The Business of Free Software

The question has come up often: how do people and companies make money in the free software world? How can you make money from something that is freely available, both in price and from other distributors who can take the source code, compile it and offer it on their own terms without being restricted by you, the creator.

However, this is a false dichotomy. It assumes that either you must have control or even a monopoly over distribution to make money, or make nothing at all. In many ways, it over values the ability to restrict people. When the question is asked in this way, it almost suggests that it’s about restricting your users to extract money out of them. Customers may feel this way some times when having used or bought certain products, but that’s not the point at all. The point is, what are you providing that I can’t provide for myself?

Phrasing the question in the first way has the effect of placing the value entirely around distribution; that if other people can get something from another source, there can never be any money made and thus no sustainable business, but this happens all the time. Companies compete with others all the time who are providing effectively the same product. It comes back down to the question, what benefit are you providing that others – including myself – can’t? Despite cheap public transportation like buses, cars are still viable. Despite cars, planes are still viable. Despite all these, trains are still in use. Despite competitive markets for bus, car, train and airline companies existing, many competing companies not only exist but do fairly well out of it.

In all these cases, the restrictions on their distribution and that effect on other, related markets may seem mostly natural, in the sense of being a draw back of current technology or cost – despite all our efforts, replicators do not exist, and so the normal rules of physical property apply (at least, for now they do). Perhaps this is why many people tend to assume with software and other goods protected by copyright, that this restriction on distribution needs to exist. We assume that without them, there are no other factors to compete on if people can provide or obtain a good for themselves at near zero cost. To some extent, we intuitively understand that these goods are fundamentally non-scarce – they can be copied and reproduced in various forms with little or no degradation, and especially with modern technology, with little to no cost and at great ease, but then don’t think about other factors on which they can compete and in turn make money, other aspects of competition in general along with the wider benefits to the economy.

In business, using open source/free software development methods to create software more cheaply and easily can be used as a means to create demand and draw customers to related markets as the model increases the availability of software through lower development cost and lower price (if not zero price) access, actually helping to create and enlarge both software and hardware markets, in direct opposition to common belief. Increasing access to software both in terms of price and ease of distribution enlarges the market for software, in turn increasing usage and demand of products that are in themselves fuelled by software. The challenge is creating and implementing a model that is advantaged by giving away access to the software and not trying to artificially limit it.

So, let’s go back to the “can’t compete with free” statement. Anyone who says that is effectively saying that they can’t figure out a way to add value that will make someone buy something above marginal cost — but it’s no different if the good is free or at a cost. Let’s take a simple example. Say I own a factory that cost me $100 million to build (fixed cost) and it produces cars that each cost $20,000 to build (marginal cost). If the market is perfectly competitive, then eventually I’m going to be forced to sell those cars at $20,000 — leaving no profit. Now, let’s look at a different situation. Let’s say that I want to make a movie. It costs me $100 million to make the movie (fixed cost) and copies of that movie each cost me $0 (marginal cost — assuming digital distribution and that bandwidth and computing power are also fixed costs). Now, again, if the market is competitive and I’m forced to price at marginal cost, then the scenario is identical to the automobile factory. My net outlay is $100 million. My profit is zero. Every new item I make brings back in cash exactly what it costs to make the copy — so the net result is the same. It’s no different that the good is priced at $0 or $20,000 — so long as the market is competitive.

So why aren’t the same people who insist that you can’t compete with free whining about any other competitive market situation? Because they know that, left unfettered, the market adjusts. The makers of automobiles keep trying to adjust and differentiate their cars through real and perceived benefits (such as brand) — and that lets them add value in a way that they can make money and not have to worry about having products priced at marginal cost. If a company can’t do that, it goes out of business — and most people consider that a good thing. If you can’t compete, you should go out of business. But, when it comes to goods with a $0 marginal cost, even though the net result is identical to goods with a higher marginal cost, suddenly people think that you can’t compete? The $0 price makes no difference. All that matters is the difference in price you can charge to the marginal cost. Everyone else learns to differentiate — why can’t those who produce infinite goods do the same?

Saying You Can’t Compete With Free Is Saying You Can’t Compete, Period

This is something that has been recognised for some time. Taken from the Free Software Report – promotional yet informative material made to get across what were then even less understood ideas of free as in freedom software – back in 1993:

Thus, time assumes the role which space has held in determining value. The value of physical products often resides in their scarcity, or limitation in space. An informational product is generally more valuable the closer the purchaser can place himself to the moment of its expression, a limitation in time.

It is likely that new models of intellectual property will look more like performance than possession. Commercial exchange will be more like ticket sales to a continuous show than the purchase of discrete bundles of that which is being shown.

We will return to something like an oral culture in which there is never a final cut to sell but only a process to place oneself as deeply in the middle of as one can afford.

