Flash! Some OSS business models don't work

For more than a decade, b-school professors have been teaching about business models. However, I suspect sometimes we spend too much time emphasizing how important it is to have or understand a business model, and perhaps not enough about the importance of a good business model. (Regular readers know that I often write about bad business models, broken business models and even the decades-long search for a viable business model).

One important area of business model experimentation has been open source business models. This morning, my friend Matt Asay posted about Monty Widenius, who five years ago sold MySQL to Sun Microsystems for $1 billion, and then bailed out of Sun when the acquisition helped drag Sun down (or failed to lift it up) — leading to Sun’s eventual dismemberment by its new owner.

His opening paragraph sets the stage:

Monty Widenius, co-founder of MySQL and founder of MariaDB, just came to a surprise revelation: most people use open source for free. What's so surprising, however, is not this fact, but the idea that Widenius wouldn't have learned this 13 years ago when he first released MySQL under the GNU General Public License (GPL) and his company's revenues dropped 80%. The lesson here, however, isn't that there's no money in open-source software, but rather that some strategies for monetizing open source are effective, while others are not.

As Matt notes, it’s inherent in offering real open source (i.e. something that conforms to the Open Source Definition) that people can and will use it for free. Widenius' current suggestion is to have semi-open source (called “Business Source”) which might generate revenue but can’t be called “open source.”

I spent almost a decade researching how firms make money off of open source, including one of my favorite (and most-cited) unpublished papers. During that study, it was obvious pretty quickly that you had to give away something useful — so people would adopt your software — and hold back something valuable (e.g. support, add-on modules) so that people would pay you something. The balance was made tricky by the one-way nature of open disclosure of source code: once something was free (as in beer or speech) it was technically and legally hard to make it un-free.

Matt barely contains his snark as he cites all the people who’ve long since figured this out:

Jim Jagielski, president and co-founder of the Apache Software Foundation, suggests that "if your open source project isn't successful with FOSS licensing, it's not the license's fault." Rather, it's a matter of trying to charge for the wrong things:

what's "destroying" open source isn't people not paying for it, but wrong ideas on WHAT they should be paying for

— Jim Jagielski (@jimjag) May 30, 2013

To wit, Facebook, Google, Amazon and others make billions of dollars selling services around open-source infrastructure, while Red Hat mints over a billion dollars annually selling a certified, binary distribution of community-developed Linux. There is plenty of money in and around open-source software. The open-source license doesn't prevent this. It enables this.

Widenius is a smart person. He'll figure it out. It's only surprising that his experience at MySQL didn't already teach him this lesson.

I’m guessing that Widenius has already figured that out, but he can’t see how to get there from here because he’s painted himself into a corner.

(BTW, there’s always been a difference of OSS business models between firms that are givers and takers. A low cost, low risk strategy has been to be a taker — or net taker — by leveraging OSS created by others. It’s the givers that incur the cost of R&D for their free stuff, and thus bear a sizable risk of not being able to monetize well enough to cover that cost.)

One thing I haven’t seen mentioned is the inherent scale requirement for OSS and other freemium business models. As my research continued, it became clear that a revenue model with 1% (or 10% or 0.1%) conversion rate might work with millions of users, but the identical strategy would fail if you only had thousands of users. So copying Red Hat (or MySQL or Sleepycat) was going to fail miserably unless you had a smash hit that would support a 1% conversion rate. This is something that has recently become painfully obvious to all the iPhone game makers who used free games to win adoption and hoped to sell upgrades.

So yes, market leading companies with billions of customers can afford to give away software and monetize off of some small fraction of their customer base. But for new companies trying to launch now — even those run by smart experienced OSS veterans — an OSS (i.e., freemium) business model is at best a risky gambit. At worse, it’s a fools’ errand, because it’s no more feasible to create the next Red Hat or MySQL than it is to create the next IBM, Cisco or Google.

When you've lost Anna and Mikko...

With its market share collapsing worldwide, Nokia has now lost its home market of Finland. Quoting IDC data, Digitoday.fi reported Tuesday that Nokia had a 33% share of the Finnish handset market in Q1 2013, second to Samsung at 36% (Apple is third at 14%).

Unwired View helpfully noted that Nokia had lost the Finnish smartphone market in Q3 of 2012, but sold enough feature phones to keep the overall crown — until now. Nokia’s home market is lagging the rest of the world by only a year. According to IDC data, Nokia lost the global smartphone market share in 2011 to Samsung and Apple, and the overall handset market in 2012.

