February 2010

"Open Source requires a willingness to acknowledge what others may see as mistakes in strategy. It goes beyond merely engaging with your community, to treating critics as adults rather than as adversaries, and questions as opportunities to provide insight. A willingness to listen and even change your mind in response to criticism is not something we see in many entrepreneurs. Is it an essential part of the open source business toolkit?"

Dana Blankenhorn

Many entrepreneurs look at open source as a panacea of sorts, a golden ticket to success. They assume that the value of the open source approach is apparent to all, undeniable, and the only way. The mistake they often make is carrying this passion into the way they form their startup. They assume that open source startups are somehow different, and that as a result they will carry themselves. I was once such an entrepreneur, with such a vision.

The reality is that an open source startup isn't really that different from other startups. It still needs to have figured out all of the essential components of a successful business. An open source strategy can certainly yield a competitive advantage, bringing faster time to market, lower development cost, collaboration opportunities, ecosystem positioning, and faster adoption. But, these advantages don't come along on their own. The open source strategy is just one piece of the larger business model. The other pieces have to be strong, too, or the whole might crumble. This article reviews the essentials for all startups and highlights special considerations and pitfalls for open source startups in particular. It also discusses how startups can use an open source strategy to gain competitive advantage by focusing the passion and energy surrounding participation in open source towards value creation and acquisition.

Are Open Source Startups Different?

One of the greatest challenges for entrepreneurs who are passionate about open source is understanding that investors and customers probably don't care that an open source approach is being used. They care about their needs, and what value a company and its offerings bring to them, at what cost, and at what risk. If you can create value for your customers or investors better or more efficiently using an open source approach, great! But the open source approach is not an end of its own.

This concept is enshrined in the founding of the Open Source Initiative as a separate entity from the Free Software Foundation, and the use of the term "open source" instead of "free software". Eric S. Raymond describes it succinctly: "[T]he term [free software] makes a lot of corporate types nervous. While this does not intrinsically bother me in the least, we now have a pragmatic interest in converting these people rather than thumbing our noses at them. There's now a chance we can make serious gains in the mainstream business world without compromising our ideals and commitment to technical excellence -- so it's time to reposition. We need a new and better label”..

A focus on the benefits of open source makes customers and investors nervous. The fact is they have their own businesses and portfolios to deal with, and while they might find the goals of the free and open source movements laudable, these goals are not their concern.

At the recent Lead To Win session, I was fortunate to overhear an exchange between an entrepreneur who was pitching an open source startup and a seasoned industry veteran who was coaching him on how to improve his business strategy. The exchange went something like this:

Industry Veteran: "I would never use the open source product your company pitches in my business because the risk is not worth the few hundred dollars I would pay Microsoft in licensing fees for their industry-leading product."

Entrepreneur: "But my open source product is better than Microsoft's product!"

Industry Veteran: "You might think so, but I can't afford to be an early adopter. It's safer for me to use industry-leading products that I know have been road-tested."

Entrepreneur: "The US Military uses the product. There's no risk!"

Industry Veteran: "Then why doesn't the product have a higher adoption rate?"

Entrepreneur: "Because Microsoft has done a marketing campaign of disinformation to discredit the product and promote their solution as better."

At this point, the industry veteran's eyes glazed over as he realised that his message wasn't getting through to the passionate entrepreneur. The lesson here is simple: from the perspective of business people, Microsoft is the market leader in many areas of software. Open source startups cannot compete with or reverse what millions of marketing dollars have accomplished. Instead, these startups need to take a more disruptive approach, focusing on niches that have been ignored by the incumbents. Roger Irwin describes the advantage of small companies thus: "In many industries there exists a David and Goliath scenario where large corporations simply do not have the agility to match fresh new startups with new ideas, or small companies who just get lucky with a product that just hit the mark at the right time".

It is the agility of the startup to come up with new ideas and deliver solutions to niche markets that is its primary competitive advantage against incumbents. Taking them head on is simply not an option.

Essentials of Every Startup

There are some essential items that every startup, including open source startups, has to make sure are rock solid in order to have a chance at success.

The product or service the company will offer must solve an immediate and annoying problem for its customers. The customer must have an "itch" that the startup proposes to "scratch" with an innovative solution. This identified need/solution pair is the primary value proposition to the startup's customers. Shopify provides an example of a strong value proposition: "Shopify is a hosted application that allows you to set up an online store to sell your goods. It lets you organize your products, customize your storefront, accept credit card payments through payment gateways, track and respond to orders — all without the hassle of running a physical store".

