How do Open Source Companies even make money?
Coca-Cola’s secret formula, developed over 135 years, is kept in a vault in Atlanta, closely guarded from the world’s eyes.
Google is highly secretive about the algorithms that power its search engines, which determine the fate of millions of businesses and organisations around the world today.
Red Hat was acquired by IBM in 2019 for $34Bn. And the code of Red Hat’s flagship products and solutions is … accessible to everyone?!
In this edition of The Conquest Communiqué, we discuss how tech companies like Red Hat, GitLab, and the Mozilla Corporation, built on open source software, succeed to survive and thrive.
But to answer the question of how open source companies make money, we first need to understand:
What can Open Source companies do that proprietary competitors can’t?
The key unique advantage of open source companies over proprietary competitors is the power of openness and collaboration. Unlike proprietary companies that closely guard their source code and restrict user access, open source companies provide full transparency and encourage community involvement in the development process. This openness brings several significant advantages.
Popular open source projects are empowered by Linus’s law: the assertion that "given enough eyeballs, all bugs are shallow". Formulated by Eric S. Raymond in his seminal essay and book The Cathedral and the Bazaar this “law” was named in honour of the creator of the Linux kernel, Linus Torvalds. Their large user base that actively identifies and reports bugs leads to faster bug fixes and patches.
Similarly, as open source software undergoes continuous peer review by a large community of developers, this review process helps identify and fix security vulnerabilities quickly, leading to robust and secure software. For example, there’s the OpenSSL project: an open-source implementation of the SSL and TLS protocols, which benefits from community audits and ensures the security of sensitive communications.
Clearly, the common denominator here is the community. Open source companies leverage their communities to drive feature development and innovation. Community members contribute code, suggest improvements, and collaborate on new features, leading to rapid advancements.
Proprietary competitors have a feedback loop that they need to traverse: gather feedback from users, formulate plans based on feedback, develop new features or modify existing projects accordingly, deploy and repeat. But open source companies skip massive steps there and can iterate faster, because of how their users and developers are often the same person. This allows open source to innovate faster.
Open source companies can further leverage community support for long-term maintenance and support of their software, beyond what would be considered possible by proprietary counterparts: Windows 10 was released in 2010, and support for it will end in 2025.
Ubuntu, on the other hand, started in 2004. It provides LTS (Long-Term Support) versions, where the community commits to providing security updates and bug fixes for an extended period, ensuring the stability and longevity of the software. So by the time Windows 10 support ends, Ubuntu will be twice as old, and still going strong.
It is said that a compelling vision is essential for the creation of any great company. A vision serves as a guiding light, providing direction and purpose to the organisation. It inspires and motivates employees, customers, and stakeholders, helping to align everyone towards a common goal.
All open source companies share a fundamental vision. Open source software aims to create a world where individuals and organisations have the freedom to access, modify, and distribute software, fostering collaboration, transparency, and innovation. It envisions a technologically inclusive society where knowledge is shared, barriers to entry are eliminated, and software is of high quality, accessible to all, and continuously evolving through the collective contributions of a global community.
This vision, with the power of community and collaboration, grants open source companies massive advantages that their proprietary competitors otherwise need to invest large amounts of resources to achieve.
What do open source business models look like?
Open source innovates and spreads faster. But to successfully monetise it, you have to have reasons for companies to buy your product uniquely. For a software company to make money doing open source, their value proposition must not be tied 100% to their source code.
Richard Stallman, popularly known by his initials rms, is a pioneer of the Free Software Movement. One of the pieces of free software he helped develop as part of the GNU project was Emacs, a text-editor. To make a living at the time, rms sold physical media like floppies with Emacs on it.
But selling floppies (or hard drives for that matter) with code on them is not that much of a value add today with the advent of cloud storage technology and high speed internet.
Here are the 3 most popular business models with open source companies today, each with its own pros and cons:
Support and Services
Here’s the other way Richard made money: doing seminars, and teaching people how to use Emacs. He made a substantial amount of money this way, and he wasn't selling the code. Support for complex software still remains a need for enterprises, and huge open source businesses have been built around monetising support through consulting, training and certifications.
The best known company with a support-centric business model is Red Hat. Red Hat built an organisation capable of supporting and servicing OS users at scale, nailing the scaling challenges that came with it.
The major downside of this business model remains that it is hard to scale operationally. In addition, such a business has to compete with companies only providing software support. Though service-only competition doesn’t know software well enough, they can do it cheaper as they do not have to bear the cost of development. If you can scale well and better utilise your stronger knowledge of your codebase, you will be successful.
Open core
This involves differentiated licensing around an open core — having a core set of technology that is open source, and then proprietary add-ons that provide extra value. This is typically suitable for on-premises software. On-prem software is installed and runs on computers on the premises of the person or organisation using the software, rather than at a remote facility such as a server farm or cloud.
This is also called the Cloudera model. Cloudera builds proprietary add-ons to differentiate from pure-play open source competitors, and then reinvest that revenue into the open source component.
While working with an open core, it is pivotal to take care of potential alienation between open source and proprietary offerings. Balancing between development of both the components, instead of favouring the proprietary add-ons bringing in the money, is crucial to the mission statement of open source companies.
Confluence and Elastic are other major companies with an open core model.
SaaS
Open source as a Service. When a service is hosted on the cloud, most users don’t care if the hosted service is based on open source or proprietary software. Through cloud computing, a hosted service allows full strategic value to the customer, regardless of its nature.
The challenge here is a low defensibility and potential fights with cloud partners. Cloud partners don’t have to pay cloud provider margins or develop actual software, so they can offer it for cheaper.
But those concerns are mitigated when you realise the competitive advantage open source companies have over public cloud:
Enterprises don’t want vendor lock-in
They want to buy from people who wrote the code
Big cloud companies don’t have your specific expertise
And these factors are a sufficient differentiator in most cases.
There are multiple ways to the top of the mountain. The most frequently treaded path to revenue for software companies may involve utilising the proprietary nature of their code. But the 3 business models mentioned above, and further business model innovation that makes the best out of the unique advantages of an open source company, gives creative and innovative entrepreneurs sufficient opportunities for profiting.
Proprietary tech companies are embracing open source.
“Software is eating the world.”
- Marc Andreessen, 2011
“As software eats the world, open source eats software.”
- Peter Levine, General Partner at a16z, 2019
It’s not just a part of the open source companies listed in the article and thousands others: it’s a part of Meta, airbnb, Google, and any tech giant you can think of.
Open source is code that all of humanity can benefit from and grow symbiotically with. As the technological innovation ↔ business innovation flywheel proceeds, open source will become more and more crucial to the next phase of human progress.
Love the article, very clear explanation