At last commerce will consist of verbs, not nouns.

Free Software Report Volume 2

The issue of scarcity and ways to artificially enforce it is not what should be the matter of discussion – it should be about what ways there are to provide benefits that people need in a world where they have high access to software, or where software they need doesn’t already exist. Just because software is priced at zero does not mean it has no value.

For example, nobody just uses hardware on its own and so there exists a vested interest in the creation and maintenance of software to help increase the market size and provide competitive advantage against other hardware vendors. If a hardware vendor doesn’t want to take on software development itself, other companies can fill the gap providing the man power and expertise, like the relationship between Canonical and Dell or Google and various handset makers. Hell, it was Intel and Nokia that started the Moblin and Maemo projects respectively, before the realisation of similar goals and common advantage in joining the projects together to form Meego. In all of these is the realisation that hardware alone is not enough, and creating or making use of already existing software can increase demand for your product or even increase the market size as a whole.

Many companies also require support due to their high ongoing demands of the software and hardware they use, in which case there is again motivation for funding and creation of software to create and fuel demand for such services, along side making support offerings themselves easier to use. Red Hat would not exist were it not for the projects they in turn help develop, and giving away the software actually enlarged Red Hat’s market by allowing companies to gain access to software which would in turn fuel their demand for support services if/when problems arrive or more specific needs have to be met. A great historical example of this is Cygnus Support, who were eventually bought out by Red Hat:

Our pricing was initially created by our inexperience. We were good businessmen, but not good marketers. We started by estimating what it would cost us to do a given development job, or provide a year’s support to a particular company or department. Then we’d add a percentage for our overhead and profit, and that would be the price we’d quote them. (We aimed to grow the company using only revenues from customers, and turn a small profit every year — and we largely succeeded at both.) This formula priced us well below much of the competition, and we were still making money. It appeared to us that the embedded system compiler market was full of “fat and lazy” little companies. We blew through it pretty well, and much of the time were getting as much business as we could handle. Many of those companies, such as Green Hills, died, or were bought and brought in-house by one of their big customers.

Later, after hiring more experienced executives, we discovered that our pricing was “leaving money on the table”. We still needed to estimate our own costs and overheads and profits — but we also needed to estimate how much money our work would SAVE our customer, or MAKE FOR our customer. When there was a big discrepancy in those two numbers, we could raise our price significantly, and the customer would still be happy. For example, the Sony PlayStation contract enabled Sony to ship the PlayStation months earlier (with working third party game software). Even a single month earlier of shipments would result in hundreds of millions of dollars of income for Sony. Similarly, big networking vendors like Cisco had tens or hundreds of millions of dollars riding on the introduction dates of their new products. We were selling them “insurance”: if any big problems came up in the development software as they worked on the product, we’d fix them rapidly so their engineers would be able to deliver the product on time. Chip vendors, for whom we built many compilers, were betting big money on getting at least one large customer for their latest chip. Early availability of our tools allowed their customers to reliably prototype large, complex products with the chip. Our pricing gradually grew to include a percentage of the value that our work was creating out in the world, for our customers.

Marketing Cygnus Support

Note how the emphasis was on saving the customer time, not on the software itself. Software can obviously be an important part of that, but software alone isn’t necessarily enough, nor is it bug free. This is a good example of defining your market properly – not by product, but by benefit. There is continual demand for improvements, fixes and other work to save the customers time, but not enough time to work on them all. Selling their developer expertise and time to help customers do what they needed by x date is the business model, and the creation and maintenance of software is what fuels and creates the market for that in the first place.

More recently cloud storage and synchronization services for end users have appeared, typically selling extra storage capacity, making use of what is effectively becoming an abundance for the service providers (hard drive space) into a scarcity again by giving out the capability to use their capacity shared out amongst many, many users and providing the benefit of accessing files from any PC. Once again, this is fuelled by high access to software and hardware, in turn fuelling demand for storage that’s accessible easily and quickly across both hardware and software platforms. This is something Canonical has decided to take advantage of by integrating their Ubuntu One service with Ubuntu itself, and something others like Microsoft and Apple have also recognised. Also interesting is how they’ve used the Ubuntu One Music store, which in itself can be said to be helping create demand for more/better file synchronization services along side merely having the Ubuntu OS itself as a driver for their services.

The way to think about FOSS in terms of business is quite simple – stop thinking of ways to artificially limit people, and start thinking in terms of what value you can provide outside of distribution. Sell the ability to spend time and fix peoples problems there and then like Red Hat, sell the need for software that doesn’t already exist like Diaspora using the likes of Kickstarter. Get sponsorship from related hardware companies that benefit from high access to your software, sell the ability to integrate and customise the software for specific needs. There are all sorts of scarcities that are made more valuable due to FOSS and high access to software – think differently about how software as a business works.

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