Free software is an example of a weak value proposition: "Free software is a matter of freedom: people should be free to use software in all the ways that are socially useful. Software differs from material objects—such as chairs, sandwiches, and gasoline—in that it can be copied and changed much more easily. These possibilities make software as useful as it is; we believe software users should be able to make use of them".

The first proposition speaks directly to customers and explains how the proposed solution will improve their business activities. The second speaks of abstract principles that most customers don't understand or care about. While the goals of the Free Software Foundation are good, they do not make a good value proposition to customers. They do not address an immediate and pressing need.

The next thing every startup needs is a unique method or novel approach that sets them apart from their competition. This "pixie dust" must be more than a gimmick. It must answer the question "Why would a client pick you over your competition?". When considering this question, I remember the words of one of my mentors: "There are only two types of business ideas: bad ideas, and ideas that are already being done". Avoid at all costs the assumption that you have no competition. No matter what the product or service is, you have competition. The competition may just not be obvious because they are approaching the problem from another angle, and their solution looks different than yours. Your pixie dust needs to help you stand apart. Examples of poor approaches are lower cost, free USB key with every purchase, or more features than company X. An example of good pixie dust is Amazon's "See what other people who liked this bought" feature. It allows customers to shop and discover new products in ways no other competitor who offer the same products can.

With the value proposition well defined, the next step is to describe a reachable, growing market. This target market should be well defined and understood. It is important to answer questions such as "Why will the value proposition resonate with this market?", "What is the best way to reach this market?" and "What does this market care about?". Spend some time researching the target market and their business needs. Understand what drives them in their industry, what they view as valuable, and the language they use to describe it.

One of the best ways to get the word out to the target market of the startup and its products or services is to engineer a public relations (PR) campaign. At a recent PR Bootcamp presentation, Matt Brezina coined the phrase "No one cares about your stupid little startup" and went on to explain strategies on how to make them care. It is a tough-love lesson that faces the reality that startups are a dime-a-dozen and most of them fail. It is difficult to get the media interested in yet another startup. But, you can help increase your odds of coverage and improve visibility to your target market.

A key component to every successful startup is the team. Picking the right balance of skills is a bigger challenge for most open source startups, as the founders typically come from a technical background. They are usually really good developers and experts in technology, but usually do not have strong backgrounds in business, marketing, sales, and all the other gears that keep the machinery of a successful startup running. The natural urge is to work with friends and fellow developers. The reality is that the team needs a complementary skill set in order to succeed. Working with friends can introduce an extra layer of stress that may hinder progress and could lead to the failure of the business and the friendships. Consider carefully what schools of thought you want on your team. Most open source startups need to focus on innovation. Be careful when selecting people and resist the temptation to focus on candidates with lots of experience. Experience is useful, but can hinder innovative thought by constraining the mind to focus on how things were done in the past, instead of creative ways to do them more efficiently. Sometimes the most innovative people come from a different field entirely and contribute to the innovative success of the startup with a fresh, unbiased perspective.

Finally, once you have put all the pieces together, make sure to focus. One of the hurdles many open source startups face is entrepreneurial ADD. It is fine to have lots of ideas for products and services, but no business can do everything. Pick one that is viable, and see it through. Be careful to avoid feature glut: the drive to add lots of features to a product before releasing it, without validating that customers even want the features.

Customers Determine Open Source Strategy

When planning how to incorporate open source into the startup's strategy, the answer to the question "Who is the business for?" should be the driving force for business decisions. There are three typical focuses, with various hybrids possible: i) shareholder driven; ii) customer driven; or iii) employee driven. Each of these different approaches has its advantages and disadvantages with some particular things to note for open source startups.

The shareholder driven model is particularly challenging for open source startups as shareholders don't like, and often don't understand, open source business models. The reason is simple: these business models don't match traditional measures for company valuations, making exit strategies more difficult to figure out. Clean, unambiguous intellectual property is quantifiable. The value of the open source strategy proposition is difficult to quantify because we haven't fully developed the measures that update the traditional business model to conditions of looser intellectual property management. This uncertainty makes shareholders uncomfortable with open source models. Open source entrepreneurs have to be sensitive to this fact and recognize that a shareholder driven model for their company will require a lot of work, and may not be viable for really novel approaches. Investment capital may be limited, so they may have to focus on bootstrap funding to get their business off the ground.

