"To succeed, companies need to find ways to use outside innovations and to become part of a distributed fabric of innovation through a combination of licensing and well-chosen gifts...This is what open source is all about: harnessing engines of innovation in software."
"How do you make money with free software?" was a very common question just a few years ago. Today, that question has evolved into "What are successful business strategies that can be implemented on top of free software?" To properly answer this question, it is important to distinguish between the legal, procedural and business model aspects of free/libre and open source software (F/LOSS) and how those aspects interact. For example, the licensing aspect influences the development strategy, the kind of development community that can be created around a project, and the potential business models that can provide a monetization strategy for a company that is interested in adopting an open source project as part of the internal company strategy.
This article provides the most recent results from the FLOSSMETRICS project and its recent survey of the business model of more than 200 open source companies.
In order to develop business strategies, it is necessary to have a clear understanding of the different aspects that you seek to address. Popular ambiguous use of some terms for fundamentally different concepts and issues makes clarity more difficult. For example, "open source" can be used to refer to a software model, a development model, or a business model.
These three models are orthogonal, like the three axes of the three-dimensional coordinate system. Their respective differentiators are control (software model), collaboration (development model), and revenue (business model).
The software model axis is the one that is discussed most often. There is proprietary software, for which the vendor retains full control over the software and the user receives limited usage permission through a license which is granted according to certain conditions. There is free software which provides the user with unprecedented control over the software through an ex-ante grant of irrevocable and universal rights to use, study, modify and distribute the software.
The development model axis describes the barrier to collaboration, ranging from projects that are developed by a single person or vendor to projects that allow extensive global collaboration. Collaboration is independent from the software model. There is proprietary software that allows for far-reaching collaboration, such as SAP with its partnership program. There are free software projects that are developed by a single person or company with little or no outside input.
The business model axis describes what kind of revenue model was chosen for the software. Options on this axis include training, services, integration, custom development, subscription models, commercial off the shelf (COTS), and software as a service (SaaS).
These three axes open the space in which any software project and any product of any company can freely position itself. That is not to say that all of these combinations will be successful. A revenue model based on lock-in strategies with rapid paid upgrade cycles is unlikely to work with free software as the underlying software model. This approach typically occurs on top of proprietary software for which the business model mandates a completed financial transaction as one of the conditions to grant a license.
The overlap of possible business models on top of different software models is much larger than usually understood. The free software model makes it generally impossible to attach conditions to the granting of a license, including the condition of a financial transaction. But it is possible to implement very similar revenue streams in the business model through contractual constructions, trademarks, or certification.
Each of these axes warrants individual consideration and careful planning for the goals of the project. If the goal is to work with competitors on a non-differentiating component in order to achieve independence from a potential monopolistic supplier, it would seem appropriate to focus on collaboration and choose a software model that includes a strong copyleft licence. The business model could potentially be neglected in this case, as the expected return on investment comes in the form of strategic independence benefits and lower licence costs.
In another case, a company might choose a collaborative community development model on top of a strong copyleft licence, with a revenue model based on enterprise-ready releases that are audited for maturity, stability and security by the company for its customers.
The number of possible combinations is almost endless, and the choices made will determine the individual character and competitive strengths and weaknesses of each company. Thinking clearly about these parameters is key to a successful business strategy.
Strategic Use of Free Software vs. Free Software Companies
According to Gartner, usage of free software will reach 100% by November 2009. That makes usage of free software a poor criterion for what makes a free software company. Contribution to free software projects seems a slightly better choice, but as many free software projects have adopted a collaborative development model in which the users themselves drive development, that label would then also apply to companies that aren't information technology (IT) companies.
IT companies are among the most intensive users of software and will often find themselves as part of a larger stack or environment of applications. Being part of that stack, their use of software not only refers to the desktops and servers used by the company's employees, but also to the platform on top of which the company's software or solution is provided.
Maintaining proprietary custom platforms for a solution is inefficient and expensive, and dependence upon other proprietary companies for the platform is dangerous. In response, large proprietary enterprises have begun to phase out their proprietary platforms and are moving towards free software in order to leverage the strategic advantages provided by this software model for their own use of software on the platform level. These companies will often interact well with the projects they depend upon, contribute to them, and foster their growth as a way to develop strategic independence as a user of software.
These enterprises are proprietary since where they are not primarily users of software but suppliers to their downstream customers, their software model is proprietary, withholding from its customers the same strategic benefits of free software that the company is using to improve its own competitiveness.
From a customer perspective, that solution becomes part of the platform on which the company's differentiating activities are based. This is inefficient, expensive and a dangerous strategy.
Assuming a market perspective, it represents an inefficiency that provides business opportunity for other companies to provide customers with a stack that is free software entirely. It is strategically and economically sane for customers to prefer those providers over proprietary ones for the very same reasons that their proprietary suppliers have chosen free software platforms.
