Closed Source is for Laggards

Open source wins

Introduction

Microsoft is becoming an open-source company, sharing 206 packages in February 2017. In 2016, 16,419 contributors affiliated with Microsoft worked on open-source GitHub projects. The company has embraced the view of Jim Zemlin, the Linux Foundation’s executive director: shared development is enabling faster development with higher quality and lower costs. This is causing the software value chain to change.”

It is a 180 degree turn for a company known for aggressively protecting its IP and which head of the security response team argued in 2001 that closed source is more secure because “because nobody’s reviewing open source code for security flaws.

Why did Microsoft reframe its strategy and what can other technology-driven companies with a traditional business model learn from Microsoft’s radical new view on open source?


 

Shareconomy

Globalization, sustainability, urbanization, digitalization and sharing shape the way we live, work and interact with each other. To thrive, companies have to sense and act on these and other key trends. Sharing, or ‘using instead of owning’, is driven by customers faced by:

  • an abundance of choice (read: supply outstrips demand),
  • a desire for instant gratification,
  • a decline of stable and full-time employment, and consequently
  • a decline in purchasing power.

Technology is an important enabler of sharing as its reduces the friction between ‘customers’ and ‘suppliers’. Apps in combination with a scalable backend platform allow for a free flow of information providing the necessary convenience and trust (e.g. via reviews).

Using instead of owning gave rise to a whole new industry, including companies like Uber (car), AirBnB (house), TaskRabbit (labor), Kickstarter (funding), Wallapop (used goods), Udacity (education), Repair Cafe (repair) and Facebook (personal content). Some are mission-driven, but most are profit-driven or at least a hybrid. According to research by PWC, the size of the sharing economy is expected to grow to $335 billion in 2025 from $15 billion in 2014. Hence, sharing does not necessarily means ‘free’.

According to Havas Worldwide, 25-34 year olds are driving the shareconomy, with 51% preferring share over owning. At least as interesting is the observation by JWT intelligence that 40% share to learn new skills or to support good causes. Which brings me to the first reason why it is important for technology-rich companies to look into open source.

Attract and retain Key Personnel 

Highly skilled developers and other professionals want to work with peers, using online communities to collaborate and challenge each other. They use sharing to demonstrate their cleverness and use feedback to learn. These developers don’t want to work in a black box, unable to communicate with others due to a classic business model where (I)

“commercial software development is based on the exploitation of the monopoly created by copyright for competitive advantage. It makes sense in that system to avoid any process that would undermine the advantage, such as, for example, the sharing of source code with thousands of potentially competing strangers.”

Why is this relevant you might ask. The demand for highly skilled developers outstrips the supply, shifting the power balance towards the developer. Senior and lead developers can choose from a dozen or more vacancies at any day. In  2016, The App Association estimated there were over 223,000 openings for developers in the United States alone. Quoting a recent report by EY on the market in the UK:

“It’s a particularly salient point given that a recent study by O2 suggests that the UK will need to fill more than 750,000 new digital jobs by 2020 and train almost 2.3 million people to meet the demand for digital skills.”

The automation of increasingly complex knowledge work, the internet of things (IoT), the shift towards the Cloud, advanced robotics and next-generation genomics are some of the trends driving an almost unlimited demand for highly qualified software and data professionals. Quoting Marc Andreessen: “Software is eating the world.” And the end is nowhere in sight.

Many leading companies already adapted their business model and hiring practices, including the aforementioned Microsoft with 16,419 GitHub contributors, Facebook (15,682 contributors), Docker (14,059 contributors), Angular (12,841 contributors) and Google (12,140 contributors).

In short,

  • Demand for highly skilled developers outstrips supply
  • Allowing employees to share positions the company as an attractive employer

Open source as driver of new business models

According to Lerner et al (II), “it will make sense for a commercial company to release proprietary code under an open-source license if the increase in profit in the proprietary complementary segment offsets any profit that would have been made in the primary segment, had it not been converted to open source.  While this statement covers the revenue model of traditional business models, it has at least two shortcomings.

First. by focusing on direct revenue streams, it overlooks the previously mentioned effect of open source on the ability to attract and retain developers, the key driver of profit. No developers, no profit. Closed source or not.

More importantly, the statement does not cover the new generation of platform business models which use open source to:

  • quickly boost the size of the ecosystem or platform (e.g. attract developers of apps, games and other source of content that strengthen the customer lock-in)
  • establish open standards (e.g. via ISO, IEEE, W3C or OASIS or another organization with a recognized consensus process)
  • improve brand awareness (spin-off of the first bullet, creating a positive feedback loop)
  • disrupt the competition (e.g. reframe established revenue models within the industry).

Sharing code lowers the entry barrier for developers to build on top of a platform, boosting its overall attractiveness. In 2014, more than 1000 developers contributed to the 107 open source projects initiated by Facebook. By July 2015, Google had released  20 million lines of code and over 900 projects as part of their open source initiative.

