Open Source businesses

I’ve tried to post three times now on open source, but I keep rambling on about too many details as it’s something I’m passionate about. But with people talking about Confluent and Hashicorp, I feel I need to post something.

Essentially my thesis is that open source companies can’t be great companies. Don’t get me wrong, I’m not against open source. I’ve worked for multiple open source companies. Open source it is a great model from a technology perspective. And from a customer perspective. And you can have a good open source business model. But there are some fundamental flaws that make me think no open source company can be a great Saul-level company. Basically it’s just impossible to have a big enough moat.

There are essentially three surviving open source business models.

  • “Pure” subscriptions. Give the software away completely for free and just charge for support, services, and conveniences. This is very difficult because it’s hard to prevent “free riders”. Essentially Red Hat is the only large scale example of this and there are some unique factors in play for them. Arguably they are the exception that proves the rule.

  • “Open Core”. Give the core of the software away, but keep certain features proprietary so that you can upsell. This is still common, but is almost impossible to succeed with. Firstly, because it’s a tight rope. If you keep too much proprietary then you don’t get the ubiquity and benefits of open source. But if you keep too little then you have the problem mandeville describes: no one pays. Plus, since the base code is open, the “community” can always step in and write their own competing versions to your proprietary features. (This happened to one of the open source companies I worked for, someone wrote an open source alternative to one of our commercial add-on features. It had a huge impact on us.)

  • “Hosted Service”. Give the software away, but sell a hosted version of the software. Hailed as being the savior of the open source business model, due to the success of companies like Databricks it has actually proven to be full of challenges as well. Yes, products like Atlas and Confluent Cloud have had some great initial growth numbers, but the nature of open source means that it will be hard to have a moat. The hyperscalers (and others) have jumped in to compete. And since they just want to sell compute, hyperscalers can set prices ridiculously low. There have been some attempts to prevent this with restrictive licenses, but that approach is fraught with challenges as well.

But fundamentally, my big issue with open source is that you end up competing with your biggest customers. Fundamentally the open source business model is about selling expertise. Confluent says “Why bother hosting your own Kafka when you can have the experts at Confluent host it for you?” Elastic says “Why not pay for subscription to Elastic so that you have Elastic’s expertise when you have an issue?”

The answer to “why not?” is cost. If I have one set of Kafka brokers, it makes sense to pay for help from Confluent. But if I have a huge number of brokers, and Confluent wants to charge me millions of dollars, it starts to make sense to just hire my own experts and use Kafka for “free”. I believe this is why we’ve seen fast growth for total customers for Confluent, but slow growth in the numbers of large customers. Similarly, if I am Microsoft, and I have only a few customers interested in a product, it makes sense to partner with someone like Mongo or Elastic. But once a threshold has been passed, I’m not going to partner with DataStax, I’m going to create my own version: Cosmos. I’m not going to partner with Confluent, I’m going to create my own version: Event Hub.

Open source is (almost by definition) about guaranteeing that no company can gain a moat. Which is why, although I might like open source as a buyer, as an investor I prefer companies like Crowdstrike, Monday and Datadog that can gain a lasting proprietary differentiation via their “secret sauce”. If the secret sauce is open, it isn’t very secret and it’s too easy to copy once the profits start rolling in. I am aware that the numbers for Atlas and Confluent Cloud look good. But I think they will hit a ceiling.

–CH

189 Likes

Essentially my thesis is that open source companies can’t be great companies. Don’t get me wrong, I’m not against open source. I’ve worked for multiple open source companies. Open source it is a great model from a technology perspective. And from a customer perspective. And you can have a good open source business model. But there are some fundamental flaws that make me think no open source company can be a great Saul-level company. Basically it’s just impossible to have a big enough moat.

There are essentially three surviving open source business models: …



Open source is (almost by definition) about guaranteeing that no company can gain a moat. Which is why, although I might like open source as a buyer, as an investor I prefer companies like Crowdstrike, Monday and Datadog that can gain a lasting proprietary differentiation via their “secret sauce”…

Thanks Conehead for the elegant and well thought out and well organized presentation. I have felt the same way for years, and tried to post about it, but never as clearly as you did.

One additional point that I tried to make is that the open source companies, almost by definition, have founders and leaders who are idealists about having an open source internet, and they tend to seem to be less concerned with their business being profitable than with it being open source. In other words their stockholders tend to be their least important consideration, while being on good terms with the open source community rather than being seen as a “sell-out” takes precedence.

