Open Advice/Free and Open Source-Based Business Models

Free and Open Source-Based Business Models

by Carlo Daffara

in: Open Advice

This text is available under the CC-BY-SA license. (see also: Open Advice/Info)

Contents 1 Introduction 2 FLOSS and Economic Realities 3 Business Models and Value Proposition 4 A Business Models Taxonomy 5 Conclusions 6 References 7 about the author

Introduction

“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 FLOSS?” The question is not as gratuitous as it may seem, as many academic researchers still write this kind of text: “Open-source software is deliberately developed outside of market mechanisms... fails to contribute to the creation of value in development, as opposed to the commercial software market... does not generate profit, income, jobs or taxes... The open-source licenses on the software aim to suppress any ownership claims to the software and prevent prices from being established for it. In the end, the developed software cannot be used to generate profit.” [Koot 03] or [Eng 10] claims that “economists showed that real world open source collaborations rely on many different incentives such as education, signaling, and reputation.” (without any mention of economic incentives). This purely ”social” view of FLOSS is biased and wrong, and we will demonstrate that there are economical reasons behind the success of Free/Open Source businesses that go beyond the purely pro-bono collaborations.

FLOSS and Economic Realities

In most areas, the use of FLOSS brings a substantial economic advantage, thanks to the shared development and maintenance costs, already described by researchers like Gosh, that estimated an average R&D cost reduction of 36%. The large share of “internal” FLOSS deployments explains why some of the economic benefits are not perceived directly in the business service market.

The FLOSSIMPACT study found in 2006 that companies contributing code to FLOSS projects have in total at least 570 thousand employees and an annual revenue of 263B Euro [Gosh 06], thus making Open Source and Free Software among the most important ICT-based economic phenomenons. It is also important to recognize that a substantial percentage of this economic value is not immediately visible in the marketplace, as the majority of software is not developed with the intent of selling it (the so-called “shrinkwrap” software) but is developed for internal use only. As identified by the FISTERA EU thematic network in fact the majority of software is developed for internal use only:

Region	Proprietary software licenses	Software services (development/customization)	Internal development
EU-15	19%	52%	29%
US	16%	41%	43%
Japan	N/A	N/A	32%

It is clear that what we call “the software market” is in reality much smaller than the real market for software and services, and that 80% of it is invisible. We will see that FLOSS has a major part of the economic market directly through this “internal” development model.

Business Models and Value Proposition

The basic idea behind business models is quite simple: I have something or can do something – the “value proposition” – and it is more economical to pay me to do or get this “something” instead of doing it yourself (sometimes it may even be impossible to find alternatives, as in natural or man-made monopolies, so the idea of doing it myself may not be applicable). There are two possible sources for the value:

• a property (something that can be transferred) and
• efficiency (something that is inherent in what the company does, and how they do it).

With Open Source, usually “property” is non-exclusive (with the exception of what is called “Open Core”, where some part of the code is not open at all, and that will be covered later in the article). Other examples of property are trademarks, patents, licenses... anything that may be transferred to another entity through a contract or legal transaction. Efficiency is the ability to perform an action with a lower cost (both tangible and intangible), and is something that follows the specialization in a work area or appears thanks to a new technology. Examples of the first are simply the decrease in time necessary to perform an action when you increase your expertise in it; the first time you install a complex system it may require a lot of effort, and this effort is reduced the more experience you have with the tasks necessary to perform the installation itself; examples of the second may be the introduction of a tool that simplifies the process (for example, through image cloning) and it introduces a huge discontinuity, a “jump” in the graph of efficiency versus time.

These two aspects are the basis of all the business models that we have analyzed in the past; it is possible to show that all of them fall in a continuum between properties and efficiency.

Among the results of our past research project, one thing that we found is that property-based projects tend to have lower contributions from the outside, because it requires a legal transaction to become part of the company’s properties; think for example about dual licensing: for his code to become part of the product source code, an external contributor needs to sign off his rights to the code, to allow the company to sell the enterprise version alongside the open one.

