Open Source Business Models and Revenue

Generation

Mikko Puhakka, SoberIT/TKK

Short Bio

-Management Consultant 1993-

-Venture Capitalist (investment into MySQL in 2001) 1999-

-Researcher 2004-

-COSS 2005-

-Open Tuesday 2006-

3

Open Source: A Simple Definition

Source: Fortune

Any software whose code isavailable for users to look at,modify, reuse and redistributefreely

OSSI Multidisciplinary Approach:

OSS Management

Multidisciplinaryapproach

Business

-legal aspects

-economics

-business models

-competitive strategy

-value networks

SociologyTechnology

Research Objectives

• The objective is to develop methods and tools forcompanies to manage more effectively the utilization ofopen source as an integral part of their business

! to develop an OSS management framework

! co-operative effort of 4 Universities (Tampere andHelsinki) and Industry

Industrial Partners:

• Nokia (Multimedia and Networks)

• IBM

• Novell

• F-Secure

• PricewaterhouseCoopers

• Plenware

• WM-data

• TietoEnator

• Technology Centre Hermia

Market Sentiments

Signs of the renaissance are popping up everywhere. Venture capital is flowing moreprofusely than it has since the late 1990s; money invested in early-stage startups couldtop $1.5 billion this year, up 50 percent from last year and almost double 2003 figure.

More significantly, the average seed investment, $4.4 million, is three times what it wasa year ago and larger than it was in 2000. That means that VCs are valuing startups athigher levels than at the height of the boom.

The downward trend in IT employment has abruptly reversed course, as companies bothnew and old hoard engineers. From January through June, tech added 161,000 newjobs, after losing 1 million from 2001 through 2004.

Business 2.0, November 2005

Why OS matters: Joe Kraus, Excite & Jotspot

Excite.com took $3,000,000 to get from idea to launch. JotSpot took $100,000.Why onearth is there a 30X difference?

Hardware is 100X cheaper In the 10 years between Excite and JotSpot, hardware hasliterally become 100X cheaper. It’s two factors ‘Moore’s law and the rise of Linux as anoperating system designed to run on generic hardware. Back in the Excite days, we hadto buy proprietary Sun hardware and Sun hard drive arrays. Believe me, none of it wascheap.Today, we buy generic Intel boxes provided by one of a million different suppliers.

Infrastructure software is free Back in 1993 we had to buy and continue to pay formaintenance on everything we needed just to build our service -- operating systems,compilers, web servers, application servers, databases. You name it. If it wasinfrastructure, we paid for it. And, not only was it costly, the need to negotiate licensestook time and energy. I remember having a deadline at Excite that required me to buy aSun compiler through their Japanese office because it was the only office open at thetime (probably midnight) and we needed that compiler NOW.Compare that to today.Free, open source infrastructure is the norm. Get it anytime and anywhere. At JotSpot,and startups everywhere you see Linux, Tomcat, Apache, MySQL, etc. No license cost,no maintenance.

Why OS matters: Belynda & Wikipedia

Couple months ago I was exchanging e-mails with an long-timefriend, explaining to her why she should take a careful at what ishappening in the publishing and content industries. After I sent hera link to Wikipedia (www.wikipedia.org), I got this very worriedresponse:

“The reason I am asking these questions is that I justrealized this threatens millions of dollars of our business inmy existing company. We sell an online encyclopedia - inmy territory alone this is over $400,000. One of our statedbenefits is that our source is authoritative - Wikipediaseems to be gaining so much ground and legitimacy thatcustomers may say why should I spend over $170,000 on aproduct that I can get basically free?”

Web-Based-> Web 2.0

E-Commerce-> Open Source

12Source: Gartner ; Novell ; Press clippings ; SaS analysis

LINUX HYPE CYCLE HAS BEEN GUIDED,AMONG OTHERS, BY PERCEPTION OF PROs AND CONs

Vis

ibil

ity

Time

Slope ofenlightenment

PROs CONs

Technologytrigger

?