The customer driven model also presents challenges for open source startups because most customers don't understand open source. There are frequent misunderstandings about such things as what "free" really means and whether a product with open source code is a security risk to their organization. To deal with these challenges, open source startups should not try to fight the battles themselves, and instead focus on adding value to customers. Speak to customers in their language, and leave the open source part out when it doesn't add value that they understand. The value of open source in a customer driven model will come in the service delivery, where the open source startup can leverage a myriad of tools at their disposal to deliver better, faster, cheaper services to their clients. The clients don't need to know how their services continue to work, so long as they do. A customer driven model will also help open source startups in their focus as they have continuous customer input on where to put development effort.

The employee driven model is the most common model for open source startups, but can also be the most limiting. By following the passions of its employees, a startup can develop a strong team that is committed to company success, lower employee churn, and create a rewarding work environment. The cost comes in the risk of alienating shareholders and customers with decisions that don't meet their needs. This conflict sometimes arises if employees are bent on preserving the principles of the open source movement, at any cost. Open source entrepreneurs should tread carefully and make sure that the strategy is well thought out to avoid such conflicts, and keep all their stakeholders happy.

The Attacker's Advantage

In their 2003 article, Gans and Stern describe a framework that identifies the central drivers for startup commercialization strategy. They examined the commercialization environment that startups face when translating an idea into a value proposition for customers, and describe the forces that affect startup success. They conclude that the optimal strategy for a startup who is entering a market that has one or more dominant incumbents is based on two factors: i) the ability to preclude effective product development by the incumbent; and ii) the fit of the incumbent's complementary assets to the new value proposition the startup is offering.

The implications of these findings are particularly important for open source startups, as they are not introducing barriers to effective development by incumbents, or other competition. As such, they have two possible strategies they can employ, depending on the incumbents' complementary assets.

Where incumbents have strong complementary assets, and are best able to commercialize the results of the open source startup's innovation, open source startups are in a weak position. They may be able to provide consultative input to the incumbent as specialists in a particular area of innovation. However, they are largely at the mercy of the incumbent and its particular strategy. The startup's efforts are best spent convincing an incumbent that acquiring them is a sound investment to bolster their complementary assets. More importantly, the startup must be careful to develop a relationship with the incumbent in such a way that it doesn't become more viable to simply put the startup out of business by investing into comparable innovation or a competing startup. This relationship between the startup and the incumbent is probably the most important factor in predicting success.

The best position for an open source startup is one where the incumbent's complementary assets don't add anything to the value proposition from the new technology. This incumbent limitation presents an opportunity for the startup to exploit its innovative leadership to capture a possibly ignored market: the attacker's advantage. The performance of the startup depends on its ability to stay below the radar and focus on niche markets that the incumbents have ignored. Using this disruptive approach, the open source startup can capture market share from dissatisfied customers, and customers who value different measures than the current path of innovation by incumbents. By consistently undermining the value of the incumbent's offering through creative destruction, the open source startup can rapidly gain market share. The open source software market has been taking this approach for years, and the success of Firefox, OpenOffice, Linux, and others are key examples. The startup must also make investments in developing its own complementary assets to ensure that its value proposition is compelling and novel, and to enable it to capture as much value as possible. These complementary assets can come in many forms, such as those described in the open source business models in Frank Hecker's Setting Up Shop.

Success Without Compromising Open Source Principles

Open source entrepreneurs tend to be passionate, and there's nothing wrong with this passion. In order for an open source startup to succeed, it is not necessary to compromise free and open source principles. Instead, make sure the startup's strategy is aligned in such a way as to harness the passion of its founders and employees for open source, and direct that passion in a way that adds value to customers and inspires shareholder confidence.

Remember to maintain perspective. The loss of perspective is a common pitfall for startups. It's easy to get obsessed with things that don't add value to customers. Listen to your customers and let them help you shape the business as it evolves and grows. Their perspective acts as a sanity check to make sure you haven't lost yours.

Heed the Linux development motto: "Release early and release often". This approach jives well with the saying "fail fast". If your business isn't going to work out, it is best that you find out early on before you and others are heavily invested. Failure is a reality of startups, and is to be expected. Don't be afraid of failure. Trying to over-engineer success is like trying to catch lightning in a bottle while spending lots of time and effort on designing the perfect bottle. Instead, accept that there will always be some amount of chance and timing that are out of your control.

Finally, remember that one of the most common open source business models revolves around reputation. By building an open source startup and getting people involved, you are contributing to the open source community in a positive way. If you do this well, and consistently, people will begin to notice. Most open source startup founders come and go from "day jobs" framing their ventures. Even if the startup ultimately doesn't succeed, the positive reputation for the open source entrepreneur will persist, and they may be an asset the next time around.


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