The Commercialization of Open Source

[NOTE: As a follow-on to my blog entry "100 Million and Counting...", the November/December issue of Enterprise Open Source Journal (EOSJ) has my article "The Commercialization of Open Source" (page 42). I am posting the article now as the new issue of the magazine has been released.]

The Commercialization of Open Source
by Raven Zachary

Several months ago, I noticed an increase in open source funding announcements. Was this just perception or were open source investments truly on the rise? I went back through archived news reports and determined that there was over 165 million US dollars in open source investments in the period from March through October of this year. This is by no means a complete survey of open source funding during the period, only funding that has been publicly disclosed. One can infer that even more was invested in open source, but remains to this date unreported. This 165 million was spread across 21 companies that were involved with open source in some way.

What we are now seeing is an increased trend in the commercialization of open source software. If you look at the history of open source initiatives, the primary form has been that of the project team – a loose affiliation of developers organized around the creation of software to solve a set of problems.

With greater enterprise adoption of open source, customers are demanding more mature services; training, consulting, and support. Project teams, by their nature, are not structured to serve this new wave of demanding customers. Many organizations want professional services to support their adoption of open source, without relying on a mix of internal expertise and the open source community at large.

Successful open source projects have dealt with the services demand either through referral to third party service providers or by going through a process of “productization,” sometimes supported through venture funding. A good example of this varied approach to growth is in the area of open source database software. PostgreSQL, for example, has spawned numerous services organizations and even a few new companies, while remaining, at its core, a project. MySQL, on the other hand transformed from a project into a company with a product, backed by the core project team, and a professional services offering. Both PostgreSQL and MySQL are open source projects with enterprise customers, but they are supported in different ways. Neither approach is necessarily any better than the other, but enterprise customers are more accustomed to the MySQL model, as it more closely resembles proprietary software.

If we compare the amount of funding in just the past eight months to the $149 million identified by VentureOne, a venture capital research firm, for open source investments in 2004, then we have already surpassed the amount invested during the prior year. The rate of open source investment is definitely increasing. So why the recent increase? It is the expected increase in demand from enterprise (a.k.a. “paying”) customers that is driving new investments into open source. Open source has proven itself in mission-critical, production environments, and adoption of open source is on the rise. It should also be noted that in this same period, we have seen three major open source acquisitions – Gluecode by IBM and Innobase by Oracle, for undisclosed amounts, and Sourcefire by Check Point, for $225M US dollars.

What’s interesting is that the 21 open source companies that have received venture funding in the past eight months, represent a variety of backgrounds. The founders of Alfresco and SugarCRM, for example, are applying prior subject matter expertise in the proprietary software world (from Documentum and E.piphany, respectively), to launch open source solutions. Funambol, a mobile synchronization project, obtained funding after the project had gained critical mass and key commercial partnerships. This is an example of open source productization that I mentioned above. EnterpriseDB and Groundwork are building businesses based upon successful open source projects, but are not founded by the project teams themselves. Laszlo, once a provider of licensed software, has transformed into an open source company in the past year to increase their customer base (and this strategy seems to have worked). Black Duck offers a solution for the management of open source code, but is not an open source project itself. The common thread through most of these investments (with the exception of commercial solutions to serve the open source market, such as Black Duck), is that the software and its source code are freely available.

The challenge with funding an open source company is that venture capitalists (VCs) have historically invested in software companies that provide revenue streams through both software licensing and services. With most open source investments, the software is given away for free, while the company charges for services. Without licensing revenue, the open source investment opportunity is with services, not the software itself.

Wanting to understand the VC perspective on recent open source investments, I spoke with Matt Miller, General Partner at WaldenVC and David Skok, General Partner at Matrix Partners. Miller serves on the Board of Directors for Palamida, an open source compliance management provider and Skok serves on the Board of Directors for JBoss, an open source middleware company.

Both agree that open source software models are here to stay. With lower overall sales and marketing costs, open source software companies carry less overhead than proprietary software companies. The customer acquisition costs are dramatically reduced with an open source business model. New software business proposals increasingly contain open source to some degree, but it takes more than adding open source to a business plan to be successful. “Hey, it’s a great new model of software. Let’s put it out there and make money on support!” says Miller jokingly.

A project must have a critical mass of users for there to be an opportunity to monetize services, turning users into customers. "One of the key requirements for a successful open source business is that it has to have a large community of users that are pro-actively coming to the company looking for support offerings. Without that inbound interest, the company will still have the high sales and marketing expenses of a traditional software company trying to evangelize their product, but would not have the license fees to offset those costs. In my opinion, it does not make sense to invest in Open Source companies if they don't have a community that has reached critical mass." says Skok.

Open source businesses may be getting more investment dollars than can be sustained by the demand right now. Both Miller and Skok caution that some VCs may be burnt on naïve open source investments, simply wanting to have a company in their investment portfolio. “The investment community is going out there right now and evaluating segments in enterprise software that don’t yet have an open source play for potential funding opportunities,” said Miller.

With over 100,000 open source projects, only a very small portion will gain critical mass in the enterprise, creating a need to support these customers with professional services. Some project teams do not need or do not want funding to pursue their goals. However, the venture funding of open source projects is on the rise, and while it’s not going to become the predominant model for growing open source projects, the commercialization of open source is undeniable. What we once thought of as a collection of projects is quickly becoming a mixed ecosystem of open source projects and products.

Recent Open Source Investments, March-October 2005

8 months, 21 companies, more than $165M US in investments

ActiveGrid (LAMP Stack): $10M
Alfresco (Content Management): $2M
BitTorrent (P2P Network): $8.75M
Black Duck (Compliance Management): $12M
Centeris (Linux Systems Management): $5M
EnterpriseDB (Database): $7M
Flock (Web Browser): $2M
Funambol (Mobile Synchronization): $5M
GroundWork (IT Management): $8.5M
JasperSoft (Reporting): $8M
Laszlo (Rich Internet Applications): $6.25M
Logicalware (Email Management): $.5M
OpenLogic (Stack Certification): $4M
Pentaho (Business Intelligence): $5M
rPath (Linux Software Management): $6.4M
Simula Labs (Open Source “Incubator”): $10-15M
SpikeSource (Stack Certification): $12M
SugarCRM (Customer Relationship Management): $18.77M
Ubuntu (Linux Distribution): $10M
Univa (Grid Infrastructure): $8M
Zimbra (Email Management): $16M

Raven Zachary is the Senior Technical Editor & Consulting Industry Analyst for EOSJ, the editor of the weekly Open Source Update eNewsletter, and is the Principal for o*rev, an enterprise open source consulting firm based in Dallas, Texas.

e-Mail: raven@orev.com
Website: www.orev.com
Blog: ravenzachary.blogspot.com