The Lack Of A Billion Dollar Pureplay Open Source Software Company Shows The Market Is Working Properly
from the economics-of-monopolies dept
A few weeks back, Glyn Moody wrote a column discussing why there were no "billion dollar open source software companies," in response to a discussion he had with Redhat's CEO (Redhat is in the $750 million range):He said that he did think that Red Hat could get to $5 billion in due course, but that this entailed "replacing $50 billion of revenue" currently enjoyed by other computer companies. What he meant was that to attain that $5 billion of revenue Red Hat would have to displace software that currently costs $50 billion. Selling $50 billion-worth of software -- even if it only costs $5 billion -- is somewhat hard, which is why it will take a while to achieve.I immediately knew I wanted to write up something about it, as it reminded me of a point I've been wanting to discuss for a while. But I got busy with some other things, and in the meantime, a bunch of other folks picked up the ball and ran with it -- and each time they did, they added something different to the conversation, which gave me more to think about before writing up this post. Matthew Aslett pointed out that this is leading many companies to adopt hybrid models while Stephen O'grady pointed out that the question was really irrelevant. Katherine Noyes, over at LinuxInsider highlighted many other points that people brought up as a part of the discussion. It's all a very interesting read, though none really hit on the two key points that Glyn's original column got me thinking about:
- There absolutely are billion dollar open-source companies, but they're not pure play open source companies. But that's okay, because a "pure play" open source company is like a record label trying to focus on just selling music. You're in the wrong business -- trying to sell infinite goods -- so of course the direct profits should be limited.
- The lack of billion dollar pure play open source software companies is a sign of a working efficient economy. In fact, billion dollar pure play open source companies would be a sign of a market failure.
Arguing about the profits directly attributable to pure play software sales of open source software is like only counting CD/digital download sales and claiming that's the "music business." It's not. It's the recording industry.
But the more interesting and more important point is about the lack of billion dollar pure play open source software companies is the fact that this is a sign of a strong, healthy and efficient marketplace. Even if you go all the way back to your Adam Smith, you would know that when you have a company making outsized profits, competitors will enter that market. That's the nature of a free market, and it tends to lead to efficiency, innovation and (most importantly) consumer surplus.
I'm reminded of various studies on modern societies without intellectual property protections (or with very weak intellectual property protections) that often saw thriving and highly competitive industries in those areas. One area that has been particularly interesting to me lately is looking at various countries that did not have patent coverage for pharmaceuticals, but then were forced into it. If you look at the pharma industry in those countries, you see the same story almost every time. Without patents, the industry is thriving with many, many different firms (sometimes hundreds). Yes, a percentage of these firms are certainly pure "copycat" firms, but the ones at the top are not. However, after patent protection is introduced (often with the claim that it will help investment, help competition and help innovation), the exact opposite occurs. Instead, many, many firms either go out of business or are gobbled up by large multinational conglomerates. The overall profits increase to those conglomerates, but the innovation and social welfare declines.
This is, of course, exactly what Adam Smith saw nearly two and a half centuries ago. If you give companies monopolies, they will take monopoly profits, but those monopoly profits come at the expense of innovation and consumer benefits.
So, giant billion dollar companies in markets -- especially markets of infinite goods -- suggests a market inefficiency of some sort. The lack of such pure play billion dollar companies is a good thing. It means the market is acting as it should, and being more efficient and creating greater economic benefit to the wider market. And this goes back to a point that Glyn makes in his original column:
I think this is the first time I've heard someone as senior as Whitehurst admit something rather profound: that open source solutions save money for customers by doing away with the fat margins for existing computer companies -- and thus shrink the overall market. Opponents of open source like to paint this as "value destruction" that takes money "out of the economy" -- as if free software went around burning down offices and warehouses.And that's exactly the point. When a market is made more efficient, that actually spreads throughout other areas and helps consumer surplus, economic growth and the rest of the world benefit. Automobiles and airplanes "shrunk" the railroad market, but opened up massive new markets. The end result was a much bigger economy and greater economic opportunity and consumer surplus. Automated telephone dialing "shrunk" the telephone operator business, but opened up massive new efficiencies, leading to advancements like the internet itself. And that created massive economic efficiencies and growth and consumer surplus.
