Open source: what investors need to know

I have blogged about open source before, but not specifically from an investors point of view. Because this is not a subject that most investors are familiar with, I am going to make this a basic introduction.

Firstly open source is software which anyone is free to examine, modify and redistribute. The opposite of open source is proprietary software whose inner workings are a trade secret, and which is distributed under the control of a single supplier.

The advantages to vendors of open source software are that they can:

  • reuse code from other open source software, reducing development costs.
  • easily redistribute complementary software together with your product (sometimes massive amounts of it)
  • gain wider distribution and therefore a bigger user base
  • offer customers a number of advantages.

The disadvantages are that they:

  • cannot charge for the initial sale of the software, and must rely on income streams such as those for support.
  • cannot lock users in so that they cannot easily switch to a competing product or vendor.

The business model works because the cost of producing most software is very low compared to the number of users. This means that sources of revenue, such as support and related services, are more than adequate. All the more so given that business customers are willing to pay very well for these – and even proprietary software is usually sold very cheap to, or pirated, by home users.

The key advantage for smaller (meaning anyone other than a few industry giants) software companies is the wider distribution. This lowering of barriers to entry is one reason why open source is regarded with such hostility by some (well, one in particular, really) of the major software companies.

One note, some people use the term “free software”, rather than open source. I prefer open source simply because it is unambiguous – most people outside the software industry are likely to take free to mean without cost, rather than also free to alter, audit, etc.

A personal note. I use open source almost exclusively. The only proprietary software I use are Flash Player, Java, Real Player and Opera – and I use none of these heavily.

2 thoughts on “Open source: what investors need to know

  1. Do you think only the support will drive enough revenue? I think for a competitive product you also need R&D like Red Hat which is developing most of the innovations on their own…the community is more doing beta things like fixing bugs or small add ons. The core of the programm is mostly developed by their own staff (see FLOSS study) and this is very expensive compared to the revenue stream from support..

  2. Red Hat is profitable. Operating margin is lower so far this year than last (which was close to the norm for proprietary software companies at 25%), partly because of increased R & D, mostly because of increased expenditure on sales. This suggests a company that is confident of getting a return on that spend.

    While their R & D is expensive, it is a lot cheaper than developing a closed OS would be – especially if one considers all the other open software then can bundle and integrate with the OS. In short, lower revenues appear to be offset by lower costs.

Comments are closed.