Strategically speaking, any company that includes proprietary software model components in its revenue model should be aware that its revenue flow largely depends upon a lack of free software alternatives. Growth of the market, as well as supernatural profits generated through the proprietary model, both serve to attract other companies that will make proprietary models unsustainable. When that moment comes, the company can either move its revenue model to a different market or transform its revenue source to work on top of a software model that is entirely free software.
Usage of and contribution to free software are not differentiators for what makes a free software company. We believe that the critical differentiator is provision of free software downstream to customers. Free software companies are companies that have adopted business models in which the revenue streams are not tied to proprietary software model licensing conditions.
Economic Incentives of Free Software Adoption
The broad participation of companies and public authorities in the open source software (OSS) market is strictly related to an economic advantage. In most areas, the use of free software brings a substantial economic advantage, thanks to the shared development and maintenance costs. Researchers like Gosh estimate an average research and development cost reduction of 36%. The large share of internal free software deployments explains why some of the economic benefits are not perceived directly in the business service market. This can be seen in Figure 1, from Gartner Group's 2006 publication Open Source Going Mainstream:
The diagram shows the relative percentage of OSS and OSS-related services in the context of the overall software market. It shows the compound aggregate growth rate (CAGR) for both OSS and non-OSS. The higher growth rate of open source is the reason for the great increase in market share for OSS. Gartner predicts that within 2010, 25% of the overall software market will be free software-based, with roughly 12% internal to companies and administrations that adopt free software. The remaining market, still substantial, is based on several different business models that monetize the software using different strategies.
We present the results from the February 2009 update of the FLOSSMETRICS study on free software-based business models. After an analysis of more than 200 companies, the main models identified in the market are:
Dual licensing: the same software code distributed under the GPL and a proprietary license. This model is mainly used by producers of developer-oriented tools and software. It succeeds thanks to the strong coupling clause of the GPL that requires derivative works or directly linked software to be covered under the same license. Companies not willing to release their own software under the GPL can obtain a proprietary license that provides an exemption from the distribution conditions of the GPL. The downside of dual licensing is that external contributors must accept the same licensing regime. This has been shown to reduce the volume of external contributions, which are limited mainly to bug fixes and small additions.
Open core: this model distinguishes between free software and a proprietary version which is based on the free software with the addition of proprietary plug-ins. Most companies following such a model adopt the Mozilla Public License which allows explicitly this form of intermixing. This model allows for greater participation from external contributors without the same requirements for copyright consolidation as in dual licensing. The model has the intrinsic downside that the free software product must be valuable to be attractive to users, yet at the same time it should not cannibalise the proprietary product. This balance is difficult to achieve and maintain over time. If the software is of large interest, developers may try to complete the missing functionality in free software, thus reducing the attractiveness of the proprietary version and potentially giving rise to a full free software competitor.
Product specialists: companies that create or maintain a specific software project and use a free software license to distribute it. The main revenues are provided from services like training and consulting. This model leverages the common assumption that the most knowledgeable experts on a software product are its developers. Developers can provide services with a limited marketing effort by leveraging the free redistribution of the code. The downside of the model is that there is a limited barrier of entry for potential competitors, as the only investment needed is the acquisition of specific skills and expertise on the software.
Platform providers: companies that provide selection, support, integration and services on a set of projects, collectively forming a tested and verified platform. GNU/Linux distributions can be classified as platforms. These distributions are licensed for a significant part under free software licenses to maximize external contributions and leverage copyright protection to prevent outright copying. These licenses do allow cloning, the removal of copyrighted material like logos and trademark to create a new product. The main value proposition comes in the form of guaranteed quality, stability and reliability, and the certainty of support for business critical applications.
Selection/consulting companies: companies in this class are not strictly developers, but provide consulting and selection/evaluation services on a wide range of projects, in a way that is close to the analyst role. These companies tend to have very limited impact on free software communities as the evaluation results and the evaluation process are usually a proprietary asset.
Aggregate support providers: companies that provide a one-stop support on several separate free software products, usually by directly employing developers or forwarding support requests to second-stage product specialists.
Legal certification and consulting: these companies do not provide any specific code activity, but provide support in checking license compliance, sometimes also providing coverage and insurance for legal attacks. Some companies employ tools to verify that the code is not improperly reused across company boundaries.
Training and documentation: companies that offer courses, on-line and physical training, additional documentation or manuals. This is usually offered as part of a support contract, but recently several large scale training center networks have started offering OSS specific courses.
