Frank Hecker’s Four Open Source
Business Models
Table of Contents
Executive Summary……………………….3
Introduction………………………………..3
Support Sellers…………………………….5
Loss Leaders………………………………7
Accessorizing……………………………..8
Widget Frosters…………………………..10
Volatility………………………………….11
Business Model Cautions…………………11
Bibliography……………………………...12
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Executive Summary
Frank Hecker’s essay “Setting up Shop” provides an outline of four open source business
models. They are designed to demonstrate how software companies are able to create
revenue without the use of traditional software licensing fees. The four models are as
follows support sellers, loss leaders, accessorizes, and widget frosters. Although these
business models have proven profitable for many companies, the software market is
volatile, and many users do not understand the developments in technology. The
following essay outlines open source software, along with the risks and advantages that
are encompassed within the strategy. Each model is then summarized and evaluated
based on an example company.
Introduction
Frank Hecker is the author of “Setting up Shop”, an essay that explains four open source
software models that have proved profitable for various companies. He is the executive
director of the Mozilla Foundation, which promotes choice and innovation on the
Internet, and was a key contributor to Netscape’s decision to release the source code for
Netscape communicator. The open source theory, which Hecker supports, states that
proprietary software and non-proprietary software should exist simultaneously. The
realization that companies need a method to maintain profitability and innovation brings
about the idea of open source software. Contrary to this, Richard Stallman supports free
software, in which all people share software.
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Hecker’s four business models are as follows support sellers, loss leaders,
accessorizers, and widget frosting. They were developed to combat the challenges that
commercial software companies face in the fast paced software industry. The target
audience for this essay is commercial software and hardware companies, along with
individual software developers. Some of the challenges that these companies face are the
requirement to continue to create new products and bring in revenue, the need to maintain
quality, and necessity to support current and old release. Hecker believes that these
challenges arise due to constrained resources. The fact that few companies have enough
people, money, or time to do everything, and compete against rival companies. Hecker
explains that a possible solution is to turn some of the products into open software,
making the source code freely available, and allowing people to revise and distribute it.
The majority of companies import revenue through the sale of software, however
the developers who are choose to work on your software, and will thus improve it for
customers provide the value in open source software. Outside developers are prompted
by the need to solve problems for themselves, the prospect of creating services and
products from this knowledge, or simply the knowledge they will gain by working on it.
The dependence on these developers, who are working for “free”, requires positive
attitudes and actions towards them. There are several standard software licenses for use
with open source software, and many of them have common features. The most
significant features is that the software is made free to the user and the buyer, and
redistribution restrictions are minimized. Many of the licenses that exist can be modified
for company use.
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Since companies cannot generate revenue through traditional licensing, they must
use services and value to provide worth customers. The four business models
demonstrate different methods of execution that suit different companies. Some issues
that companies may face when using one of these models are code sharing, export
control, and code sanitization. The majority of these issues deal with the source code,
which is the underlying programming language, which can be read by humans, and then
modified to build a functional version or derivative of the product. This is a precious
resource for software companies and is usually accompanied by legal documentation. The
source code can help customers protect their investment; understand how the software
works, and fix bugs themselves. Due to this many software companies have reservations
about releasing their source code.
There are a number of risks and rewards that open source software offer. If a
company chooses to adopt an open source strategy, Hecker’s models provide four
different formats, which are discussed in the following paper.
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Support Sellers
The “Support Sellers” model is the original software business model, and the most
commonly used today. Initially implemented by Cygnus Solutions, a for profit company
formed to provide support services for GNU tools, the model has also been advocated by
Richard Stallman in the GNU manifesto. Unlike the traditional licensing fees, companies
earn revenue through media distribution, branding, training, consulting, custom
development, and post sales support.
There are two broad selling categories within this model: physical goods and services.
Vendors differentiate themselves within the industry by offering comprehensive easy-touse software distributions. By doing this companies simplify the users experience, and
further differentiate themselves with competitive price and quality. In this model there is
limited availability to use value driven pricing; more typically the pricing is determined
primarily is determined primarily by the cost to provide goods and services, as there is
price competition with other vendors offering comparable goods and services, and
definite limits to what users are willing to pay for them (Hecker, p. 20). A good
reputation can be used to justify higher prices. Companies involved with open source
and in the Linux market commonly use this model; the most notable is Red Hat Software
Founded in 1993, Red Hat Software is one of the largest and most recognized
open source software companies. The company has nearly 1,300 employees and 27
offices worldwide, with corporate headquarters in North Carolina. They are the leader in
development, deployment, and management of Linux and open source solutions for
Internet infrastructure. The name stems from the manual of the beta version, which
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contained a request for the return of Marc Ewing’s characteristic red and white fedora
(www.redhat.com). It also used to refer to the two variants of Linux the company
produces under that name, Red Hat Enterprise Linux.
Red Hat’s major form of revenue stems from the services and support they offer
users. Although they sell their own software, Red Hat also bundles numerous software
packages for consumers. Fedora, which is a spin-off of Red Hat, is a more rapidly
updated community supported Linux distribution. Fedora’s site contains betas, which are
unfinished versions of software, and can be downloaded and modified.
Red Hat’s major focus is on the corporate market, in which numerous support
systems are offered at a high price. Through these companies are able to coordinate
computers, and find solutions more efficiently. Some products that are currently offered
are systems management solutions, enterprise technologies, RHN, and training courses.
These are used for systems management, deployment, functionality enhancements,
software engineering and development. These functions also allow companies to
continually update systems, and train current employees to design additional software.
The financials of Red Hat are highly volatile. Over the years they have increased
and decreased daily due to lack of investor knowledge and innovations in technology.
