November 7, 2005 4:00 AM PST

Open source, open wallet

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Perhaps more significantly, an active community of users helps sell revenue-generating products and services. By giving away entry-level products, potential customers can try out the software without a long, complex sales process. That dynamic can dramatically lower the cost of sales and marketing for a provider.

SugarCRM, for example, does not employ direct sales people, who are typically highly paid. Instead, the users of its open-source product are the primary source of sales leads, CEO John Roberts said. A smaller sales and marketing budget allows it to divert its resources toward engineering, he added.

There is a drawback. By the same token, open-source companies can be slowed if an active group of customers switches to another product, said Winston Damarillo, the CEO of software developer Mergere.

Other questions
There are questions about other aspects of the open-source business model. For example, if a company relies entirely on services revenue, it will likely need to have a high-volume of customers, analysts said. By contrast, small closed-source providers can get off the ground serving a small number of customers with expensive products.

"There are many open-source business models, and every one of them is an experiment," said Andy Astor, CEO of EnterpriseDB, a database software maker that recently received funding. "A support-only (revenue model) like JBoss has is a risky model."

Instead of charging an annual support service fee on a free product as many companies do, EnterpriseDB uses a "plain old software license," Astor said. The only difference with closed-source providers is that the EnterpriseDB database is based on PostgreSQL, an open-source product.

And exposing source code introduces an "inherently risk in the business model," said Bill Schnoor, partner at law firm Goodwin Procter, which represents technology companies.

Despite these risks, open-source products, notably the Linux operating system, are already mainstays in corporate data centers. Now customers are using other products, including databases, middleware and packaged applications.

Information services company Informa, for example, decided to use an open-source content management system from Alfresco Software, a company founded by document management industry veterans. The software itself uses a number of open-source components, such as the MySQL database and development products Hibernate and Spring.

The Alfresco system serves most of the company's needs, providing the "identical stack" as existing products at a cost that is three orders of magnitude lower, said Bob Hecht, vice president of content strategies at Informa. "It got so that (the choice) was a no-brainer," he said.

Echoing those sentiments, Ron Rose, the chief information officer of Priceline.com, said that the company has become "predisposed" to buying open-source products because they of the "economic benefits." A vibrant community behind a product also ensures a long-term road map, he added.

Goodwin Procter's Schnoor puts the spike in interest in open-source software in the context of big technology shifts that have already occurred, such as the Web. The attractiveness of the open-source model will likely create a surplus of open-source suppliers, Schnoor said, and he expects many more companies to be launched. But that's typical of all major changes in the software industry, he said.

"Are there a lot of spears that will get broken along the way? Absolutely. It happens every time," Schnoor said.

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Open Source - the Darwinian approach to software
Open Source projects must pass the Darwinian test (only the fittest (most interesting) survive) to attract developers and contributors to the project. Maybe 1% of all Open Source projects attract more than 30 developer/contributors. We hear a lot about this 1%...enough to make us think it is a sweeping movement.

The user community applies its own Darwinian test to that 1% of projects, as only the most useful and supported projects attracts a significant user community. The Open Source projects you read about are the ones that passed the Darwinian tests.

There are VERY few VC investment opportunities in Open Source. There will only be one or two winners in each space, and the larger spaces are already covered. Linux has already been covered by Red Hat, IBM, HP, Novell, and others. Apache is also supported by many companies including Covalent and Microsoft. The database space is already covered by MySQL, Postgres, Ingres, SleepyCat, BerkleyDB, and 4dbObjects. JBoss is the best pure play in the App Server space, but there are several others.

