Open Source Outlook - Do or Die Time?

27 March, 2009 - The outlook on 2009 enterprise IT spending looks grim. The silver lining in the doom and gloom surrounding technology spending in 2009 may be found in open source technologies. The popular business press is touting the notion that the recession could boost market share gains for open source technology companies. To date, open source technology has not proven to be nearly as disruptive or profitable as once predicted. Based on funding activity in 2008 and the distance open source companies have to go in reaching sustainable profitability, 2009 looks to be a make or break year for open source companies.

IT spending in 2009 is unlikely to be any better than 2008 levels.  MGI Research forecast 2-3% IT spending growth in 2008, a prediction that may end up being a tad optimistic, even though the average among industry watchers was 5-8% IT spending growth for 2008.  Depending on what final Q4 results deliver, it appears ‘08 IT spending was flat to slightly positive.  MGI Research forecasts 2009 IT spending to be negative 2%-7%.  Significantly for open source companies, IT budget pressures in 2009 could drive a disproportionate number of Fortune 500 enterprises and government organizations into downloading open source solutions to test their claims of being functionally equivalent and lower cost.

A strong market driver pushing users to open source would be welcome relief to open source vendors.  Judging by the revenues of the leading open source companies, users have not embraced open source.  The combined revenues of MySQL (now owned by Sun Microsystems), SugarCRM, Alfresco, Jaspersoft, Talend, and Pentaho are likely less than $200 million.  Since none of these companies publicly reveal their revenues, the true figure could be lower.  Assuming that MySQL generated $100 million in revenues 2008 (which would be very healthy growth considering that MySQL was doing less than $50 million in 2007), and SugarCRM hit $35 million in revenues, there was not a lot of money being spent on open source companies in 2008.  Considering the amount of venture capital invested in the space, the lack of revenues further underlines how critical 2009 will be for the open source companies. The table below details select financial and investment highlights (all revenue figures are MGI Research estimates/projections).

As the data above indicates, open source companies have successfully attracted millions of dollars of venture capital.  Most of the companies are on record stating that the latest capital raise is the last needed to take the company to profitability. The open source companies boast of literally millions of software downloads. Millions of downloads have not equaled millions in revenues, however.  Converting free downloads into profitable revenue is clearly the opportunity.  The challenge for these companies is raising the level of their sales and marketing to compete effectively against “proprietary” software vendors like Oracle and SAP at a time when the attention span of buyers is limited. 

Open source companies need to do three things to sell into the enterprise and become viable, durable businesses.  First, open source companies need to market based on business benefits, and avoid challenging entrenched IT departments with a message that assumes open source is embraced by all.  Too many open source companies tout their open source street credentials as their primary competitive differentiator.  Fortune 500 and SMB buyers have to solve business problems – and by and large are not concerned with technology religions.  Dropping the open source thrust of their marketing themes will not be easy, as it runs counter to management and company culture.  To win against their “proprietary” competitors, the open source vendor community needs to position itself as purveyors of unique, tangible business benefits. Second, there exists a significant skills gap as it relates to open source products/project deployments in most user organizations.  Adopting an open source strategy requires a different set of programming, maintenance, and management skills.  Even IT procurement and legal contract operations need training.  The onus is on open source vendors to provide an easy path to adoption of open source products and services – and that means greater evangelical efforts and training across the entire IT department.  Third, the spread of open source skills requires cost justification and open source companies need to demonstrate clear, independently verified ROI and attractive TCO (total cost of ownership).  As the open source companies are shifting from positioning themselves as “open source” vendors to vendors of category leading products/services, realistic ROI and TCO models that detail the precise financial benefits of open source versus proprietary software are sorely missing from the marketing collateral of most open source vendors today. 

Assuming that open source companies sharpen their marketing messages and learn how to sell effectively into SMB and large enterprises (we suspect they will all migrate into the large enterprise space in 2009 as SMB software spending evaporates in the first half of the year), the internal operations focus will require a shift to management of profitability – a transition that many software companies, open source and proprietary alike, have been unable to make. 

For the lucky few companies who make it through the next 12-24 months, there is the hope that the capital markets rebound, and an IPO is possible. An IPO looks like a far distant hope amidst the tumult of the current capital markets, however the IPO window inevitably will cycle back, and may do so with a vengeance. 

Open source companies have proven they can deliver very competitive technology and functionality.  For over five years, every Silicon Valley start-up worth its salt has used open source technologies (e.g., LAMP, Ruby on Rails) as the foundation upon which they began building their own product(s).  These development tools and application environments are firmly entrenched, with strong followings of developers and industry leaders.  Leading edge companies have figured out how to put code into the open source domain, and “harvest” it several weeks or months later more fully developed – saving time and money in the process.  The adoption rates and comfort levels of European IT departments and governments demonstrate that open source can reach a broader market. 

Bottom Line: Peering out into 2009, the question facing open source companies today is whether or not they can execute from a sales and marketing perspective and convert venture dollars and free downloads into revenue growth and bottom line profits.  Open source companies who are successful in re-positioning themselves as fast ROI, “enterprise ready”, and willing to provide buyers with the skills necessary to support an open source environment will give themselves a fighting chance for success in 2009.  Given the lack of enterprise marketing skills demonstrated by open source vendors to date, the lack of compelling real ROI models, and the extreme financial pressure on venture-backed open source companies, it appears few open source companies are adequately prepared to weather the tech nuclear winter in 2009.