Pricing and the Open Source business model

For over a year  I've been following a great series of blog posts by Tarus Balog (founder and main mover of the open source network management product OpenNMS) all about the business of open source software.

His first in the series - about starting an open source business -  uses a point made by software vendors to the value-added resellers (VARs) of their product: for every $1 spent on software licenses, a VAR can expect $8 in services revenue.  I've seen the same 1:8 ratio quoted for every $1 spent on Microsoft Enterprise licensing.

The logic of an open source business then becomes quite simple: let the customer keep the $1 instead of paying for software licenses, and then try to help them achieve the same level of services for something less than the 8x model. Tarus says to aim for $4, for example. One reason you might be able to do it is because the customer has the source code and can do it themselves. But a bigger factor is that commercial open source changes the emphasis from outbound to inbound marketing, which significantly changes the way that sales happen. Paying for a sales team to make calls on (reluctant) buyers adds very, very greatly to the total cost of goods sold, which then has to be passed on to the customer in the cost of the software license.

Simple heuristic for this - it's changing the 1:8 ratio to 0:4.

Hang on you say - isn't that just reducing the total value from $9 down to $4. How can that be smart? Because after you factor in the total cost of sales to get that $9, there's more retainable margin in the $4 scenario (if you do it right).

Starting-up an open source business isn't free (Tarus says his first year of OpenNMS cost him $5,000 of his savings) but once you get over the hurdle of paying basic salaries you realise there's savings to be made on marketing. A small open source project we donated 25 days ago has had an average of  >170 views every day since launch. If we bid for every click we would have needed around $10,000 for month 1 alone. I know page views are not the same as dollars earned, but the fact is that the marketing budget would be spent regardless of whether it brought in paying customers or not.

Most commercial open source companies change the product offer from licensing to services. You can't use the traditional software mantra that the customer is paying for bug fixes - there's no closed source that they're forbidden to reverse-engineer. It's more about selling support in the proper sense of the term - helping them achieve a business goal. You don't have to waste time proving the bug isn't in your software / / user error / their fault. Maybe it is that they've configured the software wrong, or there's some issue in their IT network outside your control. The interest comes from helping them overcome these things and getting back to being happy.

The mission statement at OpenNMS puts it better: "Help Customers, Have Fun, Make Money".

There are lots of other good points in this series. Should you show pricing on your public website, for example? The answer, Tarus says, is that open source provides free software, not a free solution. By showing your pricing on your website it helps to get across the message that there is a price tag for services. How do you price for that support? One way is to look at the year 2 costs of the closed source solution (when it's under a support and maintenance agreement). This is ususally at least 20% of a pretty high year 1 outlay. That's what you have to match or beat.

In my view, Tarus Balog is one of the top thought leaders for the open source software model.

Links to all his Blog posts:

Tags: Enterprise Software, Product Management, Open Source Software, Business Process Models