Calculating the true value of software in the post-license world

Open source offers a very capitalistic future for the software industry.

Every once in a while, it's useful to walk down memory lane and read a great analysis from the past. In this case, I stumbled across a r0ml Lefkowitz paper written way back in 2005, and was reminded just how brilliant r0ml is (now the CTO at Asurion, a billion-dollar insurance company).

In this classic article, r0ml discovers that proprietary software buyers actually place a huge amount of value on the maintenance and support aspect of the software they buy. Buying simply a perpetual license is actually not worth very much to them, which leads, of course, to the value of the open-source licensing model:

When I informally polled enterprise software buyers about what they would pay for software given that they wouldn't be able to buy any maintenance for it (as a middleman, I'd be selling that to somebody else), the universal response was that they would pay much less than the license--implying that the option to buy maintenance was clearly a significant fraction of the price....

Those who have suggested that open source and free software is somehow not capitalistic, destroying the value of software and other such assertions, have missed this alternative explanation. It is just as likely that the free and open source software folk have stumbled across the financial engineering insight that a significant portion of the value of software is the embedded "derivatives"--options or warrants--on future maintenance and enhancement. Whether one believes that software has intrinsic value is related mostly to one's view on the correct value to use for volatility in calculating the option value. Larger values of volatility mean the software itself is worth less. Smaller values of volatility reduce the option price, and the software is intrinsically worth more.

Perhaps we're onto something. I know that when I sell subscriptions to support and maintenance of Alfresco's software, buyers aren't overly concerned with the value of the license anymore. Proprietary vendors are increasingly discounting their license fees to (or near) $0.00 because they have to do so. The market has moved on to expect value in the running of the software, not in the buying of it.

Unfortunately, the vendors have yet to upgrade their revenue models to support this. They still have the same bloated sales and marketing costs required to get would-be buyers to trust them sight unseen. This is a losing proposition over time. It means lots of cash outlays with ever-shrinking cash inflows.

Oracle is attempting to resolve this difficulty by buying customers to shrink its cost of sales (one salesperson, many products). This works for a time, but once Oracle has bought every software company available, what's the next strategy? (Granted, its current strategy will take a long time to play out.

IBM? It has already focused on getting off the license nipple by focusing on hardware and services.

Microsoft? Well, there's a very good reason it is trying to rattle open-source nerves with its threats. It has yet to figure out how to survive in the post-license world. Open source as a business model is a much more potent threat to Microsoft than open source as a development model.