On the other hand, right-handed models based purely on efficiency tends to have higher contributions and visibility, but lower monetization rates. As I wrote many times, there is no ideal business model, but a spectrum of possible models, and companies should adapt themselves to changing market conditions and adapt their model as well. Some companies start as pure efficiency based, and build an internal property with time; some others may start as property based, and move to the other side to increase contributions and reduce the engineering effort (or enlarge the user base, to create alternative ways of monetizing users).

A Business Models Taxonomy

The EU FLOSSMETRICS study on Free Software-based business models created, after an analysis of more than 200 companies, a taxonomy of the main business models used by Open Source companies; the main models identified in the market are:

• ˆ 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, and works thanks to the strong coupling clause of the GPL, that requires derivative works or software directly linked 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, which seems desirable to some parties. The downside of dual licensing is that external contributors must accept the same licensing regime, and this has been shown to reduce the volume of external contributions, which are limited mainly to bug fixes and small additions.
• ˆ Open Core (previously called “proprietary value-add” or “split Free Software/proprietary”): this model distinguishes between a basic Free Software and a proprietary version, based on the Free Software one but with the addition of proprietary plugins. Most companies following such a model adopt the Mozilla Public License, as it allows explicitly this form of intermixing, and allows for much greater participation from external contributions 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 for the users, i.e. it should not be reduced to “crippleware”, yet at the same time should not cannibalize the proprietary product. This balance is difficult to achieve and maintain over time; also, 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 that will not be limited in the same way.
• ˆ Product specialists: companies that created 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 and follow the original “best code here” and “best knowledge here” of the original EUWG classification [DB 00]. It leverages the assumption, commonly held, that the most knowledgeable experts on a software are those who have developed it, and this way 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 that is needed is in the acquisition of specific skills and expertise on the software itself.
• ˆ Platform providers: companies that provide selection, support, integration and services on a set of projects, collectively forming a tested and verified platform. In this sense, even GNU/Linux distributions were classified as platforms; the interesting observation is that those distributions are licensed for a significant part under Free Software licenses to maximize external contributions, and leverage copyright protection to prevent outright copying but not “cloning” (the removal of copyrighted material like logos and trademark to create a new product)^[1] . The main value proposition comes in the form of guaranteed quality, stability and reliability, and the certainty of support for business critical applications.
• ˆ 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 the communities, as the evaluation results and the evaluation process are usually a proprietary asset.
• ˆ Aggregate support providers: companies that provide a onestop support on several separate Free Software products, usually by directly employing developers or forwarding support requests to second-stage product specialists.
• ˆ 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 for verify that code is not improperly reused across company boundaries or in an improper way.
• ˆ Training and documentation: companies that offer courses, online 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 started offering Free Software-specific courses.
• ˆ R&D cost sharing: A company or organization may need a new or improved version of a software package, and fund some 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 on its Mobile Internet Devices (like the N810); within Maemo, only 7.5% of the code is proprietary, with a reduction in costs estimated around 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 this way reduced the overall cost of creating a software product that provides in some way developer-oriented functionality. There is a large number of companies, universities and individual that participate in the Eclipse ecosystem. As recently measured, IBM contributes around 46% of the project, with individuals accounting for 25%, and a large number of companies like Oracle, Borland, Actuate and many others with percentages that go from 1 to 7%. This is similar to the results obtained from analysis of the Linux kernel, and show that when there is a healthy and large ecosystem the shared work reduces engineering cost significantly; in [Gosh 06] it is estimated that it is possible to obtain savings in terms of software research and development of 36% through the use of Free Software; this is, in itself, the largest actual “market” for Free Software, as demonstrated by the fact that the majority of developers are using at least some Free Software within their own code (56.2%, as reported in [ED 05]). Another excellent example of “coopetition” among companies is the WebKit project, the HTML rendering engine that is at the basis of the Google Chrome browser, Apple Safari and is used in the majority of mobile devices. In the project, after an initial 1 year delay, the number of outside contributions start to become significant, and after a little more than 1 and a half year they surpass those performed by Apple by a substantial margin - thus reducing the maintenance costs and the engineering effort, thanks to the division of work among co-developers.
• ˆ Indirect revenues: A company may decide to fund Free Software projects if those projects can create a significant revenue source for related products, not directly connected with source code or software. One of the most common cases is the writing of software needed to run hardware, for instance, operating system drivers for specific hardware. In fact, many hardware manufacturers are already distributing gratis software drivers. Some of them are already distributing some of their drivers (specially those for the Linux kernel) as Free Software. The loss-leader is a traditional commercial model, common also outside of the world of software; in this model, effort is invested in a FLOSS 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 are for example those of the Mozilla foundation, which obtains a non-trivial amount of money from a search engine partnership with Google (an estimated 72M$ in 2006), while SourceForge / OSTG receives the majority of revenues from e-commerce sales of the affiliate ThinkGeek site.

