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Seven Qualities of Highly Successful Open Source Software Company

Six days ago, I wrote about the key factor influencing disruptive market strategy – New Market. This post summarizes six additional characteristics of a truly disruptive open source business. Most of them derive from one of the best books I can think of in the area of disruptive business models, The Innovator’s Solution: Creating and Sustaining Successful Growth by Clayton M. Christensen. Here are all “Seven Qualities” as of March 18, 2007:

1. New Market

I believe that a new business model alone doesn’t make it, be it open source, or SaaS, or whatever. The key idea is that in order to be truly disruptive, an offering has to address a large underserved market segment, and create a NEW market in the first place. In commercial open source, the initial target is never the existing users of expensive, proprietary software. What the heck can they do with your scrappy product? The best target market is a highly growing underserved market with a lot of demand and little to no supply. Similar to what MySQL offered to all Internet small businesses who can’t afford MS SQL or Oracle database to power an e-commerce shop or a content management system of a micro business with little to no revenues. Then move up the stack and target the ones who have the budget, but are still not willing to pay 5K-20K for a piece of software if there is a cheaper or better yet FREE alternative.

2. Low Price

It takes 5x to 10x the price advantage between what your proprietary competitors charge for a solution and what a commercial/supported package of your software costs in order to create enough disruptive “leverage” to cross the chasm and enter the mainstream market.

3. Good-enough Product

A product/solution should be good enough to solve 50% to 80% of the most common customer needs. At the beginning, your competition will not consider such an  offering as a threat at all, as it doesn’t have all of the “things” and “features” their BMW-driving sales force is communicating to prospects all day long. Their customer and your customer are two different animals.

4. Easy to Implement

The product should be simple enough that it can to remain easy to implement and extract value from. Take Mule, a highly successful open source ESB as an example. Mule can be installed in several minutes compared to hours to install and configure proprietary products from EII/ ESB vendors such as TIBCO. At Apatar, we strive to do the same and make sure Apatar ETL can be installed in two minutes or less.

5. Community of Loyal Users

There should be enough supporters willing to contribute their time to requesting new features (compliment Product Marketing), testing your software and reporting bugs (compliment QA), and developing new product functionality (compliment R&D).

6. Standard Technology

A disruptive open source product/solution should utilize widely used technologies, which have already become or could become a “commodity”-type component in a technology stack, LAMP or Java.

7. New Distribution Channels

The traditional distribution models are not good for a truly disruptive product. No BMW-driving sales folks to “push” your product into the market (unless you are really short on time and have VC backing to support some direct sales). The Internet is replacing most roles in the marketing, PR, and sales functions of an emerging open source start-up.

If you have ideas about any additional components that make an “essential” package of a disruptive open source software start-up, I’d love to hear about them.

Free vs. Cheap: It’s NOT About Shrinking a Market

Josh Kopelman of First Round Capital, an early stage investor in many Web 2.0 emerging leaders (including Wikia, Mashery, and Odeo), posted an excellent article on the emerging business models across many industries:

“Here at First Round Capital, we see a lot of business plans for consumer-facing internet services. Most assume a significant portion of their revenue comes through advertising — but almost all of them have a “premium/subscription” option. Typically that subscription revenue accounts for 20-40% of total revenue, and is based on a very low ($1-5/month) subscription fee. However, that is rarely how things play out. Most entrepreneurs fall into the trap of assuming that there is a consistent elasticity in price - that is, the lower the price of what you’re selling, the higher the demand will be. It happened in music. It happened in movies. And it’s happening in directory assistance. Now I’m looking for other industries that are going to be converted. If you’ve got a plan that uses the free model to get that first penny and disrupt an industry, I’d love to hear about it. It’s a great way to shrink a market.”

When reading this, IT folks think, “open source.” Looks like that’s exactly what is happening in enterprise software. Open source vendors play the price elasticity game in the demand/price equation. Commercial open source vendors are sizing down their markets by offering free to low-cost solutions where the buyers get far more value for the dollar. But that’s only on the surface.
What I would like to describe is why open source/free software is not about shrinking the markets. Of course, there will be many cases when market leaders will have to step down.

Middleware

IBM has $2B running on WebSphere. Looks like for every dollar of revenue JBoss made, it took two dollars of revenue from BEA and one from IBM. JBoss made its fortune from shrinking the middleware market.

Data Integration

Informatica SOLELY DEPENDS on license revenue from ETL tools.
IDE Tools Borland has had its IDE business on the auction block for a while and is realizing it’s not easy to find a buyer for a sinking ship. Did Eclipse play a role in replacing Borland IDE tools? Sure it did.
For Informatica and BEA to transition to cheap/near-free subscription and OSS is a systemic shock that might literally kill them.There is no doubt that the existing software leaders would have to shrink their appetite significantly, since the disruptive newcomers have totally different cost structure and distribution business models. When you look at the drivers of the seismic shifts going on in many markets, the disruptive business models are not about shrinking markets. It’s not about “evil communists” dreaming about getting the behemoths of the software business to die. I don’t think they will.

What really happening is that new value is being created in the marketplace. Open source is so successful because it’s creating new markets. That’s the key for a true market disruption.

Just a few years ago JBoss, now a RedHat company, and MySQL were not going after the Fortune 1000 enterprise market. They are best at enabling underserved customers who previously could not afford expensive proprietary software. Now, JBoss is a part of a public company, MySQL is VC-backed, and they both have external shareholders. The latter demand returns on their investment thus pushing portfolio companies into a replacement business where the money is. But what these companies are best at is not a replacement business.

Open source is so powerful that it can destroy a license-driven software business. But the truly disruptive businesses are successful as long as they create new markets in the first place, not shrink the existing.

20th Was the Century of Technology; 21st is the Century of Marketers

Before: Century of Technology

At the end of the last century, those who had accumulated the most brilliant technological inventions became the leaders of the world of enterprise software today.
Oracle, IBM, SAP, Microsoft, and hundreds of other successful companies have created the industry based on proprietary Intellectual Property (IP) and patents.

What has the open source movement done for the industry? Apache, Linux (in the server market), and Sendmail have commoditized their product categories. Eclipse has changed Borland’s IDE business. jBoss and MySQL are more often in a replacement business instead of going only after non-users who can’t afford commercial solutions.

Can you imagine what open source will do during the next decade to the enterprise software industry?

Now: Century of Marketers

In the past, engineers and companies with the best patented technologies were the ones who received funding and developed the best products. Today, we see an array of open source companies creating products and “application stacks” using IP developed by the community.

In the last century, Intellectual Property creation and engineering were core business activities to software vendors; today, IP creation and marketing is core, but IP engineering is not. From a VC perspective, startups are not fundable unless they are ready to outsource IP engineering.

The software companies who best communicate the value of their solution to the audience, be it the end user, the community, or the enterprise customer, are sure to be the winners as the industry moves into the next economic cycle.

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