Open source 2.0: New kids on the block

Remember a year or so ago when you could probably name most of the open-source companies in the market? Try doing that now when the number of startups has skyrocketed to several hundred. While this massive growth appears reminiscent of the dot-com boom before the bubble burst, experts in the field stress that the second wave of the open-source revolution, Open Source 2.0 if you like, is unlikely to play out in quite the same way. However, that's not to say there won't be some upsets along the way.

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"There are absolutely too many [open-source] companies," Jo Tango, a general partner at VC Highland Capital Partners, wrote in an e-mail response to questions. "I predict a venture capital backlash against open source. There are simply too many companies right now raising money with the approach: 'We'll give it away for free and make it up in the back end with high volume services/support revenue.'" For example, with three open-source database companies emerging this summer, there just isn't room in the market for a fourth, he added.

The organizers of the Open Source Business Conference (OSBC) East taking place in Newton, Massachusetts, next week have also had first-hand experience of the huge uptick in the number of open-source companies over the past 18 months. When they were planning the first OSBC in San Francisco in March 2004, the organizers found it hard going to come up with enough companies for a showcase of 15 to 20 open-source startups, according to Matt Asay, the conference director and director of open-source strategy at Novell. "It was a lot of work just to find the companies, they were all over the map," he said. "It was slim pickings."

Fast forward to the preparation for OSBC West in April this year in San Francisco, and again in the run-up to the upcoming OSBC East, and Asay and his colleagues were looking at over 150 companies for the showcase for each event. "We're getting really good quality and not just quantity," Asay said.

Bryce Roberts of venture capital company O'Reilly AlphaTech Ventures LLC has worked on whittling down the 150-plus companies to the 16 that will be exhibiting at OSBC East in the conference's Emerging Elite Showcase, according to Asay.

They include service-oriented architecture (SOA) integrator Active Endpoints, enterprise content management firm Alfresco Software, software-compliance assessment service provider Black Duck Software, Linux server management firm Centeris, database vendor EnterpriseDB, mobile application server company Funambol, customer relationship management vendor SugarCRM and enterprise collaboration software firm Zimbra.

"There's a real flowering of open source emerging at the application level," Asay said, pointing to the likes of Alfresco and SugarCRM.

"I've watched the seeds of the transition happen over the last two years," he said. "I met with SugarCRM six months before they'd written a line of code. I thought they were full of it and high on something." However, with the favorable reception the company went on to receive and SugarCRM's recent raising of over $18 million in Series C funding, open-source companies started to feel like a very real career option to Asay, he said. In fact, as Asay opens OSBC East on Nov. 1, it will be in his new role as vice president of business development at Alfresco.

At OSBC East, the 16 companies will present their open-source stories to a panel of three venture capitalists (VCs) and a chief information officer (CIO). The panel will come up with a couple of winners they dub the most promising startups to watch. At OSBC West in April, the winners were BitTorrent, Groundwork Open Source Solutions, Realm Systems, and SugarCRM, all of which have attracted venture capital funding. "We're batting one thousand," Asay quipped.

It's hard for VCs to get a handle on the open-source market, Asay believes, especially since only one open-source company, Linux distribution company Red Hat, has gone public, and that was way back in 1999. Certainly, he feels that VCs are rapidly becoming much better educated about the open-source arena and more savvy at differentiating between true open-source startups and those that are just jumping on the open-source bandwagon.

However, some VCs still have the tendency to rush to crown one startup or another as the Red Hat of the CRM or business intelligence world, Asay said. "VCs have sometimes been a little too easy on themselves in terms of cheap analogies," he added. Highland's Tango mentions a friend actively involved in open-source investing who claims there's something of a herd mentality, with VCs following each other into investing in what technology areas appear to be hot.

"There is a certain element of a bubble," Asay said. "Some [open-source company] valuations don't fit the definition of rational. Some companies shouldn't get the funding they are, they have a superficial open-source wrapper."

Tango agrees. "It reminds me of the mini-waves I've seen in the past: B2C [business-to-consumer], B2B [business-to-business], optical networking, peer to peer, etc.," he wrote in his e-mail. "These things come and go. What won't ever change are, What value are you offering so that you can charge customers? How can revenues exceed costs? How can you build a business thoughtfully over time so that it is sustainable?"

The open-source 2.0 bubble, such as it is, is nothing compared with the Web 2.0 bubble building up on the West Coast around the latest generation of Internet companies, according to Asay. The problem with Web 2.0 is that VCs feel they understand the Internet and so are sometimes glossing over the flaws in those startups' business models, he said. Because the open-source world is very different in terms of its business models and software licensing, "VCs are approaching it with a significant amount more caution," Asay added.

For a VC investment in open-source to make sense, the startup needs to be doing five things well, according to Tango. It must be targeting a large area of the market with its product, ensure there's both a community to help with development of the software and a large pool of potential users likely to want to download the products, be sure its software will require support it can charge for, have expertise in the area of the market it's aiming at, and finally, be patient. "These businesses take a while to build even when you're in a large space," he wrote in the e-mail, pointing to the long steady rise of Red Hat.

Open-source, with its free software licensing terms, provides a very easy and inexpensive way for individuals to set up a company, according to Judith Hurwitz, president and chief executive officer of Hurwitz & Associates. "A lot of people rush in without thinking past that entry point," she said. "They need to build a community behind their software, spotting a real need in the market that enough people care about."

There's plenty of opportunity for open-source players to enter existing established software markets, according to Robin Vasan, a managing director at venture capital firm Mayfield Fund. "Traditional enterprise software business models are broken," he wrote in an e-mail response to questions. "Mayfield believes that the large incumbent software companies are vulnerable, and that many layers of infrastructure software are ripe for open-source entrants."

One area Nathaniel Palmer, chief analyst at Delphi Group, finds particularly exciting is in the application stack, where he sees open-source startups starting to focus more on making components of the stacks interoperable. "Open source is really becoming a design strategy rather than a licensing strategy," he said. "It's how customers can move to a point where they have control over the software development lifecycle and how to assemble components." Gradually, many users are starting to make the transition from software ownership to software usage, he added.

One likely emerging trend is that customers will start to query the possible conflict between an open-source project and the software startup that's trying to sell a commercial version of that project, according to Highland's Tango. "Whose source code requests get approved? How are improvements prioritized?" he asked in his e-mail. "How can end users be sure that the interests of the for-profit venture-backed company are aligned with [those of] the not-for-profit open-source entity?"

Some of these questions might be on the agenda at what Asay believes will be one of the most interesting sessions taking place at OSBC East. Entitled "Pitching the CIO," the session will feature executives from three leading open-source companies, application development environment firm ActiveGrid Inc., EnterpriseDB and virtualization software vendor XenSource Inc., who will have to pitch their company and products to a panel of CIOs and then field their questions. It should be a very different experience than pitching to the VC community and Asay anticipates a lively debate. "I've never been to a conference where this has happened, it should be fascinating to watch," he said.

While OSBC West attracted many independent software vendors (ISVs) and independent hardware vendors (IHVs), between 20 to 30 percent of OSBC East's expected 300 to 400 attendees will be CIOs, according to Asay.