What they fail to grasp is that the 90% savings do not just vanish like the smoke from those supposed conflagrations. That money is still in the economy, it's just spent on other items: free software allows people to use their hard-won money for things other than operating systems, office suites and applications. In developing countries, for example, it might mean more funds available for education or health.
So, just as we shouldn't worry about the lack of "billion dollar" pure play open source software firms, we should also not fall sway to the complaints of companies who are being disrupted by these models, about how all that money they make is somehow "disappearing" if the government doesn't come in and protect their business model. What's actually happening is all that money is being put to more efficient use. Unfortunately, it's rare to see politicians or business leaders who actually understand this simple, but important fact, and it leads them to propping up legacy businesses, which actually slows down innovation, economic growth and consumer surplus.
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Filed Under: economics, open source, proprietary, software
Companies: red hat
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Revenue.
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Actually, you're right. The original articles appeared to be discussing revenue, but you're correct that the economic argument applies to profits... mostly.
But, in general, the revenue argument applies to the economic argument as well: i.e., if a company is seen as making a billion in revenue -- even if they're not initially profitable -- it is seen as a market that is ripe with opportunity for others to come in and figure out ways to create profit from that revenue.
But the point is a good one. Confusing revenue and profit makes the argument a little more muddied.
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Who cares about consumer surplus, the purpose of the government is only to protect producer surplus. Otherwise, where will politicians get their campaign contributions to get elected and re - elected?
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Good write-up
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Re: Good write-up
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Family, class, or kind: he and all his ilk.
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Re: Good write-up
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yes, but...
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Thanks
I had a similar discussion ths weekend. What happens when we have 85% efficient solar cells and local storage capacity for houses. It means 1 square meter at 1kw is 850 watts of power. A house with 900 sq ft of roof space generates 85 kw for 8 hours a day. Enough to heat, cool, light, and power a couple SUV's. This weekend we discussed the failure of the energy companies. It never occured to me to look at the benefits from this perspective.
Thanks for pointing these articles out. They were most helpful.
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Re: Thanks
Enough to heat, cool, light, and power your house, and power a couple SUV's
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;)
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Where is that patent study?
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Re: Where is that patent study?
http://levine.sscnet.ucla.edu/papers/ip.ch.9.m1004.pdf
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Re: Where is that patent study?
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Re: Where is that patent study?
There are a variety of studies on the topic.
Some good places to starts:
Eric Schiff's research into Switzerland in the late 19th century, looking mainly at its chemical and dye industry (the precursor to pharmaceuticals -- many pharma companies trace their history back to these firms) in a period when it did not have patent protection.
More recently Johan Murmmann's research on this subject (especially in Germany) has been quite useful (http://papers.ssrn.com/sol3/papers.cfm?abstract_id=907189). There's a good summary of his work here (http://www.etss.net/files/JIBS_Review_Murmann.pdf) and I'll quote a couple points:
Then there's this paper: http://www.nber.org/papers/w10159.pdf by Chaudhuri, Goldberger and Jia, which notes the overall economic benefit to pharma patents in India and conclude
i.e., adding such patent protection in India drove more money to a few foreign firms at the cost of domestic competition.
Research from Josh Lerner highlighted how greater patent protection led big firms to focus on regulatory issues rather than greater discovery:
There's also the research of Lanjouw on India and Scherer and Weisburst on Italy...
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Pureplay?
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Re: Pureplay?
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Have any links to the published studies by any chance?
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OSS is a force multiplier
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Profit as indication of Market Failure
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Not a product company
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why there were no "billion dollar open source software companies,"
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Re: why there were no "billion dollar open source software companies,"
That was Isaac.
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Facebook is an open source company?
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Re: Facebook is an open source company?
That it's built it's offering on top of an open source platform. Just like Google.
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Re: Re: Facebook is an open source company?
As far as I knew, the answer was no.
They have benefited by using open source technologies, but I wouldn't say that makes then an open source company.
There are plenty of companies who use PHP on their web sites. Plenty of companies who use Flex for application development. Would you say that they are open source companies too?
Where is the line between a company that uses open source software projects and an open source software company?
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Re: Re: Re: Facebook is an open source company?
Yes.
Where is the line between a company that uses open source software projects and an open source software company?
I think that line is artificial and meaningless.