Apple is also fighting Samsung in its home market, but managed to top the Korean maker in the crucial final quarter of 2012. The two companies are splitting all the net global profits of the global mobile phone market.

As Unwired View concluded:

73% of all phones sold in Finland in Q1 were smartphones. And apparently Finns love Samsung smartphones. That kind of says a lot. When not even patriotism can stand in the way of the Android onslaught, one has to consider what chances Windows Phone (in its current form and iteration) realistically has. You really can’t say that the Finns weren’t willing to give Microsoft’s new OS the benefit of the doubt. Or that they are somehow biased against Nokia, a company once synonymous with Finland in the eyes of many.

All in all, it looks like more rough sailing aboard the S.S. Ballmer.

Note on title: Anna and Mikko are popular names in Finland for girls and boys.

Good (and bad) institutions last for centuries

A report by Stephen Findler from Brussels in this morning’s Wall Street Journal:

The euro crisis is a story of a breakdown in the mechanisms meant to manage national relations within the currency union. Its future hangs on how—and whether—these broken mechanisms can be refashioned.

In a speech to a conference in Munich last week, the Princeton University historian Harold James suggested that one of the central questions is how the 17-nation currency bloc handles its excessive debts.
…
The British-born professor offered a tale of two revolutions: Britain's so-called Glorious Revolution of 1688 and the French Revolution of 1789. The first was peaceful and wealth-enhancing, the second violent and destructive, leaving French society poorer than Britain's for more than a century.
…
So in the British case, not reneging on debts was a principle associated with the development of legal security, representative government and modern democracy—lessons taken on board by the founders of the U.S.

In the French case, the state took on too much debt and then tried to pay at any cost. The state lost credibility and, unlike in Britain, no private market developed to distinguish between risks.

On the face of it, the euro zone combines both these cultures of debt. Germany sees itself as the upholder of a set of rules that attempt to enhance governments' credibility, by limiting their borrowings and placing appropriate risk on the shoulders of private-sector investors.

On the other side of the coin are serial defaulters such as Greece, which according to authors Carmen Reinhart and Kenneth Rogoff has spent more than half of its existence since independence in 1829 in a state of default.
…
His message for the monetary union is that it needs rules—but rules that are interpreted flexibly. He drew some further history lessons for the euro.

Lesson One: Indecision leads to poor choices and policy paralysis.

Lesson Two: Finding a clear answer to a crisis is more difficult when there are conflicts over distribution of wealth and income—as now between northern and southern Europeans.

Lesson Three: Solutions become harder when economic arguments have been used to justify integration. That means when growth falters, the credibility of the project crumbles.

The entire article is well worth reading by anyone who care’s about Europe’s future, free markets or economic institutions more generally.

Latest in a series of outsourced economic commentary in a time of economic hardship

Too late to openness

I saw an interesting comment Wednesday on BlackBerry’s late conversion to openness. VC Fred Wilson wrote:

So RIM has decided that it is time to make Blackberry Messenger (BBM) cross platform. They announced yesterday that by this summer BBM will be available on iOS and Android.

The time to do this was in 2008/2009 when BBM was huge and everyone was on it. The core users were beginning to leave for iOS and eventually Android and if RIM would have let them take BBM with them, they would now own the biggest cross platform messenger out there. BBM is great and everyone knew how to use it and was comfortable with it.

But RIM execs waited four years to make this move. When BBM hits iOS and Android this summer, they will face dozens of cross platform apps that people use to message each other, one of which is in the USV portfolio. My bet is this won't help RIM or BBM much at this point.

Even when I was consulting to Symbian from 2006 to 2008, people were speculating when BB (then Research in Motion) would license or partner with its email platform. (Its BlackBerry Connect mail client was available for a few Nokia phones during that time). RIMM held strong market share in the US until 2009, when it began its unchecked fall towards zero.

As someone who studies the strategic use of openness, I’ve seen this tendency to put it off openness until too late, across a wide range of companies, product categories and decades. Wilson attributes this to The Innovator’s Dilemma, which I interpret as an unwillingness of firms to cannibalize their own high-margin business with low-margin (or low price) business.

