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What is an “Open Source Company?” The Billion Dollar Question

Way back in the dark ages of 2006, Alfresco’s Matt Asay and I debated the revenue potential of open source businesses; particularly the potential ceilings therein. Here’s how I framed the basic question:

One of the frequently debated topics concerning open source companies, both at OSCON and more generally, is how they compare in economic terms – or don’t – with their closed source or proprietary counterparts. The most common manifestation of this is the simple question: will we see a billion dollar open source business? Not traditional vendors leveraging open source to make a billion dollars, but a business built solely on open source reach the billion dollar revenue milestone. Before we attempt to answer that using crude but bottom line metrics such as market capitalization – which is impossible in a majority of cases anyway, it’s necessary to understand the fundamental compromise that open source makes.

In return for the massive distribution advantages that accompany its low or no barrier to entry approach, open source often (but not always) concedes up front licensing costs. This is in most cases favorable for customers, as they are free to pay at what Simon calls the “point of value” rather than at project commencement when value is still unproven. The question is whether or not it’s favorable to the businesses that are built on this model. Answer that, and you’ll be a fair ways down the path towards answering the billion dollar question.

My answer to the question of whether we would see “open source businesses” reach the billion dollar threshold was, in essence, not any time soon. Matt dissented, saying “Red Hat will hit the $1B mark in 3-5 years, and will likely do so without seriously tapping into the gold mine that is Windows territory.” Who was right depends largely on definitions. First, what timeframe was implied by my original statement:

At this point, however, I do not expect any of the major pure open source firms to challenge the billion dollar threshold any time soon.

Second, what firms may be included under the quote unquote open source business description. But let me come back to that in just a bit.

For now, let’s explore the first question, which is one of timing. For Matt, 3-5 years was soon, and this is how I responded to him at that time:

According to Google Finance, RHAT’s 06 revenues were 278.33M. My math is not so strong, but I believe they’d need to pick up an additional 721.67M in revenue to be able to stick a B next to their revenue. I also could quibble with Matt’s characterization of 3-5 years as a timeframe fitting the definition of “soon” [1], but let’s accept it for the sake of argument. According to Matt, then, somewhere between 2007 and 2011 Red Hat would need to hit the billion dollar mark. What I did then was relatively simple: I clicked through Google Finance to get the sales ratios from Reuters, and got their 5 year annual growth sales rate, which was 28.05% (compared to the industry which is apparently 13.95%, so Matt’s right – it’s business model is fairly remarkable).

Firing up a spreadsheet, I did a basic calculation that essentially looked like (PREV YR REV * .2805) + PREV YR REV, and projected it out five years. My totals look like this: 356.4 (2007), 456.37 (2008), 584.38 (2009), 748.3 (2010), 958.2 (2011). You’ll note, I trust, that the year 5 number does not qualify for the B title. Close, but still a bit short of what Novell makes today. For more context that would also be a thirteenth of what Sun makes today, a 44th of what Microsoft makes, and a 91st of what IBM makes (yes, the Sun and IBM examples are apples to oranges, in that both derive more money from other areas of their businesses than they do from software, but I think it’s useful to establish what a billion actually means).

Now in Matt’s defense, I’ve taken the five year average, and it should be noted that Red Hat’s sales rate increase of late has been up considerably. The sales versus a year ago are up 39.94%. If you recompute the above calculation, factoring in a sales growth rate of just shy of 40% for the next five years, the numbers look like this: 389.5 (2007), 545.06 (2008), 762.76 (2009), 1067.4 (2010), 1493.72 (2011). So not only does Red Hat hit a billion dollars, they do so in 4 years not 5.

Assuming you think 4 or 5 years qualifies as soon, the question then becomes whether you think Red Hat will grow close to 40%, buoyed by the acquisition of JBoss, further consolidation and entrenchment of the Linux server market, and potential future acquisitions, or shy of 30%, weighed down by increasing competition from Solaris/OpenSolaris, a newly relevant Ubuntu, the fact that growth is more difficult the bigger you get, and a damaged relationship with IBM. I’m currently in the latter camp, and would assume Matt counts himself as a member of the former.

How did Red Hat actually perform? Well, some two and a half years later, they have yet to hit the billion dollar revenue mark. But they are halfway there, with Google Finance reporting 2008 revenues at $523 million and change, building on 2007’s $400. You might also note that while they didn’t quite match the 39.4% growth rate from 2006, which would have put them at $545 million and change, they easily bested the $456 projected in the conservative forecast (one assumes that some of the growth is attributable to JBoss, which Red Hat had not yet acquired at that time).

So while three years later none of the open source pure plays are billion dollar firms (true, MySQL achieved that in valuation, but they are no longer a stand alone entity), Red Hat at least is on pace to get there.

But it’s equally clear that they are the exception, rather than the rule, which is perhaps what’s rekindled this debate once more. First up was Dave Rosenberg discussing the economics of open source entities, followed by my RedMonk colleague Cote weighing in on a variety of open source models – bundling closed source in the so-called hybrid model among them (or open-core if you prefer) – which in turn drew praise from the aforementioned Mr. Asay.