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first off, the open source is not the product, service is the product. the more customers you have, and the better your product is (support is for problems, not for failings of the product), then you start getting into both economies of scale and top of mind awareness / market domination.
at some point, redhat should be able to provide support for their product much cheaper than anyone else, and they should be the superior product in the marketplace. they should be the most efficient and as such, dominate the market. after all, an efficient market would naturally get attracted to the lowest cost / best service / best product combinations.
it has already been shown over and over again in other marketplaces that scale allows economies which are passed on to consumers, who in turn continue to help scale things up. the reality is monopolies or near monopolies are often the most effecient marketplaces.
"hat he meant was that to attain that $5 billion of revenue Red Hat would have to displace software that currently costs $50 billion. " - this is truly the biggest issue, if redhat becomes that big of a player, they will have destroyed more market than they will create. worse yet, they may take enough money out of the os software world to impede future progress on commercial and retail operating systems, in fact slowing progress down. so they could take net 45 billion out of the market to be a 5 billion a year company.
sometimes the short term, close up view is good, but the long term effects are terrible for everyone.
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That ridiculously bad logic is debunked clearly in the piece, but since you chose not to read it, I'll highlight it:
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remember, the company that buys the software sells something as well, that in the cycle of things, the employee of the software company may buy (or as the money cycles around, comes back to buy it).
i guess you missed that class.
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Why do you argue against the most basic economic principles then claim that Mike doesn't understand economics, or claim that he "missed that class" as a snarky way of trying to defend your moronic rebuttal?
Where did you get your MBA again TAM?
Why do I keep asking a troll for answers that I'll never get?
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Or, um, that $45 billion is used by the companies that would have paid that for software to *hire more people* for its own workplace. Or for some other service.
In other words, the money still cycles through the economy just as much -- if not more, because it's actually more efficient.
remember, the company that buys the software sells something as well, that in the cycle of things, the employee of the software company may buy (or as the money cycles around, comes back to buy it).
Remember, the company that buys the software hires people as well and buys other services as well -- and those services have employees too.
So your whole argument is flat out wrong.
i guess you missed that class.
Heh. I was there, but it seems you took another "sick day" that day. It's pretty amusing that you get such basic concepts so ridiculously wrong. I'm still trying to figure out which of the total bullshit comments you post you actually believe. This one you clearly cannot because it's so ridiculous to be beyond belief. I'm down to thinking you actually believe about 60% of what you post.
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your assumption is that the money cycles. it may or may not, it may become some offshore companys profit, or it may end up in the bank account of some rich company president who doesnt spend it. who knows? perhaps the company paying less for the software also lowers their prices to consumers, and as a result, the money never exists (because it never cycles in).
it is sad that you miss the basic concepts. it is truly a head shaker.
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Which could happen with closed source companies as well. Your point?
"perhaps the company paying less for the software also lowers their prices to consumers, and as a result, the money never exists (because it never cycles in)."
Ok, now you're just being silly. If the saving are passed to the consumer the consumer still is able to spend that money on other things. It doesn't magically retcon itself out of existence.
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if a whole bunch of industries suddenly dropped 80% of their sales because of open source, we would find a whole new bunch of companies too big to fail. that after the stock markets crash to a level that would make the dirty 30s look like a picnic.
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Indeed. And yet the actual economic evidence shows that it almost always cycles through the domestic economy more when that market is open and efficient. Can you present a single economic study that shows what you're suggesting? Of course not, because they don't exist.
if a whole bunch of industries suddenly dropped 80% of their sales because of open source, we would find a whole new bunch of companies too big to fail. that after the stock markets crash to a level that would make the dirty 30s look like a picnic.
That makes no sense at all. Lots of industries have seen their sales drop of due to advances in the marketplace, and the end result was always greater consumer surplus, not less. Your argument makes no sense and shows a near total ignorance of economics and economic history. I really do wonder why you keep making such statements when they are so obviously false. Really pathological.
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You've clearly never taken an economics class in your life, have you?
There is actual research and evidence on this, and has been for about a century now. The money cycles. The more efficient the market, the more the money cycles. No two ways around it.
it is sad that you miss the basic concepts. it is truly a head shaker.
You make me laugh.
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So by commenting on this subject which you clearly have no knowledge of, you've not only shown your utter ignorance, you've once again proven that you're a hypocrite. Way to go.
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Costs aren't as high as M$ makes it appear.
