Open Source Software Business Models

Open Source has been gaining ground for quite some time. Some would say, using the example of Linux, that Open Source has Microsoft and the rest of the traditional software giants on the run. No doubt that open source software has had a major impact on the economics of the software business, across many different market segments.

But is it a good model to use in your software business--if you are actually interested in making money?

Not Generally My Cup of Tea--But Let's Take Another Look

I will admit that my feelings toward open source business models have always been lukewarm, at best. Maybe there's a bit of dinosaur in me. But the idea of putting into the public domain the code that you've sweated to produce, at great emotional and financial expense rubs me the wrong way. It trikes me as fundamentally opposed to the basic nature of capitalism and the entrepreneur.

Like just about everything else in business, however--the devil's in the details. Using Open Source methods has been shown a number of times that it can be a competitive weapon in the software business--when used thoughtfully and strategically.

Poor Use of Open Source

Let's first examine a typical example of what I consider a misuse of the Open Source model. It often goes like this: Technical founder with a crack programming team, and little marketing money or expertise, decides that they are going to use Open Source to inexpensively roll out their new product in the market. Being programmers, they love the idea of Open Source from a user perspective, and so have a strong belief that the market they are aiming at will love it as well. Unfortunately, they aren't trained as marketers, and don't think the situation completely through.

Here are some of the negative things that can happen:

1) Since the company is releasing the initial product as Open Source, they are not quite as diligent as possible with QA of the code, as well as other "commercial product" polishing activities. Basically the product is rushed to market. The product isn't well-received, costing them the one opportunity that you have, to make a good first impression

2) Open Source tactics are used prior to developing a proven business model: "We'll release a free, Open Source product, and have so many users, we can figure out how to make money later". This is reminiscent of the old "eyeballs" business plans prevalent just before the Internet bubble burst in 2001. It's very important to have a solid idea of what the Open Source release is going to gain you, and what the steps are that will to allow you to capitalize on the wide attention. Ultimately, you need to monetize SOMETHING. There are ways to make money with an Open Source model: customization, training, training, premium versions--but in many instances, these won't really support a serious, mainstream core software development effort--if you are also interested in profits.

3) The company has done some thinking about the business model issue, and has decided that there will be a free, Open Source version released initially to seed the market. The follow on product will be commercial/paid with added features, with the hope that the large user base from the free version will upgrade to the more attractive premium version. But without expert marketing analysis, balancing how much to "give away" in the free version, and how much to "hold back" for the premium version, can be quite tricky. If you don't get the balance right, the potential revenue stream can be greatly reduced.

4) The company is in a market segment that highly values order and traditional business practices--in this circumstance, using an Open Source model could seriously devalue your product, in the eyes of your target prospects.


Good Use of Open Source

The other side of this story is that when implemented thoughtfully, Open Source can be a major strategic weapon in certain markets. Let's look at some scenarios of how an Open Source strategy might be implemented more shrewdly:

A) When entering a new market against a huge, strongly entrenched (but slow and stodgy) competitor, where it will be difficult to get traction with traditional marketing methods. This is Open Source used as a Guerilla tactic.

B) In markets where the availability of Source Code REALLY IS IMPORTANT. This may be for reasons of integration, or for reasons of business continuity (for example, a bank application) where they would require source escrow anyway.

C) Having a free Open Source version for one type of small volume customer (internal developments), but to redistribute the code for commercial purposes, there is a royalty/fee. This is using the Open Source model only partially. MySQL has used this model very successfully for quite a while.

D) Formulating a well thought out, hybrid business model ahead of time. For example, a free Open Source version is made available to seed the market. Backed by extensive research and marketing planning, a paid premium version is made available, with just the right features at just the right price, creating huge upgrade numbers with minimal marketing expense.

E) An Open Source product is created for a particular market segment, with data backed by research that this segment will require and pay for substantial levels of integration, customization and/or support.

Summary

That's my view of the good and bad in Open Source as part of a commercial business model. Used well, it can be a major weapon--when the situation calls for it. But if used blindly by companies just following a trend toward the newest thing--it can be the "Business Model of No Return".

Drop me a note or post a comment with what you think.

Phil Morettini
PJM Consulting
http://www.pjmconsult.com/
info@pjmconsult.com

Selling Through OEMS

I've recently discussed selling through VARs as a distribution channel strongly favored (maybe a bit too much!) by many early stage technology and software companies. In this article I'm going to look at another channel that is often misunderstood and misused: The OEM channel.

When a company goes about it the right way, OEM business can be an excellent additional revenue source for startups--and any high tech company, for that matter. Where I want to throw out a caution flag, is when a company decides they are going to rely on OEMs as its primary--or only--channel.

