One of the most persistent questions people ask about the impact of open source on the software industry is “how do you make money?” It’s important to answer this question, not only for the software industry but also to provide some clues for the many open source initiatives that are springing up in other industries. We’re now in a world in which customers are demanding access to the source code (or its equivalent in other industries) so that they can inspect and extend the intellectual property, and contribute their own modifications and extensions back to the community.

Given that reality, how do you charge for the intellectual property that is open for all to inspect? As you’re about to see, there are several ways to monetize open source software. There is no question that opening up the source code has the effect of commoditizing the price for that software. On the other hand, most business customers value the ability to have a certified, maintained version of the code, and are willing to pay for it.

It’s not that people won’t pay for open software. It’s simply that they won’t pay a premium for it. So, as Mark Spencer, CEO of Digium, explained, use the open source approach when you know that your customers are going to want to roll up their sleeves to customize your products for their own needs and when you can tell that a specific industry or industry segment is ripe for commoditization--e.g., there are currently too many high-priced, closed, specialty solutions, and not enough value being derived from them.

Designing a Business to Thrive in the World of Open Source

Despite the commoditization and consolidation in the software business, software start-ups abound. Many of them are now leveraging open source. To understand why and how, I decided to pick the brain of a long-time lead customer of mine, another one of “Patty’s Pioneers” who is currently embarking on a new “software as services” venture in the financial services industry.

Founder’s Background. Patrick Kerpan was one of a small band of software architects and artificial intelligence (AI) experts at O’Connor and Associates in the late 1980s that pioneered the development of financial derivatives by designing the software that made them possible. O’Connor was acquired by Swiss Bank, which, in turn, merged with UBS. Later, Pat Kerpan ran derivatives technology at Canadian Imperial Bank of Commerce. He left the financial services world to become a software entrepreneur and sold his brainchild (Bedouin, Inc.) to Borland, where he led a large software development team and ultimately became chief technology officer.

After he left Borland, in the fall of 2005, Pat had about 100 new business ideas. The one he decided to implement first is called CohesiveFT (Cohesive Financial Technologies). As of this writing, the business is still in start-up mode. But the way Patrick Kerpan has sorted through the business models available to him gives us some good insights into how one does business in a world in which open source software has become a reality.

Four Open Source Business Model Options to Mix and Match

As the “open source effect” commoditizes the layers of software required to run any business, Pat Kerpan feels there is still money to be made in at least these four distinct areas:

1. Industry-Specific Solutions. Every industry has different software requirements. Retailers have different needs than manufacturers. Financial services companies have different needs than media companies. And specialties within each industry have different needs. Retail merchandisers’ needs differ from those of supply chain managers. Stock brokers’ requirements differ from those of merger and acquisition specialists. There’s money to be made by building industry-specific stacks which integrate the key proprietary industry software components with open source software. Most companies don’t want their IT staffs spending time finding all the necessary pieces, stitching them together, and maintaining them. Pat Kerpan’s first target markets are the capital markets and global banking sectors.

2. Support Services. Open source solutions have a relatively short shelf life for maintenance. The volunteer developer community is much more interested in working on the next version of the software than it is in maintaining the previous versions. Open source software releases are much more frequent than those in the commercial software business. So, there’s money to be made if you are willing to maintain the versions of open source software that clients are running in production and to certify that they will continue to operate in their environments.

3. Custom Development. Pat Kerpan calls this the “smartest guys in the room” business model. You can make money doing custom software development on top of open source software to fill the needs of clients who don’t have the time or resources to do this custom development themselves. What Pat doesn’t like about the “smartest guys in the room” model is that it doesn’t scale. “You’ll never be the smartest guys in the room forever,” he maintains. “There’s always going to be someone younger and smarter to knock you out of your seat. And a lot of these smart people are copying your feature set right into the open source layers of the stack. This model works for small boutique firms, for a few years, but it’s not sustainable and it won’t scale.” Therefore, Pat and I agree, the trick is to make sure that “the smartest guys in the room” are your lead customers. It’s your job to empower them to do their own custom development.

