February 2009

"In all enterprises, it's the business model that deserves detailed attention and understanding."

Mitch Thrower

For a company's commercialization efforts to succeed, it needs to come up with great market offers which have great business models. Open source (OS) is neither a business model nor a market offer. A market offer with a weak business model will derive little benefit from OS regardless of how good the OS may be.

Little is known about how OS strengthens the business model of a company's market offer. This article provide a conceptual tool that can be used to capture, share and communicate the strength of a company's business model and help articulate tacit knowledge into explicit knowledge. The second half of the article provides many examples that show how OS strengthens a company's business model.

This paper is relevant to: i) top management teams who must formulate their companies' business models clearly and communicate what is expected from OS; ii) top management teams who are considering investing in OS projects, participating in OS development, or influencing schedules and priorities of OS projects; iii) staff of OS foundations who must attract company investment and participation in their OS projects; and iv) academics who undertake research in the alignment of product development and OS evolution for the purpose of improving business performance

Distinguishing Between Market Offer and Business Model

The OS literature incorrectly uses market offer types such as subscriptions, service support, and software as a service to mean business models. Moreover, this literature stream often discusses the relationship between business models and OS in a superficial manner.

In Why Business Models Matter, Magretta proposed that a business model must pass two critical tests: the narrative test and the numbers test. A business model passes a narrative test when the story makes sense and the numbers test when the expected profit and loss statement adds up. However, Magretta makes no attempt to measure business model strength.

Anderson, Narus, and van Rossum highlight the importance of developing customer value propositions based on the few points of difference for which customers are willing to pay.

According to Johnson, Christensen and Kagermann, a business model defines the:

  • value delivered to customers and other key stakeholders
  • profit model
  • key resources, processes, and norms required to deliver value to key stakeholders and profits to the company

A market offer (offer) defines: i) what is purchased; ii) rights over what is purchased; and iii) how buyers purchase. Offers get jobs done for customers, solve customers' problems, and satisfy needs that customers have. An offer needs a business model. An offer and its business model are two sides of the same coin.

It is argued that a business model is the narrative and expected profit and loss statement that define the:

  • importance of getting the job done, solving the problem, or satisfying the need
  • value delivered to customers, company and other key stakeholders
  • control over or access to the key resources, processes, and norms required to deliver value

Other key stakeholders may include channel partners, complementors, and customers' customers. The value propositions for other key stakeholders need to be as compelling as the customer value proposition. For example, a company that has a channel partner as part of its go-to-market strategy needs to deliver both compelling customer value and compelling channel partner value.

Business Model Strength

It is argued that six variables affect the strength of a business model:

  1. Significance: how important to target customers is the job to be done, the problem to be solved, and the need to be filled.
  2. Customer value: how much better is the company's offer at delivering value on the elements that matter most to target customers compared to the next best alternative offer.
  3. Partner value: how much better is the company's go-to-market model at delivering value on the elements that matter most to channel partners and complementors compared to the next best alternative go-to-market model.
  4. Profit: how likely is it that the company will achieve the desired revenue growth and profits over the next three years.
  5. Leverage: how much control or access the company has over the key resources, processes and norms required to deliver value to customers and partners compared to the strongest competitor.
  6. Intellectual property: how well the company can protect its intellectual property for which customers are willing to pay.

Each variable can be assigned a weight that reflects its relative importance, where each weight can range from 0 to 9.

The first variable captures the importance to target customers of getting the job done. The next three variables capture what value is delivered to customers, partners and the company. The last two variables capture how the value will be delivered.

Consider the case of a multidisciplinary team that is developing a business model for an offer. To measure the strength of the business model for the new offer, the team assigns weights to reflect the relative importance of the six variables. Table 1 indicates that the team perceives significance as being the most important variable and has allocated it a weight of 8. For each target statement, the team provides a response that measures the level of agreement/disagreement with the statement.

Table 1 shows two ways to measure business model strength. The first uses weights that are all equal to 1. Business model strength is the ratio of 22, the sum of the responses to the six target statements, and 42, the maximum score possible. In our case, when the weights for all variables are set to 1, business model strength is 52.4%. The second way to measure business model strength relies on a weighted average of the responses. Business model strength equals the sum of the product between weight and response score as a percentage of 378 (9x6x7) as show in the last column of Table 1. In our case, when different weights are applied, business model strength is 34.9%.