Now this can work, you might say. And you would be right. But in most cases, I believe, it isn't the best way to proceed. It can work, if you have the right type of product, and you've thought your strategy through very thoroughly. The problem is with most companies, this the usual scenario. What I find more prevalent is the old "let's make it, and we'll get someone else to sell it for us" approach. As I've discussed before, 'let someone else sell it' almost never works. This sentiment often occurs with a technology-driven senior team, without a good feel for marketing or sales. The natural tendency in these situations is to avoid the current weaknesses in this organization, and "let somebody else do it".

The problem here is that sales and marketing needs to be a core competency, in most situations, if a technology company to become as successful as possible.

So what are the "bad effects", when an early stage technology company pursues OEM relationships as their sole distribution strategy--or at least "too early" in their company development?

EFFECTS OF "BAD" OEM STRATEGY

No Leverage
If you approach potential partners with a brand and existing sales, there is no leverage in negotiating with the larger, more established OEM prospective partner. In addition, it's a much harder sale, because your company and product don't have a track record.

No development of internal sales & Marketing
Companies with OEM-only business models tend to have weak (or nonexistent!) sales and marketing departments. My belief is that sales and marketing is a core competency--making this a bad idea. While you can run a company this way, in most cases, the ultimate size and profitability will likely be a fraction of what your technology could have otherwise supported.

All push, no pull
Every sales and marketing activity works better if there are "pull" elements, in addition to "push". If selling to the OEM is almost solely a "push" activity, with no brand or your own market share to help pull--the process is much harder.

All the eggs in one basket
Even if you do well and gain OEM deals with premier partners--success is far from guaranteed. It isn't unusual for OEM deals, especially early ones, to yield actual revenues in the 10-15% range of forecasts. If this happens to you and you've built your company around these projections--you're basically screwed. You risk "crib death" or at least a difficult restart with your own brand, due to the disappointing sales from the OEM relationship(s).


Your OEMs swallow you whole
A very common scenario is a much larger OEM that starts treating its small, entrepreneurial partner like another department in its bureaucracy. The OEM stunts your overall company development by "tying up" the scarce resources of your smaller company in meetings, special projects, ever-changing product development requirements--and yes--more meetings.


Given the potential pitfalls, how do I recommend using OEMs?

THE "RIGHT WAY" TO INCORPORATE AN OEM STRATEGY

Develop your own brand/channel first
Pursue OEM business only AFTER you've established products under your own brand. It not only will provide you with a product that will be more attractive and stable to potential OEM partners, but you've got your own branded business to sustain you

Important--but secondary--revenue source
Treat OEM business as an important, but secondary revenue source relative to your own brand. This will keep things in perspective and prevent you from putting your company's future in someone else's control.

Bundle rather than integrate
Once way to take advantage of large OEMs without the downside of losing your own identity is to seek bundling deals, rather than private label deals. By doing this you are essentially co-branding, building the power of the partner brand through affinity with the bigger company. This leaves you with greater marketing, selling and support requirements, but may lead to a larger, more profitable company in the long run.

Address a vertical out of your reach
A good way to utilize OEMs is to fill a key vertical where your technology has a market. This occurs when you decide that you can't address this vertical well with your own brand, because you don't have a presence, and have decided that it doesn't make sense strategically to expend resources to develop one.

Final harvest
Another smart way to use OEMs is to "harvest" a volume product which is now in decline, and is a product which you don't intend to continue major investments. If you can get such a deal, it can be great way to maximize end-of-life revenue with minimum incremental investment.

Offer another price point
A strategy that can be used successfully in some cases (but is a bit dangerous) is to use an OEM to offer another price point in the market, one that you choose not to address with your own brand. More often you would do this with your own alternative brand or sub-brand. But there are instances where this investment might not make sense. Special care should be taken if the OEM is to fill a lower price point--care needs to be taken so that your own brands share isn't eroded significantly.

Integration with complementary products
There are some instances in the marketplace where 1+1 does indeed equal 3. In these cases it may make sense to team with an OEM, to gain the advantages of product integration with a key product in your market, offering them as a single, integrated solution.

Leverage your IP into a new market
There are also cases where you main technology base can be easily used to create an entirely different type of product, which is intended to serve an entirely different market, relative to what you are selling under your own brand. In these cases it may make sense to team with an OEM in this disparate segment, to market this spin-off product from your main technology.

Summary
The bottom line is that OEM marketing is very important in the software and technology business. I strongly recommend that most everyone pursue this type of business; however, do it as part of a balanced, overall revenue strategy. Tread carefully and wisely and this may be the distribution channel that makes a break-even, or modestly-profitable business, into a profitable winner. It's easy to say you want OEM revenue, but like most things in business, doing it right is hard--the devil's in the details.

That's my thoughts about how OEM strategy best fits into a typical high tech business. Post a comment and let us know how YOU approach OEM relationships--I look forward to your opinions.

Phil Morettini
PJM Consulting
http://www.pjmconsult.com/