4. Software as a Service. Instead of selling software, you sell the services that software performs. Customers don’t pay software licenses. They don’t have to install the software. They simply pay for the services performed, typically by the transaction. “The mobile phone industry has helped people understand this business model,” Pat explains. “You can pay by the minute/call, or you can buy a service plan that covers up to a certain amount of calls, SMS messages, etc. If you exceed that threshold, you are charged by the transaction unless you want to upgrade to the next service level.” Software as a service is, in fact, the business model that has the most upside. Nobody really cares how you fulfill the service--whether you do it with people or with open source or with some combination--as long as you can guarantee the service levels for quality, performance, and reliability that clients require.

The Future of the Software Business
PLEASE DOWNLOAD THE PDF TO SEE THE ILLUSTRATION.
Four ways to make money in the open source world: 1) Pull together a stack of commodity open source software (the open source effect) and add components required for a specific vertical market; 2) Provide support services to keep open source products running well; 3) Do custom software development and assume that you can keep being the “smartest guys in the room;” 4) Sell a software service that is paid for as it is used, rather than before it is used. We added the alternative to the “smartest guys in the room” strategy, e.g., leverage the contributions from your smartest customers.

Designing the Right Mix of Open Source Business Models

Identify a Market that Is Ready for Open Source Solutions. Just as Digium’s Mark Spencer was able to spot an industry that was ripe for an open source solution in telecommunications, Pat Kerpan feels that the financial trading industry is ready. “In the financial trading market, we have enough capacity,” Pat Kerpan explains. “In fact we have over-capacity in new product introduction. What’s happening now is margin pressure. What technology executives in financial trading firms care about now is achieving global scale and rapidly shifting more of their costs to a variable cost base.” So, CohesiveFT plans to replace internally-developed specialty software with open source, commodity software that is tailored specifically to the needs of the financial trading market.

The way Pat Kerpan’s small team at CohesiveFT has thought about designing its business can be a recipe that might make sense for other software start-ups:

• Commercialize the open source solutions that lead customers have already put together through their own trial and error improvisations.
• Add value by identifying market-specific requirements, building or buying the software that will meet those requirements and making it open source so it can be evolved and maintained by the customer community--these lead customers become your “smartest guys in the room.”
• Identify one or more customer-critical scenarios that are not currently being met--address those scenarios by delivering software services to the customer community.

Certify an Open Source Solution for a Specialized Market. In the financial trading industry, most companies are already using open source software, according to Pat Kerpan. They’ve built their own in-house applications on top of many of the same open source platforms. They’ve rolled their own software in areas in which they couldn’t match their needs with off-the-shelf software and/or open source options. They’ve tailored their open source and home-grown offerings to meet the needs of the real-time global trading environment in which they operate.

So the first step in Pat’s business model is to package up and support all the open source software that these different companies around the world have already gravitated towards. “We’re putting together the implied reference architecture that the leaders in the financial trading world have already adopted,” Pat Kerpan explains. Pat’s team, working with lead customers, has identified the layers of open source software that are robust, trusted, and already working in many of these companies. The value that CohesiveFT can add is to maintain, test, and certify it for these companies, taking them out of the “roll their own” business for all the layers of software infrastructure that are not differentiators.

Add Value by Purchasing or Developing Specialty Software. To support global trading, there are a number of specific needs these customers (the IT architects in global trading firms) have. They need middleware to execute trades instantaneously, and they need middleware to keep track of complex, very long-lived transactions. Pat Kerpan knows that there is now an opportunity for open source software that is good enough to meet both these needs. “Where there are gaps, there are boutique software companies that have filled those gaps. We’ll buy the boutique firms whose solutions we need and open source their products, adding them to our stack.” Pat Kerpan feels that his clients won’t trust this software unless they can inspect the code.

More importantly, the CohesiveFT group believes that the open source sales model more appropriately aligns with customer value. Clients will want to be sure that the software evolves appropriately over time; the open source approach gives them visibility into the governance of the project and an ability to influence it if needed. “They’ve had experience with open source community-based development and they trust it,” Pat explained.

Identify a Customer-Critical Scenario and Offer It as a Software Service. As with any entrepreneurial venture, you have to find a customer-critical need to fill. In the financial trading industry, the need that Pat Kerpan’s team spotted is the direct result of regulation...