Some companies have more than one principal model, and thus are counted twice; in particular, most dual licensing companies are also selling support services, and thus are marked as both. Also, product specialists are counted only when there is a demonstrable participation of the company in the project as “main committer”; otherwise, the number of specialists would be much greater, as some projects are the center of commercial support for many companies (good examples include OpenBravo or Zope).

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 all those surveyed; what we found is that the most probable future outcome will be a continuous shift across models, with a long-term consolidation of development consortia (like the Eclipse or Apache consortium) that provide strong legal infrastructure and development advantages, and product specialists that provide vertical offerings for specific markets.

Conclusions

FLOSS not only allows for sustainable, and even very large market presence (RedHat is already quite close to 1B$ in annual revenues) but also many different models that are totally impossible with proprietary software. The fact that FLOSS is a non-rival good also facilitates cooperation between companies, both to increase the geographic base and to be able to engage large scale contracts that may require multiple competencies, both geographical (same product or service, different geographical areas); “vertical” (among products) or “horizontal” (among activities). This facilitation of new ecosystems is one of the reasons why FLOSS is now present in nearly all the IT infrastructures in the world, increasing value and helping companies and Public Administrations in reducing costs and collaborating together for better software.

References

• ˆ [DB00] Daffara, C. Barahona, J.B. Free Software/Open Source: Information Society Opportunities for Europe? working paper, http://eu.conecta.it paper, OSSEMP workshop, Third international conference on open source. Limerick 2007
• ˆ [ED05] Evans Data, Open Source Vision report, 2005
• ˆ [Eng10] Engelhardt S. Maurer S. The New (Commercial) Open Source: Does it Really Improve Social Welfare? Goldman School of Public Policy Working Paper No. GSPP10-001, 2010
• ˆ [Gar06] Gartner Group, Open source going mainstream. Gartner report, 2006
• ˆ [Gosh06] Gosh, et al. Economic impact of FLOSS on innovation and competitiveness of the EU ICT sector. http://ec.europa.eu/enterprise/sectors/ict/files/2006-11-20-flossimpact_en.pdf
• ˆ [Koot03] Kooths, S. Langenfurth, M. Kalwey, N. Open-Source Software: An Economic Assessment Technical report, Muenster Institute for Computational Economics (MICE), University of Muenster

1. ↑ Examples of RedHat clones are CentOS and Oracle Linux.

about the author

Carlo Daffara is a researcher in the field of Open Source-based business models, collaborative development of digital artifacts, and Open Source software employment in companies. He is part of the editorial review board of the International Journal of Open Source Software & Processes (IJOSSP) and member of the technical board of two regional Open Source competence centers, as well as member of the FSFE European Legal Network. He has been part of SC34 and JTC1 committees in the Italian branch of ISO, UNINFO; and participated in the Internet Society Public Software working group, and many other standardization-related initiatives. Previous to that, Carlo Daffara was the Italian representative at the European Working Group on Libre Software, the first EU initiative in support of Open Source and Free Software. He chaired the SME working group of the EU Task Force on Competitiveness, and the IEEE open source middleware working group of the Technical Committee on Scalable Computing. He worked as project reviewer for the EC in the field of international collaboration, software engineering, open source and distributed systems and was Principal Investigator in several EU research projects.