The fact that computers and software are a fairly new development, investors tend to
provide money when stocks rise, and quickly pull out immediately as the market
declines. This can be seen in Figure 1.
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Figure 1: Red Hat financials
Loss Leaders
The loss leaders make money by giving away one product in an attempt to bolster
another. A perfect example of this model is Netscape, which opened the source code to
their popular web browser Netscape Communicator, dubbing the new open source project
Mozilla. Mozilla was released in an effort to take influence from Microsoft’s (MS)
Internet Explorer (IE) so that MS would not be able to influence the W3C, creating
standards that locked out competition.
During the late 1990’s Netscape was locked in the browser wars with MS and
their IE. During this war both Netscape and MS spent great deals of money developing
the Netscape Communicator and the MS IE. Considering that MS spent more on IE then
Netscape was worth as a company they were bound to win if things continued. After
much debate Netscape decided to release their Communicator as open source under the
name Mozilla January 1998. Shortly after the release of Mozilla AOL bought Netscape
for 4.2 billion dollars.
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After Netscape was bought out by AOL MS lost it’s anti trust case. Shortly after
MS’s loss AOL sued them and won, gaining $750 million and a license that allowed
AOL to use and distribute IE freely for seven years. The right for AOL to use IE made
the Netscape Communicator unneeded; this situation was the final blow to Netscape.
Netscape was officially disbanded July 15, 2003.
Accessorizing
The accessorizing business model for open source software companies is similar
to accessorizing in other industries. These businesses do not actually work on creating
open source software or selling it. They simply sell physical goods that contribute to the
usage of OSS. They will distribute books on OSS, sell computer hardware related to it or
sell any physical item associated with it.
The products that they sell are “piggy backing” onto the OSS industry. These
companies are not involved in software production or in offering services surrounding it.
They do produce publications that document and explain OSS. They cover most software
such as; Linux, Perl, GNU, Emacs etc… While they do not work on the software they do
bundle their product with free versions of the software. Because this is similar to selling
the product it is necessary that they have the appropriate licenses from the software
owners to distribute it with their products.
Because accessorizing companies are selling side products built around different
OSS programs it is important that they choose the right software to write publications
about. These companies are vulnerable to shifts in the software market because as each
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software becomes obsolete so do the accessories surrounding it. They are also dependent
upon the third party developers and the software technicians to maintain the software.
Companies in this industry can differentiate themselves from competitors by
creating brand loyalty through the quality of the goods they produce. The industry leader
within this business model is the O’Reilly Company. They can be found on the Internet
at www.oreilly.com. Tim O’Reilly founded the company as a technical writing firm in
1978 and later adapted to the OSS revolution. They now produce 300 titles a year. They
publish books on such software as UNIX, Linux, Perl, Java and Oracle. Their actual
financials have not been made public due to the fact that they are a private company, but
their revenue is approximately $25 million. The company currently employs 225 people.
Widget Frosters
In this model money is made by buying hardware, such as laptops and desktops
and installing Linux on them. Linux installation can be a tricky process, particularly on
laptops; having a vendor install this software avoids many headaches that can go along
with a complex install.
A good example of a widget froster is VA Software. Founded in 1993 VA
Software specialized in putting Linux on cheap PC’s in order to give consumers a
cheaper alternative to expensive Unix boxes.
VA Software is also a great example of the volatility of these open source models.
Today they have moved our of the widget frosting business moved into an accessorizing
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and loss leader model through the acquisition of the open source technology group
(OSTG). The OSTG in turn owns Thinkgeek (accessorizer), Source Forge (loss leader),
and Slashdot.
To this day VA Software still holds the record for the most successful IPO in
history. During it’s first day of trading VA Software’s stock rose to a high of $320 per
share, and finally closed at $239.25. Part of the reason for this success lies in the utter
ignorance of investors at the time, because of VA Software’s ticker symbol LNUX many
investors thought that they owned the rights to Linux. The stock history of VA Software
is shown in figure 2
Figure 2: VA Software’s stock history.
Volatility
For most of their sorted past, open source companies have been plagued with
incredibly volatile stock prices. This is in part because of the investors and their
uncertainty of how these business models will continue in the future. Secondly this
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industry, like many others in tech are constantly under threat of being made instantly
obsolete by a new product or development.
Business Model Caution
Because of the volatility of the business in the OSS industry any new entrants
need to be very cautious in how they approach such a venture. Many businesses that
were once leaders in this area are no longer in existence. Netscape is an example of a
company that simply disappeared.
The most important thing that a company entering this market needs to be careful
of is which business model they want to follow. Many people are confused about
entering the OSS market because it is supposed to be free. Investors are very reluctant to
get involved in this industry.
The second thing that companies need to carefully consider is what type of
licensing they want to get from the software producers. Even though a true OSS license
should be completely open the reality is that they are not all like this. Some software
producers are much stricter in how they license out their product. Making a mistake in
this process can be detrimental to the ability of these companies to be able to sell their
products.
The last decision that a company needs to make is what role they are going to
have in creating OSS. They need to decide if they are going to be converting proprietary
software or if they are going to be creating software from scratch.
Many companies have failed in their marketing of OSS goods. Despite the
volatility of these companies it is still possible to make money in this market. Smart
companies are continuing to grow and to be relevant to their customers.
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Bibliography
Hecker, Frank. Setting up Shop. June 2000. http://www.hecker.org/writings/setting-upshop. Viewed May 15, 2006.
O’Reilly Company. www.oreilly.com. Viewed May 20,2006.
Red Hat Software. www.redhat.com. Viewed May 17, 2006.
Yahoo Finance. www.yahoofinance.com. Viewed June 1, 2006
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