Table 1: Two Ways to Measure Business Model StrengthTable 1

OS and Business Model Strength

OS can strengthen or weaken a business model. OS can strengthen a business model if its use:

  • persuades customers of the importance to get a job done, solve a problem, or fill a need
  • makes the offer more valuable on the elements that matter most to customers, channel partners and complementors relative to the best alternative offer
  • increases the likelihood that the revenue and profits from the offer will achieve company's targets
  • increases access or control over the key resources, processes and norms required to deliver value to customers, channel partners and complementors
  • increases the company's ability to protect its intellectual property for which customers are willing to pay

We provide some examples of how OS can strengthen business models. The examples are organized by variable and do not provide an exhaustive list of the many ways in which OS can increase business model strength.
 

  1. Significance: community plays a major role in OS. The free exchange of ideas and code benefits everyone. When members of an OS community convince customers of the importance of getting a job,done, scores in the significance dimension increase and the offer's business model becomes stronger.

    Various communities have convinced customers of the importance of avoiding vendor lock-in. This results in stronger business models for many offers that build on OS stacks. Similarly, the Xen community has convinced customers of the importance of server virtualization. This results in stronger business models for companies such as Cintrix and Virtual Computer that market offers which use a Xen-based client hypervisor as a tool.

  2. Customer Value: OS assets such as open hardware, software, and content offer many elements that essentially deliver the same value to customers as that delivered by the best proprietary alternatives. Customers do purchase and benefit from proprietary software, hardware, and content. There is little benefit to a company that relies on OS in coming across to customers as being zealot-like. This may undermine the credibility of the company's customer value proposition. The objective is to identify the points of difference OS provides and that customers value. If OS delivers value elements that customers consider to be superior to those offered by proprietary alternatives, the offer's business model will be strengthened.

    For example, with OS you see what you get. Customers can examine the source of the asset line by line. An OS asset that is widely distributed and frequently fixed can deliver significant value to customers. With OS, hundreds of professionals examine the asset's source to discover bugs and fix them quickly. Contrast this with commercial assets where customers may end up being at the mercy of suppliers of secretive and bug-filled proprietary products.

    With OS, access to the source code accelerates the development of add-ons that enhance the asset's functionality.

    With OS there are no license fees for development or runtime. For this reason, OS reduces ownership costs and increases flexibility as to where to operate the asset. Contrast this with proprietary alternatives where you must pay license fees and make decisions on where to run the asset based on licensing agreements.

    With OS, customers do not need to upgrade their assets with other customers as they can stay at a previous version and add enhancements selectively. Moreover, with OS, customers do not have to wait for a supplier to provide the features they require as they can add these features themselves.

    With OS, customers can monitor development and no longer have to depend on suppliers' promises of delivery dates. Frequently, these delivery dates are not met or the dates are met with assets that lack all the promised features.

    With OS, all can beta test the next release of an asset without the restrictions associated with testing proprietary assets such as restrictions on time or the number of users. In OS, beta testing is not restricted to a few organizations and platforms as is the case of proprietary assets. Moreover, the results of tests are public. Contrast this with tests of many proprietary products where suppliers prevent customers from publishing test results and portray products in their best light.

    In OS, both users and suppliers are stakeholders of OS assets as everyone must succeed. Contrast this with the adversarial relationships that frequently exist between suppliers of proprietary assets and their customers.

    With OS, talented individuals who are not part of the core development team are more likely to contribute to user documentation. Contrast this with the development of documentation of many proprietary products where there is lack of communication between product developers and documentation writers.

    OS provides more opportunities for developers to incorporate users' ideas into OS assets. Users are more likely to try OS assets and provide feedback based on its use.

    With OS, development efficiency increases. OS enables: i) rapid learning of how products work; ii) greater collaboration; and iii) faster debugging.

    When an organization adds features or functionality to an OS asset, a large number of smart people that the organization does not have to pay will help improve these features and functionality.

