Monday, August 28, 2006

Marc Fleury, Game theory and open-source

Marc Fleury has written a very interesting post on the future of Red Hat, Linux from Oracle and game theory. He makes the point that a new player has little to gain by entering the Linux market, a self-serving but well thought out argument. He also refers to Red Hat becoming a target of PeopleSoft/Siebel playbook. I think this is going to generate a lot of buzz again over the issue of a new Linux distribution disrupting Red Hat.

I wrote this post on open-source and how to play this game of oepn-source back in July, titled " Let's play games! Open source generates lots of value but little revenue". In my article, I made the point that the prize catch in open source software is not selling open source software but leveraging it to deliver new software and services. Here is the entry in its entirety.

Let's play games! Open source generates lots of value but little revenue

Yes, it may sound counter-intuitive but many technologies over the last 100 years have successfully added a lot of value without being a profitable business. Airlines add a lot of value to both individuals and businesses allowing us to meet people, establish relationships, ship goods and deliver services. However, since flying is a highly competitive business little value is added by any individual airline. Adam Branderburger and Barry Nalebuff illustrated in their ground-breaking book "Co-opetition" how the revenues and profitability of a business depend on how much value they add in the context of the industry. We will apply these concepts from Game theory to open-source here.

Open-source games

Open source software is created mostly by interested individual contributors that take pride in the software they write. They also gain appreciation and respect from the software development community. Several large vendors such as Red Hat, Novell and start-ups like SpikeSource are attempting to provide open-source solutions that include pre-configured, easy-t0-install distribtutions and support for enterprises. But as Larry Ellison of Oracle recently pointed out they own little to no IP and other players can easily enter the market. Even if companies like IBM and Oracle have not entered the open-source market, the threat from new entrants due to low barriers of entry ruin the game for incumbents forcing them to keep prices low. And this is exactly what game theory predicts- in a market with low barriers to entry it is hard to charge premium prices and make profits over an extended period of time.

Value for consumers and businesses
There is no need to despair for those interested in the open-source phenomenon. The open-source is creating value for companies that are leveraging it including such companies as Yahoo! and Google. In fact, corporate IT departments are using Linux and the LAMP stack (Linux, MySQL, Apache, PHP). And those that are not, are benefiting from the competitive pressures this is exerting on the likes of Microsoft resulting in weakness in pricing. It is interesting to note that traditional math does not apply to the game theory economics and so the value added by open-source to the customers is not equal to the value added by open-source vendors. The reason for this is that even though there are only a few visible open-source players, there are infinitely large numbers that are potential competitors due to low entry barriers. And we all know what happens when you divide billions of dollars by infinity.

How do I play this game?
If you are looking at the open-source trend and looking to benefit from this trend there is a right way and a wrong way to play this game. You are much less likely to succeed by entering the game as a vendor. Your gains are much larger if you can leverage the low cost of open-source software to provide new services to the customer- consumer or businesses. Enterprise software delivered as a service (Enterprise SaaS) companies that provide CRM and other ERP functionalities over the web are some obvious examples. Increasingly services like Intuit's Quickbase, Salesforce CRM and NetSuite ERP will provide attractive alternatives to customers. As yet unforseen compute-intensive services may be offered in the future that may include anlaytics applications, data warehousing and backup, etc. that have as yet been only delivered by installing software within the enterprise firewall. On the consumer side services like Google's Web2.0 Office (Spreadsheet, Document writer, etc), Zoho, FlickR are popular and obvious examples of what low-cost hardware, open-source software stack and advertising-driven revenue model can deliver to users at zero cost to them.

In summary, open-source software is changing the way we build, deliver and consume software and services creating untold billions of dollars in increased productivity. However the obvious instinct to profit from this by entering the market as an open-source vendor may be exactly the wrong approach to take. In stead look for opportunities to provide new services to the customer that were earlier economically infeasible due to high cost of hardware and software. Cheaper, faster, better online applications that improve upon Microsoft Office, SAP ERP, Business Object's BI, etc. is where the action is. Now go play!!!

Housekeeping- My blog's comment feature was blocking some readers. You can easily leave comments now, so do express your opinions.

(Disclaimer: The views expressed on this blog are personal and do not represent opinions or views of my employer.)

1 comment:

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