I’ve had a few startups ask me recently regarding the pros-and-cons of going the open source route especially regarding the types of business models that are viable for open source based companies.
Given how influential open source has been over the last two decades, surprisingly little has been written in the public domain on the topic so I’ve put together a broad summary.
It focuses on business models that could enable companies to reach billion-dollar+ valuation levels (and so are VC investable) which means it's specifically excluding some models which can work for smaller scale companies (i.e. donations, grants, advertising, etc.)
I’ve illustrated the models with examples, these include companies where the company hasn’t been the primary developer of the underlying open source product but still has the product at the core of their business.
There are essentially only six open-source business models that either have already produced billion dollar startups or look likely to do so within the next decade:
Support and Services
Also known as the “Red Hat Model” it’s based around the provision of a services business for users of the open source product. Typically this includes support contracts, training and certification, consulting and customisation work.
Example vendors include RedHat and Hortonworks.
One of the original open source business models it now faces some concerns over the low margins and issues of competitiveness. While the company that creates an open source project has some competitive advantages when selling services (direct access to core engineers and product mangers, brand, lead-gen, etc.) there’s still significant risk in competitors underpricing due to not having to pay for the products development costs (i.e when Oracle significantly undercut RedHat for Linux support work).
Most open source companies will offer some level of services although increasingly startups are now waiting until they reach a level of maturity before building out a significant services (read “consultancy”) business.
Earlier stage startups are tending to offer services limited to specific areas which have additional value-add to the product business (training of third party vendors, support and bug-fixes).
The hosted or “managed’ model is where the vendor provides a hosted version of the open source product.
These businesses tend to largely fall into traditional SaaS (Wordpress, Odoo) or IAAP (Joyent, Heroku) models. In many cases this is combined with the "Value-Added SaaS" model where proprietary offerings are combined with the hosting service in order to provide a competitive defence against lower cost competitors offering equivalent hosting services.
With open-core the core part of the product is open-source but with the vendor offering an enhanced version as proprietary commercial software.
Typically this is done by having a “core” version of the product which is open source and then an “enterprise” version of the software which includes features such as analytics, security, auditing, etc. which are likely to be required by high-end customers. Vendors using this model include Cloudera, SugarCRM and Mongodb.
In some cases vendors will offer these features as add-on products rather than as a drop-in replacement to the main product (for example ElasticSearch).
This business model is similar to that of traditional proprietary software vendors. However there exists a risk of conflict-of-interest when a vendor is deciding whether a feature should go into the core or enterprise edition of the software which can fuel resentment among users of the core product.
There’s also the risk that other third parties will develop open source alternatives to the enhancements.
One of the newest models is the Value-Added SaaS model which is similar to the open-core model but where the proprietary software is provided as a SaaS service.
This model is particularly effective where the SaaS service has a network effect as it can create a strong defence against new vendors entering the market.
Vendors taking this route include GitHub and Docker (the later has yet to release their SaaS offering).
The Marketplace Model is where the vendor creates a platform for commercial products or services that relate to the open source product. The platform then charges a commission on transactions.
The most successful use of this model has been Google Android with their Play store, but other vendors have included Themeforest (Themes for Open Source CMS systems) and historically OpenX (ad-exchange integration into their open source ad server).
Again due to the strong network effects implicit in marketplaces we’re likely to see more open source startups with this model in the future.
Dual-licencing is the model where the vendor relicences the open source project under a traditional commercial propriety licence for a fee. Vendors have included MySQL and Trolltech.
At one time this was considered to the be the future of open source businesses (Gartner once stated “By 2012, at least 70% of the revenue from commercial OSS will come from vendor-centric projects with dual-license business models.”) — however this model is now largely considered dead.
Historically there were two major factors driving this model (1) The dominance of usage-restrictive and viral open source licences which restricted commercial integration (2) Companies being uncomfortable with using open source software.
However most modern open source projects now favour Apache or MIT style licences which are much less commercially restrictive and open source software has now become mainstream and widely accepted into businesses.
Some modern open source companies such as MongoDB still offer dual-licensing but it’s generally regarded as a service to enable customers who would otherwise be unable to use the product rather than a core revenue stream.