April 5, 2005 4:00 AM PDT

Open-source companies chase steady money

When entrepreneur Byron Sebastian started his company last year, he set his sights on the business software industry's ultimate cash cow: maintenance contracts.

Rather than charge large up-front fees for a product, his company, SourceLabs, will try to siphon off some of the millions of dollars corporate customers earmark for support. Like a growing number of start-ups, Sebastian's weapon of choice is open source.

The spread of open-source software, which generally is freely available, allows smaller companies to compete for maintenance money that until now has been locked up with incumbent software vendors, he said.


What's new:
In the absence of software license fees, open-source companies are adopting a services-intensive business model, accelerating an industrywide shift toward ongoing, rather than up-front, revenue.

Bottom line:
Established software companies often tout the benefits of subscription-based revenue models, but it is unclear whether smaller open-source outfits will be able to grow their businesses effectively.

More stories on open source

"Open source creates a competitive market for support and maintenance contracts," Sebastian said. "For the first time, you can build a successful business by being great at that, rather than just being mediocre."

Many industry veterans argue that open source is accelerating a shift that has been going on in the software industry for some time: Rather than hinge their business on big-ticket license contracts, software providers increasingly rely on recurring maintenance revenue.

And because most open-source tools don't have license fees attached to them, commercial open-source companies are often forced to build their businesses around services revenue, in the form of support, up-front installation or training.

With this model, purchasing software is more like committing to a yearlong cell phone contract--and less like buying a car with a large cash outlay and making regular payments later.

Although upstart open-source companies are relatively small and untested, the services-led business model reflects how more value is being attached to follow-on services than the actual the software, analysts and industry executives say. In fact, this week, industry executives at the Open Source Business Conference in San Francisco will consider the impact of open-source products on how software is acquired.

Unearthing support money
Once a backwater of the industry, attention is increasingly being paid to the amount of money spent on support and maintenance.

Chief information officers report that as much as 70 percent to 80 percent of information technology budgets are consumed by maintenance, rather than new initiatives. The recipients of much of that money are entrenched suppliers.

Database giant Oracle, for example, makes more on product updates and support than it does on license revenue. During an earnings call last year, Oracle CEO Larry Ellison touted the company's maintenance as an "extremely high-margin business."

"(The subscription approach) allows you to focus on strategic issues."
--Matthew Szulik
CEO, Red Hat

James Goodnight, CEO of analytics software provider SAS, said that Oracle's acquisition strategy, which has included buying PeopleSoft and making a deal to buy Retek, is a play at existing maintenance contracts.

"Larry (Ellison) is buying everything he can get his hands on to consolidate the (business applications) industry. He believes that innovation in software is over. It's all about maintenance revenue," Goodnight said.

Compared with other industries, software has very high margins, in excess of 20 percent, said Mark Driver, an analyst at research

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Neat spins...
It sure sounds like "Pay Me instead of Them!"
Posted by TheMidnightCoder (61 comments )
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If it's cheaper...
Well, if paying "Me" is a fraction of the cost of paying "Them" for the same type of service, who do you think companies will reward the contracts to?
Posted by Richard G. (137 comments )
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Summary with no support
The article summary suggests that it remains unclear whether smaller open-source outfits will be able to grow their businesses effectively. Yet the entire article seems to be based around the quote:

"Open source creates a competitive market for support and maintenance contracts," Sebastian said. "For the first time, you can build a successful business by being great at that, rather than just being mediocre."

To me, this seems like an extremely skewed perspective. Open source did NOT create the market for support and maintenance contracts. This is NOT the first time business are being built based on support services.

The support business has been alive and well for many years and those companies have grown, but not nearly as fast as traditional software companies. Why? Simple. If you *sell* software, AND obtain maintenance contracts, you have multiple revenue streams.

What open-source has effectively done, is remove one of the two primary revenue streams from the software business. This is not good for the industry, or for workers who need jobs, and is a detriment to open-source support companies competing with more traditional "sell and support" software companies. With open-source still trailing far behind proprietary software in total installations, how is it possible for open-source software companies to do any better than traditional "sell and support" companies? It simply does not make sense, unless A) open-source dramatically passes proprietary software in popularity, B) All those open-source users are willing to pay for support, AND C) support costs equal or exceed the alternative total cost of "sell and support."

Selling at a reduced price (or giving software away) is a decent way to grow market share. But if the question is about support companies being able to do as well as other companies, then ultimately support revenues will have to match total revenues from more traditional companies. Otherwise, the shift merely decreases the size of the overall market and reduces the amount of money available for good employees.

Open source founders never had the intent to create a new market that was more financially competitive than what already exists. Why should we be surprised when support companies start realizing the limits to their growth potential? The focus, was to propel technology at the expense of business.
Posted by David Arbogast (1709 comments )
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Think it again my friend
Selling software is a "decent" way to make a living you say?, so you think that is "indecent" to profit from adapting Opens Source solutions to business organizations or communities where the commercial software companies have no interest?. I totally disagree with you.

I live in Mexico, there are communities in Michoacan State that talk purhépecha language, no commercial software company will EVER do a versions of office or an operating system in that language.. but I can organice the community teachers that can speak spanish and purhépecha and make a purhépecha version of Open Office or Linux.

I could sell the PCs and charge the local goberment or the state's goberment for doing that and for mantaining small computing labs on the small towns of the sierrra purhepecha. I dont see the indecent part of this.. and I only see benefits for everybody.. People could mantain their cultural identity while entering into the digital era....

Small business in Mexico have a lot of pirated software.. they would like to be on the right way but the costs are just to hig.. they preffer to have pirated software than to dedicate they entire revenue to pay licencees and anual feeds for software. Bussiness with Open source can offer a solution.. there are many small Open Source systems that can be "good enough" for small bussiness and if I charge for an integral service of accounting, software mantaining and general managment that could be akiller service that Microsoft Oracle of SAP will never be interested in providing.. so asu you see there are a lot fo DECENT wasy to profit from Open source and services.

Greetings from Mexico
Posted by (23 comments )
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