Canonical's services play: Revenue windfall or trap?

Small vendors who dabble in services to underwrite their software may find they're biting off more than they can chew

It's tough to compete in an industry where your customers expect your product to be free. Such is the case with software, where giveaways have seemingly become the norm. (Try selling a Web browser or an audio player in 2010.) Some developers have turned to advertising to underwrite their efforts. More recently, a few software vendors have begun offering Internet services as a way to add value to their products and raise revenue. But the latter model is not without its pitfalls.

Take Canonical, for example. The company behind the Ubuntu Linux distribution now offers cloud-based data synchronization services under the Ubuntu One brand. You can get 2GB of storage for free; $10 per month gets you 50GB. Soon Canonical will be expanding its offering to include contact synchronization for smartphones -- also for a fee -- and an Ubuntu One Music Store as a Linux-based competitor to iTunes.

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These are bold moves, to be sure. Canonical seems to be borrowing a page from Microsoft's playbook, where "software plus services" is the new mantra. But there's just one problem: For a small company whose core competency is software development, an online service-based business is a whole new ballgame. Software vendors who hope to follow in Canonical's footsteps should tread carefully.

Small software firms: Few prospects for growth
As popular as Ubuntu Linux has become, it's not hard to see why Canonical is searching for new revenue opportunities. Dot-com billionaire Mark Shuttleworth founded the company on his personal fortune, and his investment has largely sustained it to date. But Shuttleworth stepped down from the CEO role in December to make room for "a more commercial focus at the top."

Canonical was founded as a classic commercial open source venture. Until now, its core business has been providing commercial support and maintenance for Ubuntu, typically for enterprise customers. It has done reasonably well; in January 2009, Shuttleworth reported that its annual revenue was approaching $30 million. By comparison, for the fiscal year that ended Feb. 28, 2009, revenues for Red Hat, the leading commercial Linux vendor, topped $652 million.

Canonical's woes echo those of the commercial open source software industry as a whole. Ubuntu aims to be the most user-friendly desktop Linux; its motto is "Ubuntu just works." But the easier the product is to use, the less need there is for commercial support. Most customers get their questions answered on blogs and online forums. Red Hat sees a tidy profit from its strong enterprise customer base, which uses the product in mission-critical data centers. But Canonical -- like most commercial open source ventures -- will never get as big as Red Hat selling commercial support to desktop users.

These problems aren't limited to open source companies. Any fledgling software venture faces an uphill battle when trying to gain a foothold with new business customers, who often fall back on large vendors out of a desire for "one throat to choke" for service and support. Little wonder that the "software plus services" model seems so tempting: Give away the product and have customers pay for value-added services.

The perils of services
The problem with a late-inning shift to a services-based model, however, is that offering online services is a fundamentally different business than developing software. I'm reminded of all the failed e-commerce startups of the dot-com boom: Running a Website is one thing, but moving products to customers is quite another. Similarly, a software company that pins its revenue hopes on services may find itself ill equipped for the job.

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