I’m not saying that an open source company can’t be successful, but just that the deck is stacked against them, and they have to overcome so many obstacles that a Datadog or Crowdstrike doesn’t have to deal with (and which you described so well in your post).

Best,

Saul

74 Likes

Conehead (great SNL skit, btw)

Thanks for sharing.

The key point you arrive at is very important.

The moat concept is based on the company performing and growing through special sauce of some kind.

The PROBLEM with the field of reliable consultants is that the company not only has to be better than most at the same tasks, they also have to be very close to cost parity in what is, by definition, a COMMODITIZED service set.

As a result, the opensource host has to execute development, product expansion and enhancement in general, while ALSO competing with COMPANY SPECIFIC issues for each customer. All of this while accepting mediocre margins (relatively).

The model for most enterprise software solutions has used the customer facing segment for trial, validation and expansion of customer wants/needs. This is actually a structural benefit for the company which is NOT Open source.

Unless they are open source.

In that case the company ability to assess future product options and growth opportunities has been muted and diluted. That, among other things, has been SPECIFICALLY handed out to the competition. Innovation funneling and new product development is only partially available and partially visible to the team, leading to longer cycle times and less optimal deployment of NEW features.

Hypergrowth is about racing ahead just to the point of breaking your products and services.

“Break the model. Then break it again.”

https://review.firstround.com/Hyper-Growth-Done-Right-Lesson…

6 Likes

Excellent post. You wrote a very simple and succinct summarization of all my concerns regarding open source software – but laid it all out in a clear and concise way, one that I was never able to do.

Thanks,
GC4p

Let me challenge this a bit…

  • Apple’s core Operating System is open source (see here: https://www.quora.com/Is-macOS-open-source-or-closed-source-…)
  • MongoDB Atlas is open source (with some debate, but you have the source)
  • Redhat is based on open source technology (linux as a start)
  • Google has a ton of pieces open source code
  • Microsoft is the largest contributor to open source (see here: https://www.whitesourcesoftware.com/resources/blog/the-top-1…)
  • Mulesoft, now part of Salesforce, has a version of its extremely successful software open source
  • Facebook open sourced several of its developments, or (as Google) embraced an open source technology and it supported it to take it to the next level

The common factor I see among these companies is that they use Open source as an entry into their premium or SaaS offerings. For example many of the open source versions of the pieces they provide is named “Community Edition”, ie: they use it to build a community (of developers), to build an ecosystem. They build platform economy around the technology and the same programmers that embraced the technology find in it a source of income and move to deliver services on the premium version for example. And yes, they play a very well thought out game about open sourcing some things and closing some other things.

It is NOT that a SaaS product does not need support, quite the contrary, they could create literally billions of income of related services, for example take a look here about the Salesforce Economy: https://www.salesforce.com/news/press-releases/2021/09/20/id…

To an extent, Open Source if properly supported, is one of the best “content marketing” engines to attract developers to expand your product. I worked at Microsoft and there you are encouraged to contribute to Open Source, but they are clear that you must to commit to be supportive, you just cannot post code and forget about it. And this is to some extent monitored. I can imagine the same of the rest of Big Tech.

So the “moat” is the ecosystem you build around, plus services that solve ordinary people problems. You use Open Source to lower the barriers to entry into the ecosystem, as a growth engine, and you build the SaaS offering to create a product with a moat dependent on focus and economies of scale (or just a product, no SaaS needed, however that’s the best approach nowadays).

It’s like the Coke formula. As of this day, it could be easily replicated, what you cannot replicate is the whole brand, business operations, reach, scale, distribution, etc. That’s the moat.

Open Source enables within a technology play, a way to build this moat for free, in a crowdsources fashion (well, not exactly for free as you need to support and encourage and that takes time and resources). If you give back to the community that helped you create your product, be ready to make big money.

34 Likes

The answer to “why not?” is cost. If I have one set of Kafka brokers, it makes sense to pay for help from Confluent. But if I have a huge number of brokers, and Confluent wants to charge me millions of dollars, it starts to make sense to just hire my own experts and use Kafka for “free”.

The flip side of this is what happens when there is a critical technical or a security issue. Where is support going to come from ?

“Subbu the main guy who knew all the setup left a few weeks ago, Tim in IT is on vacation and does not know enough and Raj is now beginning to read the documentation”
Company is losing thousands of dollars an hour and Ken the VP is looking for someone to call and fix it ASAP."

If an enterprise takes upon itself because it is cheaper, then need to staff up for the support and maintenance and that is not cheap anymore.

2 Likes