By Lou Grinzo,
LinuxProgramming.com Lou’s First Law of Computers: A
sufficiently large economic incentive beats a royal flush.
Dennis Powell and Kevin Reichard recently talked in LinuxPlanet
articles ( here
and here)
about the difficulty that some software companies are having (or
anticipating) in making a profit in an open source-dominated
market. If you hold the situation at arm’s length, and consider all
the factors involved, this really isn’t a surprise, although it
seems it’s not as clear to some people around here as it was to
Dennis and Kevin. For those who’ve yet to see those articles,
Dennis was directly addressing Linux distro companies and the
economics of selling free software, while Kevin focused on the
recent decision by Adobe to cancel their port of FrameMaker to
Linux.
First, a disclaimer and a warning, of sorts: While I don’t own
stock in any of the companies Dennis, Kevin, and I mention, I do
have a degree in economics, a field which will forever be known as
“the dismal science”, thanks to that irrepressible party animal
Thomas Malthaus. Holding that degree means I’m legally entitled to
reverse my position on any economic issue, with zero advance
notice, by invoking the magic phrase, “on the other hand.” (The
tendency of economists to do this reputedly caused US President
Harry Truman to ask someone to find him a one-handed
economist.)
The basic problem for the Linux distro companies, despite the
wishes to the contrary of many in our community, is that software
does indeed want to be free, as in beer. There’s nothing special
about software, nor is this a special trait of its being
intellectual property instead of a physical good, like a car or a
bowling ball. Economists have long observed that in a sufficiently
competitive environment the price of any product is driven down by
the market to the cost to produce each unit, or in econ-lingo,
until marginal revenue equals marginal cost. It doesn’t matter if
it’s software, hardware, or underwear. As for what “sufficiently
competitive” means, consider what those shrink wrapped boxes from
Red Hat, SuSE, Mandrake, et al., are competing with: Not just each
other and the other OS’s on the market, but most important of all,
they’re competing against the free version of themselves. Linux
newbies quickly figure out that the free copy isn’t sorta kinda
almost like the shrink wrapped copy, but it’s the same exact
product, at least in terms of the bit pattern on the CD(s), even if
it lacks other goodies like support.
But these identical copies aren’t just free beer, they’re free
speech, which is why we see mail order companies that can legally
sell $2 Linux CD’s. It also explains why they can still make money
at that absurdly low price–the bits they put on the CD’s are free
(beer), so their only cost is that of duplication, order processing
and fulfillment, running a web site, and normal business
administration. Most important, they’re not paying a flock of
developers at an annual, fully-loaded, labor cost (not salary) of
$100,000 to $200,000 each to develop the software they’re selling.
That keeps their expenses and the prices we pay low. Economics
doesn’t get much simpler than that.
The story for the distro companies is conspicuously less rosy,
to say the least. For starters, they do have to pay that flock of
programmers, and they also have to pay the support people, bear the
promotion cost to build brand awareness and loyalty, etc. But since
the CD’s in the package can be freely copied, they have a gaping
hole in their revenue stream. I haven’t seen the numbers, but I’m
willing to bet that the vast majority of their users don’t pay them
a cent for the software and don’t pay for support–they buy a $2 CD
or they get a free copy from a friend or the Net, and they subsist
on free online help or they buy a book or two.
Aside from the relatively small number of people who buy the
shrink wrapped package, the only time the distro companies receive
revenue is when someone pays them for support or subscribes to some
other service, or they hire the company at consulting rates to do
custom development work. (That kind of consulting was supposedly a
solid revenue stream for Cygnus before they were consumed by Red
Hat, in fact.) This means the companies must fund the entire
outfit, including developers, support techs, management,
advertising–the whole ball of wax–from the revenue stream
generated by things only a part of their customers will pay for.
Whether this explains why Red Hat’s stock is trading at under $7 a
share as of the morning of December 4th, can be debated endlessly,
I suppose, but it sure looks to me like Wall Street has figured out
that even if the Emperor Penguin isn’t completely naked, he’s still
wearing far less than a full Armani suite.
The inescapable conclusion is that the Linux distribution
companies will never grow very much, even if they do turn a profit,
since there’s just not enough revenue there to fuel a big company.
The open source model eviscerates their revenue stream, making the
outlook for these companies pretty grim.
On the other hand (hey, you were warned) aren’t we in a
wholesale movement away from “bits for bucks” to a services and
subscriptions model, anyway? I believe we are, and that’s why I
think the two most fascinating developments in the industry are
Eazel and their subscription services, and Microsoft.NET, MS’s
attempt to go distributed with Windows. The big unknown in all this
is how much people will be to pay for which subscription services.
I’ve spoken to clients who see nothing wrong with this shift,
provided they get something in return, such as greatly simplified
system management. (Trust me on this one, all you would-be software
tycoons: Figure out a way to insulate Windows users from DLL Hell
and Linux users from Shared Library Misery, and you’ll be both
wealthy and worshipped beyond your wildest imagination.)
A key main reason there’s so much uncertainty in the industry
right now is simply because we’re in between equilibrium states.
The prior state saw the closed source software/bits for bucks model
dominate, with free support, later moving almost entirely to paid
support. In that state we had software-only companies of all sizes
making a profit, from one-person shareware shops to outfits like
our cousins up in Redmond. It was and largely still is an
economically viable business model, and it fueled a lot of
companies and some spectacular investment portfolios.
The next equilibrium point will be more oriented toward open
source, and I suspect that in the long run this will all but
eliminate the software-only companies. There will be a lot of
consolidation as companies merge and acquire each other, and also
evolution, as companies try to stay independent and convert
themselves into service companies. I won’t guess how far this new
equilibrium point will be from the old one, in terms of either time
or degree of change from the last point; I don’t think anyone can
tell for sure while we’re in the middle of the transition.
The really interesting thing is that the further we go along
this path, the more software will be produced by either the
stereotypical open source project, staffed by people scratching an
itch and not getting paid for their work, or by large companies,
like IBM, HP, Compaq, Intel, and others, that have a financial
incentive to spend big money on software they can give away. Don’t
think for a nanosecond that these companies want to spend
horrendous amounts of money developing software they can give us
because we’re nice or lovable; it’s simply in their best interest
to do this to promote more pragmatic endeavors, like making money
from hardware sales. Seen in this light, the only thing surprising
about IBM’s stunning, wall-to-wall Linux commitment is that it’s
not even bigger. IBM, thanks to the variety of hardware platforms
it sells and supports, probably has more to gain from Linux’s
long-term success and arrival as a unifying platform than any other
single company.
The good news is that there are no surprises here. Drive the
market price of a good to almost nothing, and companies either
leave the segment entirely or find another product or service to
sell, since there’s no way for them to make a profit. It’s not
about right or wrong any more than is the speed of light or the way
you react to a loved one’s voice; it’s just economics, pure,
simple, and sometimes a little dismal.
Lou Grinzo has been a professional programmer and technical
writer since 1980. He’s written for numerous computer publications,
including Dr. Dobb’s Journal, Software Development, EXE, Linux
Magazine, PC World, and Computer Shopper, and Windows Magazine
(hey, a geek’s gotta eat). His dream is to win the lottery, retire,
and spend his days creating the perfect programming language, which
he’ll then use to write the perfect operating system. His
non-computer hobbies include juggling and woodworking. He lives in
the wilds of upstate NY with his wife, Liz.