Basically, you may distill much of the above down to a simple assertion that says that while open source offers massive advantages in several areas such as distribution, its intrinsic economic disadvantages are likely to compel commercial open source organizations to seek complementary – and likely non-open source – software models to avoid an early plateau in their revenue potential. To the surprise of probably no one, I more or less agree with this assertion – with one important caveat. Sure, there will be plenty of non-commercial open source that is pure. And there will be a wealth of projects that cannot be made less than pure due to the applied licensing. But the trend in the commercial open source supplier space is clear, and in the direction of hybrid models.

But what if we weren’t just talking about those who sell and service open source software, but also those who’ve built businesses upon it? The 451 Group’s Matthew Aslett, an analyst colleague, quite efficiently articulates a number of open source models but omits the one that I personally consider most compelling: building other businesses on open source, businesses that may have nothing to do with selling software.

My poster child for this is, predictably, Google. As I discussed last year, I consider Google to be an “open source business” because the business is effectively built on open source. True, its software is no more open than, say, the pieces of the IBM portfolio that embed the Apache HTTP server, but it’s undeniable that Google is a business that is built on, with and from open source software. And while some will undoubtedly challenge their side of the give and take equation, given their contributions from Summer of Code to Mark Callaghan’s MySQL patches I find it hard to argue that they are not benefiting a variety of communities.

Should I care then that the business model they settled on isn’t selling software? Does that preclude them from qualifying for the title of open source business?

How you answer that question will provide your answer for the larger question above, of course. Because if you can find room for the Google’s of the world – businesses built from open source – in your philosophy, then the entire debate is academic. At nearly $22 billion in revenue for fiscal year ’08, after all, they’re a little bit beyond the billion yardstick.

Categories: Uncategorized.

  • http://krow.net/ Brian Aker

    Hi!

    I’ve always told people “if you really want to make a lot of money from open source, then find a way to use it”.

    This doesn’t mean that there is not money in writing open source… but I believe the overwhelming amount of cash that can be made is in putting it to work.

    MySQL made the makers of it a lot of money… but that money is small in comparison to the amount of cash that has been made using it.

    Cheers,
    -Brian

  • http://www.webmink.net/ Simon Phipps

    If your metric for “open source business” is a successful exploiter of open source, then surely Microsoft is the poster-child and has been for decades? Windows itself is riddled with BSD code and more recently other products have included open source, as Asay points out[1]. All that let them down all those years was their transparency and honesty in displaying their contempt for the communities they exploited…

    [1] http://news.cnet.com/8301-13505_3-10172150-16.html

  • http://freelock.com John Locke

    Hi,

    I don’t think you’ll see businesses like Microsoft or Oracle come out of open source. I completely agree with your point about Google being a business built on open source, and Red Hat being an exception in that it is a product company.

    I’d say the fundamental thing that open source does is turn the proprietary software model on its head. No longer is most of the profit and control in the hands of software companies–it’s now in the hands of service providers. We own the customer relationships, and can pick and choose software that best meets their needs.

    So it’s going to open up a thriving mid-market of software consulting companies, and some of those may turn commodity software into big business, the same way McDonalds did–by franchising. Open Source business scales horizontally.

    That’s my bet, anyway, and what Freelock is all about…

    Cheers,
    John

  • http://iquaid.org Karsten Wade

    Note that you have significantly changed the question in the last 2.5 years. It will change just as significantly in the next 2.5.

    This whole company valuation of open source is harder to calculate because the advantage is not to one company. When there are few players or a dominant player selling closed source software, they can include new functions for free or reasonable cost that attract new users and increase their market share. In some cases, people use them regardless of quality. For example, if the product really does work terribly, but it is the only way to interoperate with a more important big tool that the vendor has lock-in for, then the weak-but-useful app gains lock in. Compare the quality of early Outlook with Eudora. If it had been a mere features and quality battle, we would be saying, “Outwhat?” But the ability to open important features via Exchange made it an actual competitor.

    I would be interested to see what the overall market value of all open source companies is. I know that is hard, since many are private. We also get in to the question of what is an open source company. As you see, just changing the question to include Google and the whole equation tilts heavily.

    The point is, the pie gets bigger, while each companies share of the overall pie gets bigger; is that potentially exponential growth?

    Keep on predicting …

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  • http://www.gandalf-lab.com Niraj

    “Should I care then that the business model they settled on isn’t selling software?”

    If you do not care then you should not use the word “open source business”. Open source becomes and enabler and not a business in itself. To be called a business you need to link the revenue directly with the product/service and not the revenue to the business performance accelerator.

    If someone like Accenture was to say that they are in the People Business I can understand. Because they make money from selling bill time. But if Google was to say that they are in the people business because people are there single diffrentiating factor – I would not buy in

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  • http://monty-says.blogspot.com/ Michael Widenius

    What is an acceptable definition of an open source company? Without a clear definition, it’s hard to have a relevant discussion about the topic.

    I have suggested a definition in my blog at:
    http://monty-says.blogspot.com/2010/07/what-is-open-source-company.html