Peak of inflatedexpectations

PROsCONs

Plateau ofproductivity

PROsCONs

Trough ofdisillusionment

CONsPROsPROs &

CONs in

the press

2001-2002 2003-now2000-20011997-20001991-1996

Governing ModelTechnology Adoption Life Cycle

by Geoffrey Moore

Pragmatists create the dynamics of high-tech market development

Innovators EarlyAdopters

Early Majority Late Majority Laggards

Techies:

Try it!

Pragmatists:

Stick with the herd!Conservatives:

Hold on!

Skeptics:

No way!Visionaries:

Get ahead of the herd!

Business Evolution

1. Free Software 1985-2. Open Source 1998-3. Commercial (Professional) Open Source 2005-

Financing Reflections 1/2

So far the OS experience has not been a happy one for venturecapitalists. According to research firm VentureOne some $714 millionwas invested in 71 Open Source companies in 1999-2000, and mostof those projects collapsed or were run down.

One of the biggest successes of those experiences is Red Hat whichwent public in 1999 and makes money by selling enhancements andmaintenance services to corporations using Linux open-sourceoperating system. Still that is relatively mild success as it still hassome $200 million in revenues with capitalization of 2 billion. So this iscertainly no Google or EBay that aggressive venture capitalists oftenuse as a reference as companies they want to fund as the !Next BigThing".

Source: Ripos Project

Financing Reflections 2/2

After few years of trying to figure out whether money can made byOpen Source companies, the answer from venture capitalists seem tobe again a reluctant yes. 20 Open Source businesses raised $149million in venture money in 2004 in United States alone (VentureOne).

There are no numbers available for the rest of the world, but at least inEurope several investments took place. Looking at that total it wouldseem that most of the investments are still on seed or first round level(comparing to average level on various rounds of realizedinvestments) as if distributed evenly among companies the amountwould be $7.45 million. In other words, the first bets to the potentialfuture successes have just been made and how successful those willbe can only be known in the coming years.

Source: Ripos Project

Business Success - Historical vs Now

Initially very little compared to investments, remember 99-00!

Now some success among the true OS Start-ups, very little compared tocompetition (MySQL, JBOSS etc)

Real benefactors so far have been utilizers of Open Source such as Google,using Joe Kraus’ formula would it have required 30x the used venturecapital (26 million USD) to build Google, and would they have been able toraise that 780 million USD??? Maybe we would not have Google withoutOpen Source??!!

Businessmodels 1/6

1) Open Source + ServiceWhat it means: Companies sell support and services around open-source software.

Who’s doing it: Compiere (ERP), JBoss (middleware), Red Hat (Linux)

Advantages for CIOs: You pay only for support, not software. The cost to switchproviders is relatively low because the source code is available to anyone.

Startup challenges: Difficult to build businesses because switching costs are low, asare barriers to entry. CIOs will always favor large, established vendors over startupsunless the startups also control code development. Hard to get venture fundingbecause venture capitalists are looking for sustainable competitive advantage intheir investments. Unless the software is complex or mission-critical, CIOs maychoose to support it themselves.

Businessmodels 2/6

2) MixedWhat it means: An open-source code base with proprietary add-ons.

Who’s doing it: Sourcefire (security), SugarCRM

Advantages for CIOs: CIOs may not need the proprietary stuff, but if they do they’llalready have acquired deep experience with the open-source product before buyingthe add-ons.

Startup challenges: There’s ample motivation to make the open-source productinferior to the proprietary package, transforming the open source into trial software. Ifthat happens, there may be a backlash among open-source developers and userswanting to see all the code.

Businessmodels 3/6

3) Open Source + Buy OffWhat it means: Companies offer a proprietary license for their open-source softwareso that users can modify the software and redistribute it without having to make thecode changes available to the public.

Who’s doing it: MySQL (database), Sleepycat (database)

Advantages for CIOs: The open-source software has all the features of theproprietary version.

Startup challenges: Sales of the proprietary version are limited mostly to thosecompanies that want to redistribute it as part of their own hardware or softwarepackages.

Businessmodels 4/6

4) Open Source + AggregationWhat it means: Companies assemble various open-source software packages intointegrated units that are easier for CIOs to consume.

