Open Source is Not a Market…

This post is more about the technology business than about technology… but it may be relevant as you try to sort out winners and losers… and this sort of sorting is important if you consider new companies who may, or may not, succeed in the long run.

To make my point let us do a little thought experiment. Imagine a company doing $100M in revenue with a commercial, not open source, database product. They win the $100M in revenue by competing with Oracle, IBM, Microsoft, Teradata, et cetera… and maybe competing a little here and there with some open source products.

Let’s assume that they make 50% of their revenue from services and support, and that their average sale is $2M… so they close 25 deals a year competing in this market. Finally, let’s assume that they break-even each year and spend 20% of their revenues on R&D. The industry average for support services is 20%.. so with each $2M sale they add $400K in recurring revenue.

They are considering making their product open source. Let’s assume that they make the base product free… and provide some value-added offering that costs $200K for the average buyer. Further, they offer a support package for the same $400K/year customers currently pay. How does the math work out?

Let’s baseline against the 25 deals/year…

If they make 25 sales and every buyer buys both the support package and the value-added offer the average sale drops from $2M to $200K, sales revenue drops from $50M to $5M, the annual revenue drops from $100M to $55M… and the company loses $45M. So… starting off they need to make 225 more sales just to break even. But now it gets complicated… if they sell 5 extra deals then in the next year they earn $2M extra in support fees… so if they sell 113 extra deals in year one then in year two they have made up the entire $45M difference and they are back to break-even going forward. If it takes them 2 years to get the extra recurring revenue then they lose money in year two… but are back to break-even in year three.

From here it gets even more complicated. The mythical company above sells the baseline of 25 new copies a year with an enterprise sales force that is expensive. There is no way that the same sales force that services 25 sales/year could service 100+ extra deals. So either costs go up or the 100+ extra customers becomes unattainable. We might hope that the cost of sales will drop way off as the sales price moves to $200K. This is not unreasonable… but certainly not guaranteed. Further, if you are one of the existing sales-staff then you have to sell 10X just to make the same commission. Finally these numbers assume that every customer buys the value-add and gets enterprise-level support. Reality will be something less than this.

We might ask: is it even possible to sell 100+ more with the same product in the same market? Let us be clear that the market the database product plays in has not changed. Open Source is not a market. All we have done is reduced the sales price for the product with some hope that price is a significant driver in the market.

This is not meant as an academic exercise. Tomorrow we will consider how this thought experiment applies to Pivotal’s announcements last week… and to the future of Pivotal’s database assets (here).

5 thoughts on “Open Source is Not a Market…

  1. Interesting post, Robb. Apart from Red Hat, I don’t think there is any other successful largish company that has succeeded with the open-source model so far.

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  2. You are not right here. Over a year ago Pivotal has introduced “Big Data Suite”, which changed the sales model from perpetual per-TB licences to per-core subscriptions, allowing the customers transition from one product of BDS to another without even notifying Pivotal (within the same amount of cores). During the previous year this model was well accepted by the market and the sales started to be driven by this subscription-based licensing.
    So your statement “let’s assume that they make the base product free” is wrong: after open sourcing the products the subscription model and its price will remain the same. The last 2 quarters has proved that subscription model works, so I don’t expect Pivotal to lose the market share. I think that introducing the subscription-based licensing as the main sales engine was the first stage of opening sources of the products – testing the market readiness for this model.

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    • This is interesting. I understand the issues associated with moving to a subscription-based revenue model… they are daunting (better to have started out with subscriptions than to move). But what does going to open source have to do with going to a subscription model? Nothing methinks. In other words… if price was already reduced to open source levels then my argument is unaffected. If the price holds at commercially-viable levels then the only reason to go to open source is to build a development community and reduce R&D expense.

      At the announcement it was stated that the Pivotal database business is generating $100M/year. Greenplum as a VC-backed company, with one product only, more-or-less operating only in the US, with a start-up-sized salesforce and engineering team, generated nearly half of that amount before they were acquired. At $100M/year they are surely losing money for Pivotal on the database stuff… and that is what is behind the announcement. To have grown to $100M in 4.5 years is not the definition of success in the market.

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      • Price reduction is a global trend on the MPP market and is caused by increased amount of competitors and Hadoop introduction as a free opensource alternative to MPP. Here’s an example of how it affects different vendors: http://goo.gl/VEDmv2. So the price is still on commercially-viable level according to the current market
        Pivotal is not limited by database business (http://goo.gl/E7zTQp), and Big Data Suite is not limited by Greenplum. Of course, I agree with the point that Greenplum could have been more successfull on the market with no 3-year stagnation under EMC and the brain drain caused by this acquisition, but after all it is a great product still hitting the market in both GPDB and HAWQ incarnations.
        I think that open sourcing these tools would increase product adoption by startups and software companies and would largely grow the community around these engines, which in turn would attract enterprises. It is not a fast process, but we’ll see how it turns out in 2-3 years

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      • I appreciate your view… Even though, as you can imagine, I disagree.

        I also disagree that EMC is or was the problem. I know they will be blamed… But they poured tons of money into Greenplum while I was there and did everything that was asked of them…

        The brain drain was the result of diving all in to Hadoop… A venture not designed to keep database developers on board.

        And a Hadoop strategy without services was doomed to fail (even the “successful” Hadoop ventures are bleeding money).

        This is really the point of my posts… Open source is not a market.

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