red Hat to fix a problem direct instead of hoping for it to filter down through a downstream redistributor /if/ one of Red Hat's paying customers or community devs has the same problem.

It's still support though.

[Matt Asay]

I suppose it is support, but it's productized support, which is kind of what Microsoft says it does, too. (Actually, Microsoft will tell you that it tries to build products that require less support, so the support is "baked in", as it were.)

Matt ... this article in insightful. Almost every board meeting I go to the question is asked: "Should we open source the software?" It will get us a lot of buzz and inbound interest. then the usual arguments follow about monetization, crown jewels etc. The discussion is pretty much the same in all companies.

Most Sand Hill folks tend to think of open source as a marketing and sales tool. One of the best explanations I heard about it was (I think ...) from Peter Fenton .... where he pointed out that most sales contracts were about 50% s/w licence, 20% maintenance and 30% professional services. But if you look at the P&L of a company, it had 50% in marketing and sales also. If you could replace that 50% cost with open source thats a win win as the profitability remains the same, the revenue is a bit lower, but the chances of success with less amount of money increases significantly.

Do you know of any company which has taken a closed stack, made it open source and done well with it?

http://rosensharma.wordpress.com/

[Matt Asay]

That's a very good question. Answer? I'm not sure. Red Hat open sourced Sistina, but I don't know enough about the outcome to say that it made a lot of money from it.

Generally speaking, I think opening up closed code usually misses the point, which is community. Having the code open makes it easier to download/evaluate, but it usually doesn't attract the community that makes the code interesting to a wider group.

Anyone else have a good example? I'm really struggling to think of a closed-source product that became wildly successful when open sourced. Except MySQL (which was proprietary originally, if memory serves).

[OpenSourceBizExpert]

Guys (and girls) I am going to jump in to defend Matt Asay...from hereon I will also start to engage in selective debates he leads around the business side of open source (read on for why this may be of interest to followers of his blogs).

I will not comment on the merits of this specific article...but I do want to defend Matt for his many years worth of genuine contribution to the debate around open source business models (that I have to date "silently" monitored...).This is actually the first time I have responded to ANY kind of blog (so please bear with me...).

In any debate you will get different - and often opposing - views. This is both desirable and indeed necessary as it helps to create a healthy, stimulating and often balanced perspective on each subject.

He should not be knocked...and no, this does not mean you should not be controversial, or have to agree or side with his position. Just continue to engage in a positive and healthy exchange of your own individual point of view...rather than mud-slinging if you genuinely want to "help move the debate forward".

I have read (and actually rate) most of his postings. I am glad to observe that the vast majority of folk who respond to his postings do indeed move the debate forward. This is perhaps why so many folk follow what Matt writes...and why he is respected by some of the true luminaries in the open source and VC community (see below for the ones I follow and rate if you want to expand your reading-list ...)

Declarations:

I do NOT have a direct business connection or interest in Matt (or any company for that matter) that he advises or works for.

I DO however have perhaps something of value to bring to future debates: I have worked in a senior (executive) business capacity for 3 of the most successful Open Source business spanning the past 12 years involving customers all across the globe. Collectively these firms were either bought - or currently have business models built around open source - that are worth in excess of $2B USD (yes that's 2 billion dollars...)...so I think I may know a thing or two about the "business side" of open source.

The open source technical and business visionaries/voices that I tend to follow and respect are:

Alan Cox - lead Linux maintainer and open source technologist (ex Red Hat and now at Intel)
Michael Tiemman - open source pioneer (Cygnus Solutions and now Red Hat)
Danny Rimmer - VC at Index Ventures (MySQL, Zimbra, Zend and others...)
Peter Fenton - VC at Benchmark Capital (Jboss, Zimbra, Xensource, MySQL, Twitter, SpringSource...)
Rob Bearden - EIR at Benchmark Capital (JBoss, SpringSource and others...)
Larry Augustin - VC (VA Linux, SugarCRM and others...)
Matt Asay - CNET blogger (Alfresco and too many others to mention...)

These folk all have one thing in common: they all know what they are talking about as they have all "been-there-and-done it"! (I am not "knocking" others you may personally value - its that these are the ones I rate and follow).

I hope (as a 12 year source business veteran) that as OpenSourceBizExpert I also get the opportunity to contribute to future debates...

If you genuinely care about open source and its effect on the IT landscape please stay or get involved in the debate and discussion. It truly has, and continues to have, a profound effect in the industry but often lacks the PR muscle (and $$$'s) that other opposing "camp's" use to push their to own agenda (no need to mention names here...). We need the debate to continue...

Matt - thank you for "moving the ball forward" and keep up the good work!

OpenSourceBizExpert

[Matt Asay]

Thanks for this. I make no claims to be right all the time: I tend to throw ideas out well before they're fully baked, not so much to get a reaction as to determine if the ideas make sense. If they can hold up after a few different posts/angles on a theme, I adopt them. Otherwise, they're one-post wonders.

Thanks for your patience, and for engaging.