Christensen’s law in the context of open source business models

I wrote yesterday that Christensen’s law of Conservation of Attractive Profits could be used to explain why open source vendors are increasingly turning to hybrid development and licensing strategies to generate revenue from open source.

Before I could think about doing so Arjen Lentz wrote a comment that did a lot of the explaining for me.

To recap, “The Law of Conservation of Attractive Profits”, articulated by Clayton Christensen in his book The Innovator’s Solution, states:

    “When attractive profits disappear at one stage in the value chain because a product becomes modular and commoditized, the opportunity to earn attractive profits with proprietary products will usually emerge at an adjacent stage.”

Arjen wrote:

    “OSS vendors turn to hybrid development and licensing strategies (or in some cases, not turn to but cling to even though other newer revenue streams have emerged successfully) because their sales organisations a) don’t always understand how the OSS market place works – they should indeed read a good dose of Clayton Christensen’s works! and b) it is a known path for revenue, and since sales people’s income and job is directly related to this month’s performance, they won’t naturally experiment with that. Sales people will do what’s been successful in the past, for a long as it remains succesful.

    The fact that other avenues *might* be more successful (or nicer to the clients and the ecosystem) is in this context, irrelevant. They won’t go for it. Can’t. It’s one of the basic innovator’s dilemma factors.

    The point is that being a vendor that publishes OSS, does not make it a non-traditional company. The vast majority are really very traditional in the way they do business. Which is quite understandable, given the above aspects.

    In the long run, of course, these vendors will find their “safe” and known market disrupted, even if they once considered themselves a disruptor. Yes, the disruptor can and will be disrupted. It’s happening all-over the place in our business.”

This explains the initial attraction of hybrid licensing in my view, but doesn’t go the whole way. Yes, a lot of these vendors are continuing to think like traditional companies and perhaps, as Dave Neary recently suggested, they shouldn’t.

However, given that these vendors are attempting to maximize profits it is understandable that they will look to traditional licensing methods to achieve that.

In the context of Christensen’s law open source specialists are engaged in commoditizing their own stage in the value chain. Unless they make money from other stages in the value chain such as other products (e.g. HP, Oracle) and/or embedded open source in commercial hardware and software (e.g. IBM, Cisco) then those vendors face a problem.

It is of course possible to generate profit from support (whether it be ad hoc or subscription based) but that arguably does not scale, presents problems in terms of balancing community and commercial requirements, and is unlikely to provide the sort of profit margins most vendors will be looking for (especially as hybrid development models maintain higher development costs, as opposed to pure open source community development models).

This explains why the likes of Matt Asay and Savio Rodrigues have recently argued that Sun and MySQL should return to the idea of closed source extensions to the open source software in order to close the gap between large but declining proprietary revenue and small but increasing open source revenue.

One of the problems this Open-Core Licensing approach has, however, is identifying value-add features that will persuade users to becoming paying customers and maintaining the balance over time (to stretch Arjen’s point, the open source disruptor is disrupted by its own disruption).

In the context of Christensen’s law it is probably easier in the long-term to generate profit from adjacent proprietary products than it is to generate profit from proprietary features deployed on top of the commoditized product.

This is why I would agree with former Sun employee Rich Sands and his view that the better long-term model for Sun lies in using open source to generate revenue from other products and services.

Which isn’t to say that one model is intrinsically better than the other, but that each has its place depending on the stage of commoditization and the short- and long-term goals of the individual vendor. I think I’ll come back to that later.

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#1 Arjen Lentz on 11.06.08 at 8:40 am

Re maximising profits, a business does not necessarily have that as an imperative.
Yes of course a business should aim to be profitable, but focusing on *maximising* profits can warp the way it interacts with its customers and the market/ecosystem in general. In OSS land, I think that can be quite damaging.

VC-funded companies tend to have this problem though, they *have* to go for a rapid revenue growth trajectory to produce the ROI for the VC. It doesn’t matter what they “want” or whether they decide to “be nice”. Business imperatives will drive them to where the VC funding demands the revenue needs to be in N years.
Again this comes back to a Christensen rule… if you have certain revenue needs or a certain cost structure, management decisions will inevitably take that into account and thus activities that would conflict with that trajectory simply get neglected if not actively murdered. It’s not about bad intent, but it is natural.

IMHO, the only way to not have this problem, is
a) be self-funded, and even better organically growing rather than getting into debt with anyone including the founders
b) develop processes and infrastructure so that the cost structure is where you want it to be. For example, if you can create a product or service you can easily sell online without human intervention, do so.

Re b: a sales person is costly on their own, there’s a lot of overhead in even just having one: it ups your prices. If you do need a sales person, set up their salary in such a way that it will not warp your long-term customer relationships, or the sales person’s focus.

There are of course many more aspects to this…. setting up a business in an efficient way is not that easy to do, but I think it can be done. Mistakes will be made along the way, as each business is different. The key is to not presume that the way others do it or the way it’s always been done is the right way now. Every decision needs to have its underlying reasoning re-examined. I find it most satisfying to be involved in this, as you’re not building “just another company”.

#2 Benjamin Reed on 11.06.08 at 9:21 am

I agree with Arjen.

Additionally, it’s funny that you point to the idea that it’s hard to “balance” in a pure-services model, when I’d argue that Open-Core makes that even *harder*. Note that all of the examples in Matt Asay’s post were companies with VC pressure to perform, rather than a simpler internal pressure to be profitable.

You are always at odds with the community if they could write a free add-on to your open core that replaces a revenue-producing proprietary add-on. You will always be resenting the community for not buying your money-making add-ons, rather than loving them for every time they make the software better.

In the long run, support is much more sustainable, and in-line with the community, IMHO. It’s not the support model that doesn’t scale, it’s VC funding of community software.

#3 Matthew Aslett on 11.06.08 at 9:49 am

Thanks Benjamin,

If done properly Open-Core should be easier to balance than the subscription model as vendors accept that the community users will not pay for the add-ons and instead focus their attention on users that are likely to pay (they should have done their homework on this and designed the add-ons accordingly).

I take your point that this is much more of an issue for VC-backed vendors than self-sustaining or community-focused vendors. That is what I meant when I wrote “is unlikely to provide the sort of profit margins most vendors will be looking for” but I didn’t express it as well as I could have – I’ll amend that sentence.

I actually think we are in agreement, but we are coming at this from different perspectives. If the business is not focused on *maximising* profits then I agree with you and Arjen, support is sustainable, but if the focus is on *maximising* profits then I believe generating revenue from other product and services and embedded soft/hardware is a better long-term strategy than support or add-ons.

#4 Benjamin Reed on 11.06.08 at 8:34 pm

Right, I just believe that that particular style of “maximizing profits” is only good if you want to maximize them for 3 years and go out of business or sell the division off. In the long term it’s very hard to win that way.

It’s a tired cliché, but sometimes slow and steady *does* win the race. But hey, perhaps I’m just old-fashioned. 😉

#5 451 CAOS Theory » On open source business strategies (again) on 02.25.09 at 4:29 am

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#7 Melina Benninghoff on 05.27.09 at 7:37 pm

Open sourse was their claim to fame in the 80’s and helping with redhat. Why would they go against this it only help the evil genius Gates.

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