Research and development cost sharing: a company or organization may need a new or improved version of a software package and will fund a consultant or software manufacturer to do the work. Later on, the resulting software is redistributed as open source to take advantage of the large pool of skilled developers who can debug and improve it. A good example is the Maemo platform, used by Nokia in its mobile Internet devices. Within Maemo, only 7.5% of the code is proprietary, with a reduction in costs estimated at 228M$ and a reduction in time-to market of one year. Another example is the Eclipse ecosystem, an integrated development environment (IDE) originally released as free software by IBM and later managed by the Eclipse Foundation. Many companies adopted Eclipse as a basis for their own product, and thus reduced the overall cost of creating a software product that provides developer-oriented functionalities. A large number of companies, universities and individuals participate in the Eclipse ecosystem. As recently measured, IBM committers constitute around 32% of the Eclipse project and 43% of commits, with individuals accounting for 15% of commits and 29% of committers, while a large number of companies like Oracle, Borland, and Actuate participate with percentages ranging from 1% to 7%. These results, similar to those obtained from analysis of the Linux kernel, show that a healthy and large ecosystem reduces engineering costs significantly. This is the largest actual "market" for free software, as demonstrated by the fact that 56.2% of developers are using at least some free software within their own code.
Indirect revenues: a company may decide to fund free software projects if those projects can create a significant revenue source for related products which are not directly connected with source code or software. One of the most common cases is the software drivers needed to run hardware. Many hardware manufacturers distribute software drivers at no charge and some manufacturers distribute some of their drivers under a free software license.
Loss-leader: is a traditional commercial model, common also outside of the world of software. In this model, effort is invested in a free software project to create or extend another market under different conditions. For example, hardware vendors invest in the development of software drivers for free software operating systems like GNU/Linux to extend the market of the hardware itself. Other ancillary models include: i) the Mozilla Foundation, which obtains a non-trivial amount of money from a search engine partnership with Google, estimated at 72M$ in 2006; and ii) SourceForge/OSTG which receives the majority of its revenues from ecommerce sales of the affiliate ThinkGeek site.
We found, confirming previous research from the 451 Group, that at the moment there is no significant model, with companies more or less adopting and changing models depending on the specific market or shifting costs. During 2008, a large number of companies shifted from an open core model to a pure product specialist model to leverage the external community of contributors.
According to the collected data, among free software companies the fully free software approach is still prevalent, followed by the open core and the dual licensing models.Figure 2 shows the prevalence ratio of the models from our research data:
Some companies have more than one principle model, and are counted twice. Most dual licensing companies are also selling support services, and are marked as both. Product specialists are counted only when there is a demonstrable participation of the company into the project as a main committer. Otherwise, the number of specialists would be much greater as some projects are the center of commercial support from many companies. OpenBravo and Zope are good examples.
Another relevant consideration is the fact that platform providers, while limited in number, tend to have a much larger revenue rate than both specialists or open core companies.
Many researchers are trying to identify whether there is a more efficient model among those surveyed. We found that the most probable future outcome will be a continuous shift across models. We foresee a long-term consolidation of development consortia, like Symbian and Eclipse, that provide strong legal infrastructure and development advantages, and product specialists that provide vertical offerings for specific markets. This contrasts with the view that mixed models provide an inherent advantage. Matthew Aslett of the 451 Group, one of the leading researchers in free software business models wrote: "The Open-Core approach is mostly (though not exclusively) used by vendors that dominate their own development communities. While this provides benefits in terms of controlling the direction of development and benefiting from the open source distribution model there are also risks involved with promoting and managing community development--or not. In fact, many of these companies employ the majority of the developers on the project, so they are actually missing out on many of the benefits of the open source development model (more eyeballs, lower costs etc)".
Additionally, by providing revenue-generating features on top of open source code, open core vendors are attempting to both disrupt their segment and profit from that disruption. It is probably easier in the long-term to generate profit from adjacent proprietary products than it is to generate profit from proprietary features deployed on top of the commoditized product.
While open core is the commercial open source strategy of the day and is effective in building the revenue growth required to fuel an exit strategy, we have doubts as to whether it is sustainable in the long-term.
The fact that free software is a non-rival good facilitates cooperation between companies, both to increase the geographic base and to engage large scale contracts that may require multiple competencies. Three main collaboration strategies were identified among smaller companies: i) geographical, with the same product or service in different geographical areas; ii) vertical among products; and iii) horizontal among activities. Geographic cooperation is simpler, and tends to be mainly service-based. An example is the Zope Europe Association that unites many service providers centered on specific Zope and Plone expertise. Vertical cooperation is done by companies that perform an integrated set of activities on one or more packages. Multiple vendors with overlapping products can collaborate on a single offer, such as an operating system, that may form a more interesting or complete offer for the selected customer segment.
Table 1 summarizes our findings.
OSS has demonstrated its role in the current IT economy, with more companies adopting OSS as an addition or as the basis for their business models. The success of those endeavours is dependent on the appropriateness of the model used to monetize the open source asset. This article tried to present a coherent summary of research activities in the area of business models and the advantages and disadvantages of the current models.
This article was partially adapted from the results of the following EU projects: i) FLOSSMETRICS; ii) OpenTTT which studied open source business models and adoption of OSS within companies; iii) COSPA which studies the adoption of OSS by public administrations in Europe; iv) CALIBRE; and iv) INES which studies open source in industrial environments. I am indebted to Georg Greve of FSFE, who wrote the introduction, and permitted redistribution. The original article is available here.