Who’s doing it: Exadel, Navica, SourceLabs, SpikeSource

Advantages for CIOs: Simplifies open-source integration and support.

Startup challenges: Barriers to entry are low, brand differentiation is difficult, lack ofownership of open-source projects limits the influence of the company in thedevelopment of the code.

Businessmodels 5/6

5) Open Source + HardwareWhat it means: Hardware makers use open source as the foundation for the softwarethat runs their machines.

Who’s doing it: Cisco, Digium, Netezza, Nokia

Advantages for CIOs: Lower prices on hardware.

Startup challenges: It’s difficult to differentiate on hardware alone, especially whenCIOs are looking to standardize their infrastructure

Businessmodels 6/6

These companies illustrate some of the OSS strategies being

used to create product value.

What we do understand - and do not (1/2)

We have understanding of…

• What kind of business and revenue models may be possible

– At least some examples already existing

• How OSS may impact on the various areas of the softwareindustry

– Regarding software products, tailored programs andembedded systems

• What are the benefits of building on top of mature OSS

– Often quoted examples are e.g. Google, that has built itsservice on top of OSS and comparison of Jotspot andExcite.com where the difference of building basic infrawas 30-fold

What we do understand - and do not (2/2)

We do not yet have understanding of…

• Is OSS approach better way for conducting business if metricsused for success are time-to-revenue and time-to-profit?

• What is return on investment (ROI) with OSS?

• How to manage OSS-based ventures with non-contractualparties involvement? How sustainable OSS-based business is?

• How to valuate OSS-based ventures? Is it able to considercommunities to be equivalent to IPR portfolio? How to createbarriers of entry in order to achieve competitive advantage?

• Which are really sustainable and appliable ones of thoseexample cases (and which ones may be just anomalies)?

Lessons from the year 2005

Large incumbents’ open source efforts

• “Everyone” seems to have some kind of OSS strategy

• Rules of conducting business with OSS more clarified

Open source in handhelds

• Linux gets backing of major vendors in order to make it suitablefor handhelds

• Very interestingly, this opens a market for OSS where clearexisting business and revenue model is not challenged

Positive revenue development for key OSS companies

• Early signs that OSS model might be a way to challenge largeenterprise software companies and to make money

What to follow in 2006

GPL v.3

• How will existing OSS business practices be affected?

• Will everyone embrace GPL3? (cf. Torvalds & Linux)

Realization of value through exits

• IPO’s or tradesales will validate the value creation of OSS further

• Division of interests as value created by large communities stay inthe hands of few

Emergence of for-profit companies may support the adoptation of opensource

• As creation of value becomes more apparent among OSScompanies, e.g. Venture Capitalists specialized in OSS are likely toemerge

The Future 1/3 -Analysts View 1/2

(Gartner)

OSS will not destroy industry giants, such as IBM and Microsoft, but itwill revolutionize software markets by moving revenue streams fromlicense fees to services and support.

In doing so, it will be a catalyst that restructures the industry.

The Future 1/2 -Analysts View 2/2

By 2008 95 percent of Global 2000 organizations will have formal open-source acquisition and management strategies; and, OSS applicationswill directly compete with closed-source products in every softwareinfrastructure market.

By 2010, IT organizations in Global 2000 companies will consider open-source products in 80 percent of their infrastructure-focused softwareinvestments and 25 percent of their business software investments.

The Future - Personal View (Nov. 2005)

MySQLJBOSS (Bought by RedHat 3/2006)SpikeSourceSugarCRM

One IPO by the time we meet at Open Mind in 2006 - One company strugglingwith increased competition

Acceptance of new ideas such as Open Source

Open Tuesday May 2nd

Where: Club Ahjo at Klaus KurkiWhen: Starting at 1800Sponsored by Nokia = free entrance, first beer freeWho will be there: 50-100 industry people involved inOpen Future

Registration: e-mail to register@open-tuesday.com

Additional info: www.open-tuesday.com

Contact Details:

mikko.puhakka@soberit.hut.fiwww.soberit.hut.fiwww.coss.fiwww.coss.fi/ossiwww.open-tuesday.com+358 500 200 200