Defining open standards is another way to boost a platform business model, like Rackspace and NASA did with their OpenStack project. By being first or at least early in combination with adopting an open source policy, a company can create a community and hence momentum difficult for competitors to catch up with. Quoting Knorr:

“Open source is leading the way in technology development. It’s become the vehicle of choice for startups to gain traction, as customers (mainly developers within companies) take new technologies for a spin, provide feedback, and eventually put them into production. Meanwhile, other developers see what’s hot and start building an ecosystem around a core project, as has occurred with Docker, Hadoop, OpenStack, and others.”

Considering the widespread disruption caused by startups in almost every industry, open instead of closed source should at least be seriously considered. Especially those companies heavily relying on technology.

In short,

  • Open source and open standards are important enablers of disruptive business models
  • Open source allows new business initiatives to scale fast or fail fast

Open source disrupts existing licensing models

Nor Microsoft Office 365 or Google’s G Suite are open source (LibreOffice is), but they provide a clear cut example of changing revenue models within the software industry.

Google’s productivity apps (‘G Suite’) and Microsoft’s Office 365 offer comparable functionalities. Both suites offer email, storage, a word processor, a spreadsheet, a presentation program, and the ability to create webpages to share documents and other types of content. Where Googles offering targets everyday use, focuses Microsoft on doing everything imaginable. Their revenue models reflect this.

Everybody can use Google apps for free due to ad generated revenue. For those power users or companies that want an ad-free environment, support and more storage, a paid premium model is available. In 2015, Google Apps passed 2 million paying companies, demonstrating the viability of the business model and potential to disrupt the de facto monopoly of Microsoft’s Office.

IBM followed a similar path when it was unable to compete with Microsoft in the server space. It adopted open source Linux in order to undercut the license prices of its competitor and regain lost market share. RedHat’s business model is also build on open source. Red Hat shares all its code with the community, relying on value adding support services for its revenue streams.

More generally, business models based on open source software are based on offering:

  • value-added services (e.g. consultancy, training, implementation, optimizations)
  • software as a service (e.g. including service desk, maintenance, hosting)
  • advertising or another cross-subsidy model
  • dual licensing model (e.g. commercial companies have to pay)
  • freemium (e.g. paid optional proprietary extensions)

WordPress is open source and by far the most popular content management system (CMS) with around 15,886,000 websites in January 2017 (50-60% market share). According to Sketch Themes, WordPress was the most requested skill in the world in 2014, with developers charging an average $50 an hour. By January 2015, Freelancer.com had closed 243,161 WordPress projects at a total value of $60,571,205. That is serious money.

In short,

  • Disrupt or be disrupted. Traditional business models have an expiry date
  • Done right, open source can be a money printing machine

Open source as driver of productivity

Productivity is “a measure of the efficiency of a person, machine, factory, system, etc., in converting inputs into useful outputs.” Productivity can be increased by reducing the input for a given output (e.g. initiative to consolidate datacenters to better leverage scale) or increase the output for a given input (e.g. use the same team to create higher added value services). Open source can improve the companies’ productivity by:

  • providing innovative processes to improve operations (e.g. Facebook reporting a 24 percent decrease in cost and 38 percent increase in energy efficiency after switching to open source hardware designs).
  • creating, technology-rich, high value-added value propositions (e.g. The Open Bank Project is an open source API for banks allowing them an secure ecosystem of 3rd party applications and services).

More generally: “It is common for people working for a technology company to suffer, at least a little, from the belief that all the really innovative people in their particular technology happen to work at that company. This can cause such a company to work too hard to produce every last bit of related technology, which is often not the best competitive approach” (III). With Github reporting 19.4 million active repositories written in 316 unique programming languages, smart companies combine externally sourced open source components with their own capabilities to create a distinctive value proposition.

Many companies already found the pot of gold at the end of the rainbow. With  Github reporting 331k+ active organization, including 44% of Fortune 50 companies in 2016, these companies understand the value of being part of a distributed network whereby the sum of parts create more than all the individual parts can (e.g. one bee versus the hive as a whole).

Only laggards think they can keep up with the relentless  increase in complexity and uncertainty by acting like a clamp.

In short,

 


Notes and references

(I)  Andrew M. St. Laurent, Understanding Open Source and Free Software Licensing: Guide to Navigating Licensing Issues in Existing & New Software, 2006.

(II)  Josh Lerner, Parag Pathak, Jean Tirole, The Dynamics of Open-Source Contributors, 2006. In: The Roots of Innovation, Vol. 96 No. 2.

(III) Ron Goldman, Richard P. Gabriel, Innovation Happens Elsewhere: Open Source as Business Strategy, 2005.

Additional reading

More on business models used to monetize on sharing can be found here.

More on why and how Microsoft transformed itself from a traditional software vendor struggling to keep up with the competition into a leader here.