Yes, cannibalization is hard. Yes, Clay Christensen made an important observation why such cannibalization is so hard. But having studied these sort of choices over and over again, I think “Innovator’s Dilemma” is too pat an answer: sometimes it explains why a firm can adapt, but it’s rarely the complete explanation.

It often happens that the managers know exactly what they're doing — increasingly likely after the publication of Christensen’s book.. I’d split this into two subcategories. One is that it’s a rational choice — milking a cash cow to the end and using that cash while it lasts to do something else. (For example, from 1999-2002 I took the rents from my printer driver business and used it to finance a shift to a new career).

The other variant is that the managers get it but the owners do not, a classical principal-agent problem. If I’m getting commission on sales (or stock options on current capital appreciation), why do I care about company performance 2, 3 or 5 years from now? It may be perfectly rational for me as CEO to get while the getting’s good, even if I know it will eventually all come crashing down. (I call this the Ceaușescu theory of management, given the predictably unhappy end to the Romanian ruler’s reign.). As such a CEO, I hope to be lucky enough to be I’m retired to my Maui estate before everything falls apart)

Finally, what I think the most common explanation is Da Nile (that river in Egypt). I’ve worked with, for and competed with a wide range of companies that just can’t recognize — or can’t admit — that the competition is a serious threat. Christensen identified conditions where this happens, but often the explanation is much simpler one: arrogance or hubris. (In marketing, we say “they’ve come to believe their own propaganda.”) Certainly BlackBerry/RIM has had this problem for years.

Intel’s once great founder-CEO (now Stanford business professor) had it right: only the paranoid survive. But having escaped Hungary after Soviet tanks invaded the country to crush a popular uprising, the former András Gróf lacks the complacency common among highly successful US business leaders.

Aboard the S.S. Ballmer

Microsoft’s success has always been about its alliances: Bill Gates lining up Basic licensees, the 1980 deals with IBM and Seattle Computer Products and (most importantly) licensing the IBM-funded DOS to all of Microsoft’s competitors.

With declining PC revenues, Microsoft is using its $50+ billion cash horde to buy friends. The Redmond company has created alliances with Nokia and Barnes & Noble in hopes of gaining a footprint in smartphones and low-end tablets. But into doing so, both companies have (for better or worse) paced on their platform bets on Microsoft’s (thus far) losing hand.

As part of my studies of Nokia’s smartphone strategy, I’ve been following the Microsoft-Nokia deal for several years. Tomi Ahonen has done a great job of covering how badly thinks have gone since Nokia threw away its (declining) smartphone lead and cast its lot with Microsoft.

However, the Barnes & Noble story is a different one. It has been searching for a viable tablet strategy for years. When it signed its surprising $300 million deal a year ago, it was losing its decade-long battle fight with Amazon over books, online sales, tablets and every else. The original 17.6% equity investment in the B&N spinoff of Nook Media was supplemented by a promise of $305 million in other payments.

Last week, rumors surfaced that Microsoft would pay $1 billion for the remaining shares of Nook Media. Barnes & Noble shares jumped on the news.

This would be the only good outcome for B&N: Microsoft gets a portfolio of online assets to fight Amazon, Apple and Google, and B&N gets some cash to prop up its dying retail business. To quote Steve Miller: “Go on, take the money and run!”

In the meantime, both Nokia and Nook Media are aboard the S.S. Ballmer without a lifeboat. Microsoft has known for 15 years that it needs a viable mobile strategy, and despite billions in R&D (and funds for products and alliances), has been unable to break single digit market share on either phones or tablets.

It’s not for nothing that Ballmer was named the worst CEO by Forbes a year ago, saying “"Without a doubt, Mr. Ballmer is the worst CEO of a large publicly traded American company today”. Ballmer was merely second worst in CNBC’s 2012 rankings. Both were before the recent Windows 8 fiasco exploded in the company’s face.

On Sunday, Al Lewis of Dow Jones cited yet another Ballmer critic:

Former Microsoft executive Joachim Kempin released a book timed to the Windows 8 launch last fall, called "Resolve and Fortitude: Microsoft's Secret Power Broker Breaks His Silence." In it, he, too, says Mr. Ballmer should be fired.

"He has no clue about technology," Mr. Kempin said in a telephone interview. "All the guys around him agree with him or they get fired."

Because of his long friendship with America’s second richest billionaire, his job has been secure thus far. As long as Ballmer remains at the helm, Microsoft (and Nokia and B&N) shareholders should expect more of the same.