Open-source companies chase steady money

Start-ups specializing in open source are speeding up an industrywide shift to subscription-model pricing.

When entrepreneur Byron Sebastian started his company last year, he set his sights on the business software industry's ultimate cash cow: maintenance contracts.

Rather than charge large up-front fees for a product, his company, SourceLabs, will try to siphon off some of the millions of dollars corporate customers earmark for support. Like a growing number of start-ups, Sebastian's weapon of choice is open source.

The spread of open-source software, which generally is freely available, allows smaller companies to compete for maintenance money that until now has been locked up with incumbent software vendors, he said.


What's new:
In the absence of software license fees, open-source companies are adopting a services-intensive business model, accelerating an industrywide shift toward ongoing, rather than up-front, revenue.

Bottom line:
Established software companies often tout the benefits of subscription-based revenue models, but it is unclear whether smaller open-source outfits will be able to grow their businesses effectively.

More stories on open source

"Open source creates a competitive market for support and maintenance contracts," Sebastian said. "For the first time, you can build a successful business by being great at that, rather than just being mediocre."

Many industry veterans argue that open source is accelerating a shift that has been going on in the software industry for some time: Rather than hinge their business on big-ticket license contracts, software providers increasingly rely on recurring maintenance revenue.

And because most open-source tools don't have license fees attached to them, commercial open-source companies are often forced to build their businesses around services revenue, in the form of support, up-front installation or training.

With this model, purchasing software is more like committing to a yearlong cell phone contract--and less like buying a car with a large cash outlay and making regular payments later.

Although upstart open-source companies are relatively small and untested, the services-led business model reflects how more value is being attached to follow-on services than the actual the software, analysts and industry executives say. In fact, this week, industry executives at the Open Source Business Conference in San Francisco will consider the impact of open-source products on how software is acquired.

Unearthing support money
Once a backwater of the industry, attention is increasingly being paid to the amount of money spent on support and maintenance.

Chief information officers report that as much as 70 percent to 80 percent of information technology budgets are consumed by maintenance, rather than new initiatives. The recipients of much of that money are entrenched suppliers.

Database giant Oracle, for example, makes more on product updates and support than it does on license revenue. During an earnings call last year, Oracle CEO Larry Ellison touted the company's maintenance as an "extremely high-margin business."

"(The subscription approach) allows you to focus on strategic issues."
--Matthew Szulik
CEO, Red Hat

James Goodnight, CEO of analytics software provider SAS, said that Oracle's acquisition strategy, which has included buying PeopleSoft and making a deal to buy Retek, is a play at existing maintenance contracts.

"Larry (Ellison) is buying everything he can get his hands on to consolidate the (business applications) industry. He believes that innovation in software is over. It's all about maintenance revenue," Goodnight said.

Compared with other industries, software has very high margins, in excess of 20 percent, said Mark Driver, an analyst at research

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