Apparently comments above assume that support is needed (for business, I guess) and won't *also* be provided free by enthusiasts. That's simply not the case with much of Linux today. The actual cost is only a download, plus a CD if old-fashioned and installing on base hardware. That's it so far as direct *costs* to have any of numerous versions of Linux that easily rival Windows 7 plus any applications for what *most* people will actually do. It's amazing that this still isn't generally known, because it's certain that today's Linuxes are better than any Win9x version, at zero cost, and probably won't need to know anything to install and use.
Anyway, to tie this to the topic: if development costs are *low* then overall revenues will of course be proportionately low, or maybe lower.
And I agree with Raffi that people insanely pursue money as if it's the *only* measure of value or success. It's an unstable basis for civilization, and we need another round of cutting down The Rich, by about a head.
(# Source: http://blogs.msdn.com/e7/, W7 battery problems, angry comment after M$ tech *requested* such detailed report. Their free forums have no guarantee of even a shrug in response.)
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OSS can only be a means to an end - Google, FB, Twitter et al. If a business sees OSS as an end in itself they need to get a new business model or fail.
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No, where did you come up with that?
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I think you meant "Does that imply that OSS businesses are ethically superior?" Regardless, it wasn't implied, but somehow you infered it. Pureplay has nothing to do with ethics. How you came to that conclusion is beyond me.
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Um. No. It's just a way of saying that the company's only business is in open source software. That's all. No ethical implications at all.
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If it was proprietary people would have to live with the guy for eternity minus 1 day.
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Scarcity & Scalability
Proprietary software companies get large because they get economies of scale thereby; because proprietary software is so expensive to develop, but the marginal cost of copying and distributing it is so low, in a competitive market, prices can sink to the point where only the largest company is making money, and everybody else loses and goes out of business. Sound familiar? Yup, it’s happened lots of times.
Whereas I don’t think the economies of scale are that pronounced with Open Source service and support. A one-person operation like myself can offer it to a correspondingly small customer; there’s no benefit to their going to Red Hat, who probably wouldn’t be able to offer them the personalized touch anyway. And most of the world’s GDP comes from small businesses, not large ones. That’s why I think Open Source will never be dominated by large companies.
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Open Source is a failure,,, sadly..
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Re: Open Source is a failure,,, sadly..
Thanks!
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Acquisition curbs the quantity of large players
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Acquisition curbs the quantity of large players
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Why are you deleting my posts Mike ??
I could guess, but I would rather hear from you why ??
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Here is why it has failed, or more specifically never suceeded to start with.
Thanks!"
If my previous post was not deleted, it did explain it, Fist I compared it with other markets, and compared it with its own "market".
Then I gave the definition of markets and market share, that shold FOSS really has no market share, as market share is the share of the market, the market is how much of a product is bought or sold.
FOSS do not sell product, so by definition it cannot have a market share.
If you give away dirt, you cannot say that everyone who uses dirt is using YOUR dirt, or that your dirt forms part of the market for dirt. it does not.
By your logic, if 100% of the people on earth uses dirt, and you give away dirt, you have 100% market share.
Then I compared it with other business models that attempt to profit in some way off something with no actual value (money value, that is).
Bottled water, it can be argued that your local council has a monopoly on bottled water, you allready pay for it with your taxes and rates. It's piped to your house, and its very very cheap.
But people will go out and pay between 240 and 10,000 times the cost of tap water for bottled water !!.
And the bottled water industry is massive, huge multi-billion dollar business, with many players and lots of competition.
So if groups can make huge profits selling water you can get out of the tap, and FOSS cannot make even moderate profits from their (they consider far more valuable than water) why cant FOSS turn a profit, clearly bottled water is an industry where the suppliers have worked out what the consumers want, and are willing to pay for, they is what they provide.
People who buy bottled water, dont care about high idealogies like "freedom" and "open" they just want something they want.
But with something that is supposed to be far more valuable than water, over the span of well over 20 years has gained very very little traction in any market.
Sure, they took some apps of UNIX, but after 20 years plus, far more is expected from FOSS than it has delivered.
And it still have no saleable product, therefore it cannot enter 'a market' because 'a market' is a trade of goods or services for money.
And foss products, (IT service is not FOSS), dont exist.
RED HAT is as much a FOSS or open source company as your local mechanic is toyota, he may fix toyota cars, RH might fix open source, does not make them "open source" and certainly not "pure" open source, whatever that means?
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Re: Here is why it has failed, or more specifically never suceeded to start with.
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