Open source and billion dollar ($109USD) companies

An interesting post in computer world UK on why open source companies, and Redhat in particular are not larger. The raison d’etre for open source in business is an effective reduction in costs. The increase in quality over some of the closed source alternatives is also very attractive. Increased quality lowers costs. Of course, not all open source is better … witness the changes Ubuntu has made in their NVidia support, opting for the lower quality nouveau driver as compared to the very good NVidia driver. But the points in the post are worth considering, especially by open source companies seeking to turn their project into a product. Pitching billion dollar (e.g. $109USD) future revenues for something that is ostensibly a point product … no, this doesn’t work well. Redhat is arguably the most successful open source company, and it is working on breaking the $1B USD mark. This isn’t because open source is not profitable, or that it is destructive of value. It can be profitable, and it is creative of value. But it does so in a different manner than a closed source product. At the same time, building a business model around an open source product/project is very hard. To achieve break even is hard enough. To achieve break even when you have a freely distributable product is even harder. You have to reign in the tendency to provide free support. That is where you will make money as an open source product provider. And to build a billion dollar company on a support model … well … lets just say that this is hard.

Most of the VCs betting on these smaller open source companies assume that the exit is an acquisition. For the acquisition to be good for the company, it has to have a high enough multiple for a good IRR. A purchaser has to look at the possibility of purchasing and taking ownership of the company, and what it could mean to the product. Will it be an accretive effort, or will it drain resources/value? Will it increase other sales, or do nothing at all? And they have to compare this to the alternatives, the opportunity costs for example, or simply hiring a few people skilled in the product/project. In fact, this might be the preferential pathway for most acquisitions. Allow the company to get crunched under the weight of getting more financing with limited revenues, and then swoop in, do an asset purchase, and hire critical staff. A company purchase on the cheap. This is what happened to CFS, to VirtualBox, to LNXI, to a number of others. If the business model is not viable, if it can’t stand on its own, then it probably shouldn’t be funded. Likewise, if it can stand on its own, or be used in a roll-up play, definitely, it should be looked at. I see quite a number of companies who’ve gotten money recently for their OSS project/products, who don’t stand a chance at hitting $109USD or even $108USD. Most will be lucky to hit $107USD. And VCs won’t go for that. Or at least they shouldn’t, if they actually want to make money. Redhat is very well positioned, there might be room for one other. Centos as a rebuild is eating into some of the licensing revenue, but none of the support revenue. So Redhat has stability. In fact, it is in Redhat’s interest to encourage Centos, and make sure they are on top of things, as their users will often want to get support licenses for patches (ahead of the Centos patch stream), or have management insist upon “licensed commercial” bits. I find that last bit amusing in the open source context, but I have seen serious and large RFPs with that in it.