A value chain approach to understanding Open Source software
Open Source is a way of developing products – usually software ones, although this is changing – in an open and public way. To qualify as “proper” Open Source, a product must grant several key freedoms to its customers: The user must be free to use the product, they must be free to copy the product, they must be free to study and modify the product. This approach to software distribution started in the 1970s. At first it only applied to research projects produced in universities, but in the 1990s it became used commercially, especially as backend (i.e. not user-facing) systems. In recent years, Open Source software left the backend and is now very present even in customer facing products.
A recent example is the one of Sun Microsystems: they used to develop proprietary systems but decided to open source the Java programming environment. Java was then reused by several other companies, including Google, who use it for their Android phone operating system (an open source project in itself). Sun was then bought by Oracle in 2009, due to financial problems. This begs the question: why was this Sun’s strategy? Surely, they could have earned a lot more by selling a license for Java, if their product was good. In this essay, I try to take a look at the Open Source movement from a value chain perspective in order to explain this kind of behavior. Value chain analysis is concerned with three aspects: value creation, value capture and the global network surrounding those processes.
We must first ask how are open source products creating value when compared to proprietary one. First, the open source solution can be cheaper than the proprietary one through a process of commodification: some parts of modern IT systems are not a key strategic advantage anymore, for example web servers or operating systems. Therefore, it makes sense economically to split the development costs with other actors.
From the customer’s perspective, open source software has an increased value because it reduces risks associated to vendor lock-in. Proprietary solutions can become a liability when the development is stopped by its vendor. Open source, on the other hand, allows the user to continue fixing bugs and go on with their operations.
We now need to understand how a company can capture value by releasing their intellectual property as open source. Obviously standard methods of selling licenses cannot be used: since the freedom to copy the product is guaranteed without conditions, it is not possible to sell it “as is”.
One business model which circumvents that limitation is the use of so called “dual licenses”: the idea is to offer the product as open source but with limitations which might not be acceptable by commercial users. A commercial license is then offered which removes the limitations. The most common limitation is to force one company to release their complete product as open source if it includes open source component.
The second commonly used business model around open source products is the sales of complementors, e.g support contracts or additional features. This is the approach chosen by Google for their Android system. By providing phone manufacturers with a high quality open-source model, they attracted users to their platform. They could then try to sell those users their more lucrative products such as personalized advertisements.
From a network perspective, open source has a lot for it. Obviously it eases existing forms of collaboration between actors in a value network, through the process of commodification explained before.
However it also creates new interesting connections: users of an open source product can now contribute back to the product they use. They leave the role of being a pure customer to being directly involved in the creation. They don’t contribute their solution to the project for the “greater good”, but for economical reasons. It is usually cheaper to integrate a change into the original project than to maintain a list of changes internal to the company (a practice called “forking”)
Sharing technology through open source also allows company to find engineers already well-knowledgeable on a given technology. This reduces their time to market and allow them to scale their staff easily, by only having to train them on in-house, key technologies. On the other hand engineers also benefit from this, by being able to take their experience with them to a new employer without violating an eventual non disclosure agreement.
Looking at the open source economy from a network point of view also reveals that software companies have their own form of the “smiley curve”. The smiley curve was proposed by Stan Shih, founder of Acer, in the early 90s. He theorized that both ends of the value chain (design and distribution) were much more profitable activities than in the center (manufacturing). Software companies tend to follow a similar pattern: selling application and user-facing services has a lot more value than selling operating systems. A good example of this is Microsoft of which most value comes from their Office suite and not from the Windows operating system. Therefore, it makes sense to try to be at the end of the value chain while avoiding the middle of the technological stack, sharing the cost with other companies.
In conclusion, we see that the tendency for companies to release some of their software as open source can be explained by a value chain approach. We also see that open source can increase the value captured by a company, especially in higher value activities. Similar effects are already emerging in the field of open hardware, and time will tell if this trend continues its rise.
This essay was originally written for a class at EPFL. Thanks to Guido Albertelli for his feedback before putting it online.