The Analyst’s New Confusion

Brian Prentice at Gartner has a new post titled Open Core: The Emporer’s New Clothes – click here to read it

I met Brian at OSBC recently and chatted with him for a while about several topics including patents and Microsoft’s open source strategy. While I like Brian, and we agree on many things, I (somewhat predictably) don’t agree with this latest post.

There are some important things that are missing from his piece.

For most proprietary software companies the biggest expenses are sales and marketing.

Let’s look at a proprietary competitor in Pentaho’s market – MicroStrategy (stock symbol MSTR). In their last quarterly report they state that

• Revenue from Product Licenses $34.4m
• Revenue from Support and Services $69.6m
• Sales and Marketing (S&M) Expenses $31.5m
• Research and Development (R&D) Expenses $11.4m
• G&A Expenses $14.2m

MicroStrategy’s figures are fairly typical for an independent proprietary software vendor. You can see from these figures that R&D is the smallest expense, and S&M is the biggest. In fact the S&M expenses are more than all other expenses combined. You can see that revenue from licenses is about the same as the S&M budget. It takes almost as much money to convince people to buy the software as they get from the sales. The word ‘convince’ is important – the S&M teams have to convince companies that the software both does what they need, and is worth the cost. Each quarter the money made from selling licenses is poured into next quarter’s sales and marketing budget. It is therefore support and services where they make most of their money and all of their profit.

To re-iterate, because the S&M expenses are so high, MicroStrategy make no money selling software licenses, they make most of their money (and all of their profit) on support and services. From this perspective they sound very similar to the pure-play open source companies – who make no money selling software licenses, they make it all on support and services.

If you contrast the S&M strategy and budget of a proprietary software company with a commercial open source one you will see fundamental differences. The commercial open source company provides open source software. This software has to be be fully-functional and useful, otherwise their will be no adoption. The R&D costs of this software will be lower and, more importantly, development will be quicker than that of a proprietary company. But, as proved above, the R&D costs are the lowest costs anyway – lowering your lowest cost does not provide you with a significant benefit. The major difference is that the open source community edition of the software enables an efficient, cheap, in-bound marketing strategy instead of an expense, out-bound, enterprise marketing strategy. By switching to a primarily in-bound sales model a commercial open source company can drop its marketing budget dramatically. The reduction of the S&M budget allows the license fee to be eradicated. So the tasks and strategies of S&M in an open-core company is significantly different from those of a proprietary company.

These facts about the S&M activities of proprietary and open source companies seem to be largely ignored by many analysts and commentators:

• Tarus Balog (CEO of The OpenNMS Group), says that open core vendors use open source as a marketing gimmick. As far as I know Tarus has no prior experience running a software company so I’ll forgive him his confusion. This is no gimmick, this is a fundamental part of the business model.
• Matt Aslett (451) and Brian Prentice (Gartner) talk about code contributions and R&D practices but rarely mention S&M

I have worked my entire professional career in either proprietary software development or commercial open source software development. I have experience of the differences between these models first hand. I have only covered differences in the S&M domain. There are also numerous, significant differences in the development, QA, partnering, business development, support and service departments etc. Some of these I cover in part II of the Bees and the Trees

As I have said before, the software industry is in a transition from proprietary software, to some mix of proprietary and open source software. Is that eventual mix 0% proprietary and 100% open source? I don’t know. I do know this transition has been in progress for over a decade and has a long time (decades) to go. Maybe the open core model will only be relevant during this transitional period. But this transitional period is long, and many start-ups and existing proprietary companies have no viable way through this transition without the open core model.

Brian Prentice seems to be trying to find something to say about open source. Using invalid comparisons with ‘freemium’ and SMB strategies isn’t a good idea. Heavy-handed, one-sided statements, about an entire business model  – based on seemingly incomplete knowledge of that model, doesn’t seem good either. Companies like Gartner are struggling to show value in an increasingly-open world. Brian’s latest post, in my mind, doesn’t exactly help them do that.