I wrote a blog on this subject today with my take on how this will play out. Read the whole story at <a class="jive-link-external" href="http://dondodge.typepad.com/the_next_big_thing/2005/11/open_source_the.html" target="_newWindow">http://dondodge.typepad.com/the_next_big_thing/2005/11/open_source_the.html</a>
Posted by Don_Dodge (64 comments )
Reply Link Flag
donation ware..
this is one dam big bubble... now, if they can just keep the returns circulating... we might all be able to afford a trip into space!
Posted by (187 comments )
Link Flag
Yup
Agree on just about every point, Don, except the motivation behind VC interest. That is, and always has been, a statistically-based ROI-over-time formula. Any underlying "goodness" to VC choicess is purely incidental. Open Source today is an attractive investment because:

1. The general stock-buying public and institutions don't understands what it means, and related business models are still in the experimental stage.
2. Investment costs per company will tend to be lower.
3. Time to market will tend to be less.
4. It has, or is achieving, a critical mass of buzz value. (forgive the mixed whatever)

Sound familiar? These factors translate into a proverbial bubble (bubble size TBD) for any investment area of interest. Eventually, hoards of Open-Source-labeled VC portfolio companies and attendant hype will hit the stock market, spike, decline into oblivion - and around we go again.
Posted by parich1776 (13 comments )
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This has to be a good thing
These investments will undoubtedly be helpful to the open source software movement in the long run and that's definitely a good thing. As for the financial welfare of the venture captitalists-who cares?
Posted by Michael Grogan (308 comments )
Reply Link Flag
Maybe Not
Venture Capitalists will be laughing all the way to the bank, Michael. Meanwhile, public shareholders who bought in at $30.00 a share are left holding pieces of paper worth $0.14, or maybe $0.00.

Take a step back and ask yourself this: Is it in the best long-term interests of the country, the economy in general and the tech sector in particular for large amounts of investment capital to be consciously squandered on the movement du jour to the detriment of eventual business owners and employees? What, among other losses, are the economic opportunity costs?

The VC investment model continues to exist because, like any enduring business model, it benefits VCs and their investors. Period. So you might want to consider the larger picture more carefully before you so casually say "who cares" the next time.
Posted by parich1776 (13 comments )
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VCs are Always Wrong? Sort Of
Maybe its because of the herd mentality, or maybe its because most VCs today come from accounting or legal but not from tech backgrounds, or maybe its just because the VC business is about fashion, but whenever these guys dump money into 100 startups, they are always wrong.

Amybody else remember the 170 floppy-disk drive companies? How about the 250 PC-clone companies, each of whom only needed 5% market share in order to make a ton of money?

Or the 99 router companies? Or dogfood.com?

During the search engine boom, didn't something called askjeeves get funded? Wow.

Here is comes again, folks. We're going to see 100 open-source word processor companies, another 100 open-source web browser companies, and another 200 voice-over-IP companies.

Why do the VCs keep doing this? Because they are making money on the deal. You see, Venture Capital firms are in the business of selling stock. So, what you do looks like this:

1. Start a company in some interesting sub-field.
2. Hype the sub-field to your local media hos.
3. Sell the company before the bubble bursts.
4. Repeat.

It's a good business model. As long as they're competing against publicly traded dinosaurs, they are probably able to move quickly enough to execute.

The problem is that whatever sub-field gets targeted for a tsunami of VC money is doomed: Overshoot and collapse is inevitable.
Posted by (139 comments )
Reply Link Flag
OpenSource is more capatalistic I think
Isn't that what Darwinism is? The strongest
survive?
So from the outset if an OpenSource project works
then it will grow. If it doesn't then no time and
investments has been substantially wasted.
Using money to buy off people to produce a
successfull project isn't based on merit but
money incentives.
I think Google takes the approach of see if it
grows, then invest.
Posted by Blito (436 comments )
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Google invests in people and not money from the outset
Google is investing in people from the outset
money can come in later if needed but the kicker
is that it costs less.
Posted by Blito (436 comments )
Link Flag
If they want to invest in IT it's their only option
Currently the only place where new innovations can happen is in open source. There is no other option left. All is concentrated in some few big, well established corporations (MS actions being the main culprit of it)
The things these VC's are conting on is that they can fund a cool start-up, make sure it gets popular to the point it gets swallowed by one of the bug ones. That is when they make their profit
Posted by Steven N (487 comments )
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