The great open-source software debate: Does this model have a future?

It sounds like a good idea in concept: Outsource costly software development and testing operations to a community of skilled developers who work for free.

Then take the fruits of their labours and package it up with other add-ons and extensions – also created by other people for free – and sell it to enterprises that can’t be bothered with all the hassle of configuration, installation and support. Undercut your competition’s prices by 90 percent and still make money because your development costs are near zero. Rinse and repeat in other product categories.

That’s the pure open-source software business model. It’s the one that Red Hat Inc., which opens its 13th annual Red Hat Summit conference in Boston this week, has ridden to $2.4 billion in annual sales and a market capitalization of better than $15 billion.

The problem is that no one else has even come close to duplicating it, though many have tried. One school of thought holds that Red Hat was a one-hit wonder, a unique example of all the right forces coming together at just the right time. But that didn’t stop investors from pouring more than $3.5 billion into open-source startups between 2012 and 2015, according to Crunchbase. Overall, some $7 billion has been invested in open source but only $1 billion of that has been returned to investors.

And the startups keep on coming. Two open-source-based companies in the Hadoop world are attempting to repeat history in a different market. There are also data analytics startups in software project hosting, and more.

All of which raises some important questions: Why are pure open-source business models so challenging? Will consensus emerge for a viable open source business model? And do enterprise software buyers even care?

One throat to choke All open-source business models are predicated on the idea that enterprises want stable software, world-class customer service and “one throat to choke” accountability, in addition to the appeal of openness and more rapid innovation thanks to crowdsourced programming. This works well up to a point, but the irony of this approach is that companies can easily become victims of their own success.

That’s because as long as a technology inhabits a market niche, the skills to cultivate it are scarce, so companies that want to adopt it must pay a premium for stability and support. That’s a good business. But once an open-source project becomes popular, everyone jumps into the pool. Prices fall, skills become commodities and the whole thing implodes, at least as a business proposition.

Open-source companies don’t have the costs of proprietary firms, but they also don’t have the margins, which can exceed 90 percent for successful products. As a result, the open source business “is labor-intensive and expensive to provide,” said Milan Hanson, a senior analyst at Forrester Research Inc. “Profitability is a struggle. There will only be a few players who succeed, and it will always be a small market.”

Companies need to realize they can’t make it entirely on a self-service model. Eventually, they need to hire a sales force to scale up.

That that’s tough to do given the realities of open source. Most Apache Software Foundation projects have at least one company building a profit-making business around user support, but those companies rarely get very large. Many will either fade away or be acquired by someone else with a broader and more sustainable portfolio.

But there’s no lack of entrepreneurs willing to try, and now they’re asking public investors to support them in their efforts.

Cloudera Inc. staged a successful initial public offering Friday, finishing its first day of trading at $18.10 a share, up 20 percent from its $15 opening price. Cloudera’s business is based upon the open-source Hadoop framework, but its moneymaker is an enterprise edition that includes proprietary extensions for the likes of management, security and backup/recovery.

In other words, it’s not fully open source. Indeed, in what might seem like a surprising declaration, Mike Olson, Cloudera’s co-founder and chief strategy officer, told SiliconANGLE after the IPO, “We’re not an open-source company. We’re an enterprise company.” The company recorded $261 million in revenue in its most recent fiscal year, more than $200 million of which came from software subscriptions.

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