How open source companies can make money

The open source model works for eLearning business

Posted 10 Nov 2015 by 

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Opinions vary on whether open source companies can make money, thrive, and truly compete with their proprietary counterparts. As a CEO and co-founder of an open source company, I am frequently challenged to reflect on our strategy, company ethos, and commercial risks we undertake—not only on behalf of the shareholders, but also our employees, partners, and customers.

At a conceptual level, it can be a valuable exercise to think through an open source business strategy along the same lines as the Prisoner's Dilemma game, although I'll happily mix and match a few other concepts such as disruptive innovation and value networks to help explain why, at Totara Learning, we are committed to the benefits of open source along with all the challenges that come with it.

The Prisoner's Dilemma is a well-known model for a two-person game in which each side can choose to either cooperate or switch sides. Payoffs are arranged in such a way that if only played once, the highest payoff is achieved by defecting while the other player continues to try to cooperate. When played repeatedly, it becomes obvious that two entities would benefit from collaborating or alternatively suffer from the failure to do so. If everyone makes the choice not to collaborate, eventually nobody wins at all. We firmly believe the objective should be to increase value for all participants. To achieve this, collaborative innovation networks provide a better model for software development.

First, let's look at the challenges. Perhaps in the context of the overtly capitalist societies in which many of us live, it is to be expected that some commentators will argue that open source is flawed because it's not a winner-takes-all business model—too much value leaks out to potential customers and to competitors alike. The argument goes like this: Open source companies can't thrive (relative to their proprietary competitors) by only selling support subscriptions, and therefore have insufficient funding to invest in innovation and differentiate their products. They can't charge more because of the "free rider effect" of past or potential customers using the code without a subscription. Therefore, they must eschew the open source model by either moving to the cloud on a proprietary basis or adding proprietary code to their products in order to succeed.

While this line or argument appears to have some logic, I believe it is too simplistic and ultimately wrong for a number of reasons. While it may appear counterintuitive to people that an open source company supplies its products for low-cost subscription fees, in today's technology marketplace it is the open source company that has the greatest long-term strategic resilience. That's because in today's fast-paced technology marketplace, the value of proprietary software products approaches zero at an accelerating rate.

Duplicating investment means less innovation

Let's take the Learning Management System (LMS) as an example. At its basic level, it is a technology used to manage learners and learning events. Most platforms will also enable the creation, management, and delivery of eLearning courses. As with other product types, it's often only a small part of the application that differentiates the feature-set between Product A versus Product B. The core components become commoditized, and this drives down prices.

The problem is that the vast majority of vendors offering proprietary solutions leads to significant duplication of investment across solution providers, which slows innovation and provides no additional value or innovation to the customer. It is therefore the proprietary vendor that is disadvantaged through not getting enough inputs and resources to drive new innovation. In Prisoner's Dilemma terms, by going your own way, you get a worse outcome than if you chose to collaborate.

Collaborate to innovate

Conversely, an open source innovation network can accelerate the innovation cycle. Open source enables new innovations to be built on top of the commodity software on a mass scale. Open source, collaborative software development reduces costs while providing the foundations for more targeted innovative development specific to a company or situation.

The fun is often at the edges—the differentiating features that disproportionately add value by strongly aligning to a business's or a sector's specific requirements. Some of those innovations—not all—find their way back into the core product, and that accelerates the innovation cycle. Each "player" benefits because promoting and collaborating on a common platform helps grow the market opportunity for everyone participating. Partners can focus (and differentiate) on the implementation services, support, and innovations the customers really value whilst alleviating the challenges of sustaining investment in bespoke or the alternative of proprietary solutions on their own.

Clearly the incremental cost of adding a new feature is much smaller than the cost of the entire development if any player was doing it on their own. Partners and customers who create feature extensions mostly see the long-term benefits of collaboration because if it is a common requirement, the continuing cost of maintaining the added feature on your own will be higher. With an open source ecosystem, the community members themselves provide a significant amount of research and development by contributing ideas and information on user priorities, problem solving, and in many cases actual code into the core product.

As participation and momentum builds around a software product, the rate of innovation accelerates and value is delivered to all participants.

Open source is good for business

Let's look at the revenue per customer argument. It is true an open source company doesn't make money directly from selling its products and therefore typically generates lower revenue per customer compared to other licensing models. Plus, if there is a channel strategy, a lot of the commercial value will reside with other parts of the network (system integrators, implementation consultants, training, etc.). However, it is incorrect to assume that open source companies cannot generate stable and scalable revenue streams.

For open source companies that can produce quality products and generate a good reputation for service, customer acquisition rates can be significantly higher than their proprietary counterparts. Quality open source products quickly obtain large market share because of the far-reaching impact of word-of-mouth networks generated by customers and channel partners. True, an open source company probably won't take you out to play golf or wine and dine you—the competitive advantage comes from flexible, open systems and the transparent value that support subscriptions provide.

For those of us working in an open source company, we understand real-world market forces mean the value of software ultimately lies in the value-added services around the product rather than any intellectual property the product represents. Information wants to be free, and innovation should be enabled throughout all parts of the value chain. One downside can be that the concept of open source is so enticing that it also attracts its fair share of sanctimonious zealots who extrapolate the concept of software freedom to demand that open source also means that you owe them free service. Open source delivers software freedom, it does not mean free.

Everyone benefits from a more collaborative model. The customer receives more transparent value, choice, opportunities to collaborate, freedom to innovate, and business agility. For suppliers, multiple scalable business models are available throughout a successful open technology innovation network.

Win-win is the winning strategy

This segues into my final point regarding the financial yardstick you use to measure business success. The venture capital world tends to view success as a single entity: capturing as much financial value as possible. Market capture, customer lock-in, and closed intellectual property are perceived as positive attributes because margins can be driven ever higher. But logically only a handful of winners can emerge with that approach, and for how long? In contrast, open source support and professional services centric models are perfectly viable and scalable. However, we're more likely to see multiple players work together and collaborate around a technology stack, and each attain the $5 million, $10 million, $20 million, $50 million levels with reasonable profits rather than single-company, billion-dollar big bets venture capital firms like to see.

Which world view do you prefer, and what do you think is best for the customer?

1 Comments

Don Watkins

I love what you've written and I've shared it a couple of times already. You make great points I hadn't thought of before.

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Richard Wyles | Chief Executive Officer, Co-Founder of Totara Learning SolutionsRichard played an instrumental role in founding Totara Learning Solutions in 2010 and has led the company since start-up. Prior to Totara, Richard played a leading role in the dramatic rise of Moodle as the e-learning technology of choice in his home country New Zealand and internationally. He has led large government funded