As a marketer, I’m a fan of open source software. After all, if you can’t dislodge Microsoft from mid-range server operating systems, Microsoft Office from desktop productivity suites, or Oracle from relational databases — and doing so through traditional means is a virtual impossibility — then blowing up the whole business model isn’t a bad start. It’s creative and it cuts right to the core of the problem.

But as a business-person I am not. When you play the role of market spoiler it’s much easier to be famous than rich. For example, when MySQL was acquired by Sun in 2008 for $1.2B, MySQL was doing only about $65M in annual revenues. While the revenue multiple on the exit was spectacular, their capture rate was not: MySQL disrupted literally billions in “big three” (i.e., Oracle, DB2, SQL Server) database revenues. But if your value proposition is rooted in “almost free relative to leading commercial alternatives,” then you won’t succeed at 50% of their cost; you’ll need to be more like 2-5%.

I refer to open source as both a development model — i.e., a way of building software — and a business model. While the former is more well defined than the latter, the typical way to make money in open source is through selling subscriptions or licenses to certified and more-quickly-patched releases as well as selling technical support and/or consulting services to go with them.

While a spectacular exit multiple may occasionally pay off big time for shareholders (e.g., JBoss, MySQL), my theory is that in general it’s very hard to make money with the open source business model. Red Hat is the obvious exception, and we’ll talk about them in a minute.

The basic paradox of open source is this:

The smaller the community the worse the software quality and the more people need certified releases and support.

The bigger the community the higher quality the software and the less people need certified releases and support (i.e., the community version will do).

So you can have a large community who doesn’t need to buy from you or a small community who does.

Two other drivers complete the picture:

The nature of the software and to what extent it truly requires an almost-daily stream of patches and updates and …

The monetization rate which is a function of the commercial market structure. For example, the lower-level the software (e.g., operating systems) the more the market tends towards natural monopoly as customers want to minimize entropy at the bottom of the stack. This should drive high pricing/margins on the commercial side of the market, and a parallel opportunity for someone to establish clear leadership on the open source side.

This is why Red Hat does so well when most others end up stagnating in the tens-of-millions of revenues range. The market is huge. The software is low-level and thus the market “wants” a clear leader (think: increasing returns) who can provide a hardware-independent, low-cost, supported product as an alternative to the proprietary Unix-es of days past.

Put differently, the bigger the commercial market and the more monopolistic its structure, the better the open source opportunity. Conversely, the smaller the commercial market and the more fragmented leadership is within it (e.g., enterprise search, document management, and to some extent BI), the worse the open source opportunity.

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