    OS assets are released when the community feels it is ready. Contrast this with commercial alternatives which are released to meet revenue targets set by senior executives.

    OS assets often support multiple compilers and do not lock customers into one supplier platform.

  3. Partner Value: OS provides significant value to partners as many of the elements that differentiate OS from proprietary alternatives are also valued by partners.

    Some value elements are unique to partners. For example, to founders of startups, venture capitalists (VCs) are important partners. VCs are institutions and high net worth individuals who bring managerial and technical expertise as well as capital to companies with high growth potential. VCs like OS because they can spend more money in global go-to-market strategies instead of research and development (R&D). For startups, OS can significantly reduce time-to-cash for the startup and increase the return on investment for capital suppliers.

    The governance, IT infrastructure and norms of OS make it easier for partners to collaborate. OS provides an out-of-the box approach that supports collaboration across partner organizations and individuals and harnesses global innovation to meet customers' needs. For example, OS can enable two companies that use the same OS asset as the means to two very different ends to partner.

    OS assets are readily available to existing partners and can be easily distributed to new partners. OS ubiquity increases the value of OS to partners.

  4. Profit: when a supplier uses OS, the likelihood that the profit targets for its offer will be achieved increases. A supplier that uses OS may have more control over its costs and better assessment of market size and sources of revenue.

    OS makes the development and sales costs of a supplier more predictable. The supplier does not have to worry about changes in the prices of commercial alternatives. Moreover, OS reduces the cost of finding customers, promoters and distributors for the suppliers' offers, and the cost of shaping the message promoters will pass on to their friends.

    A supplier can readily find on the Internet those individuals and organizations that promote the OS upon which their offers rely. These individuals and organizations are important to the supplier for two reasons. First, they are potential customers. Second, they can recommend the supplier's offers to others who may benefit from the offer.

    If a supplier's growth is a function of the number of its net promoters, OS can significantly increase the growth of the supplier's revenue and reduce its cost of sales.

  5. Leverage: a company that uses OS can increase control or access to the resources and processes it requires to deliver value to customers, the company and other relevant stakeholders. For example, the use of OS can increase the number of talented individuals that a company can access to develop its offers.A company can observe the behaviour of contributors to OS projects and approach the most talented individuals to work in company projects as full- or part-time employees or as contractors.

    A company can gain access to a well defined customer base that is anchored around the OS projects upon which the company's offers rely.

    A company can use OS to reduce the barriers to enter a market that is dominated by proprietary vendors.

    A company can lever OS communities to reduce the number of unfair comments from detractors of its offers. Members of the OS community are more effective at arguing against unfair public comments about a company's offer than company employees. They are diligent on countering the fear, uncertainty, and doubt (FUD) that may be spread by competing proprietary alternatives.

    OS is available to anyone. This places companies, large and small, on equal footing. However, a company can become involved in the governance of the OS community and influence project direction. To strengthen its offer's business model, a company needs to exert more control over the OS project than other companies.

  6. Intellectual Property: OS enables a company to compete based on the points of difference for which its customers are willing to pay and collaborate with other companies on the development of assets for which customers are not willing to pay. This enables companies to concentrate their resources in creating intellectual property. The greater the number of customers that wish to pay for the intellectual property a company owns, the stronger the offer's business model.

    An example of this is Apple's use of the user interface of Mac OSX as the differentiator. This user interface is built on top of Darwin, an OS computer operating system.

Conclusion

There is a need to understand how OS affects business model strength. The tool introduced in this article enables a new product team to design a strong business model at the initial stage of the offer development life cycle and communicate how OS strengthens the business model.

The tool introduced is offer-centric. A business model is linked to an offer, not a business unit or a product portfolio.

Coming up with great offers that use OS assets is not a winning proposition. To win in the marketplace, great business models are needed for the offers that rely on OS for generating revenue and profits.

Recommended Resources

Open Source is not a Business Model

Open Source Business Model is "Broken". Really?

Open Source: The Model is Broken

Licensing and Business Models

What Vendors Really Mean by Open Source

Clarifying Business Models: Origins, Present and Future of the Concept

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