Google, open source alter who gets paid for what

Despite criticism that both Google and open source suck value out of their respective markets, the reality is that they create value, but just charge for it differently than past incumbents have.

Tech Culture

Open source, like digital media, doesn't suck money out of hitherto profitable industries. Instead, the opening up of software and information simply changes where the money gets made.

This is obvious to the Googles of the world. It's probably equally obvious to the Microsofts of the world. The difference is that the latter can see the train coming but is powerless to stop it, and the former is driving the train.

The evidence for this is increasingly clear and is driven by a shift in how content is sold and consumed. The problem is neatly summarized by Google CEO Eric Schmidt in a Wall Street Journal op-ed piece directed at the newspaper industry:

[T]he Internet has broken down the entire news package with articles read individually, reached from a blog or search engine, and abandoned if there is no good reason to hang around once the story is finished. It's what we have come to call internally the atomic unit of consumption.

That newspaper was "the package," but is increasingly too slow and out-of-sync with how people prefer to discover news content. New packaging is rising, including Google News, that will shift who makes money on news content.

Reporters will still get paid. They'll just have a new employer on their payroll check. Maybe it will be Google.

News isn't dead. Paper is.

Think about what is happening in music. I could download New Order's "Regret" for free using LimeWire, but I bought it on iTunes because of the "packaging" which makes my experience easy, high-quality, and legal.

Still, the primary drivers are ease and quality.

Such packaging is worth a lot of money--and to an entirely new breed of vendor--as a quick look at Google's latest income statement suggests.

It's happening in software, too, particularly in open-source software. Red Hat is an example of a company that does a great job of turning software license into an ongoing service contract that enterprises buy. It does this by packaging the power of others' development in the form of a subscription, as Red Hat CEO Jim Whitehurst recently highlighted.

But Red Hat is just Open Source 1.5. Open Source 2.0 looks more like Google or IBM. For every dollar Red Hat makes selling subscriptions to use open-source software like Linux and JBoss, both Google and IBM make multiples of that dollar using open-source software to sell something else, something they've packaged in hardware or Web-based services.

The hardware is running open source. The services are based on open source. The money is made in the packaging of open source.

But it's not just enterprise software and search. Such packaging is also why we buy TiVos, which is just free Linux packaged in a set-top box.

Even iTunes, which does so much to streamline music discovery and delivery, heavily relies on open-source software.

Of course, not everyone is prepared to move to a Google-esque model today. The Microsofts of the world are very likely to end up buying into open source as they seek to disrupt their competitors.

It's therefore not surprising, as Vyatta's Kelly Herrell points out, that while open-source companies have been sold for high premiums, they haven't been picked up by incumbents in their respective markets, but rather by those seeking to disrupt such markets. Herrell writes:

A large handful of major open-source companies have been acquired for anywhere from 20 to 500 times their trailing revenues--astronomically high compared to other acquisition price ranges. Here's the key: Not one major open-source acquisition has ever been initiated by the proprietary incumbent. Instead they were acquired by a company in an adjacency (e.g., Xen by Citrix, SpringSource by VMWare, MySQL by Sun, JBoss by Red Hat, etc.)

This is the dynamic caused by the constant shifting of technology markets: Stand still and other vendors will morph around you, surrounding your offering and reducing your industry power. Aggressive acquiring companies push this envelope, crafting strategies that are missing a key component--one that is unfortunately the property of another proprietary software company. They covet that missing piece, so they choose to acquire the open-source inheritor of the space--and in the process, pay a large strategic premium.

Such "adjacencies," as Herrell styles them, use the open-source product to cripple the incumbent and drive developers to their platforms, making connections to developers with open source but selling an ancillary proprietary product. This makes sense, as open source is a fantastic strategy for attracting and encouraging developers, but offers relatively weak direct revenue models.

Whether disrupting "the past," as in using open-source developer communities to destabilize market incumbents, or disrupting the future, as in using open source to build proprietary hardware and services businesses, there's one constant:

The money is in the packaging. Oh, and that the incumbents carp on the new packagers for not delivering value commensurate with their revenues. It's a criticism leveled at both Red Hat and Google, and it's incorrect in both cases. There's plenty of value provided by both, but it's different from the old-world value.

Packaging has always mattered. The only thing that has changed is who is most effectively packaging products like news and software today, and therefore selling it.

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