Open source is where the action is in 2007

The pace of change in the open source software business is likely to accelerate in 2007 as developers climb up the software stack from the operating system and databases to applications.

Proposals to invest in open source-based software companies increased by a factor of two or three in 2006 over 2005 at Index Ventures, said Bernard Dallé, general partner at the venture capital firm.

Index Ventures invested about $10 million in open source companies in 2006. These include investments in MySQL, a provider of database management software, and Pentaho, which delivers business intelligence software.

For a variety of reasons, software companies are increasingly looking to add value on top of base open-source platforms. The main Linux distributor, Red Hat, is a case in point.

The move in October by Oracle to undercut Linux distributor Red Hat on price for services shows that an open source company is vulnerable if it relies primarily on platform support for revenue.

Red Hat made its own move beyond the operating system in June with its $350 million acquisition of Java application server vendor JBoss. Although JBoss is considered open source software, JBoss, now division of Red Hat, has more control over the source code for its software than Red Hat does over Linux. With control comes a greater ability to monetize the code.

"The days of making money off the open source operating system are over," said Cameron Lester, a general partner at Azure Capital Partners LP, a venture capital firm that also has invested in several open-source startups. "These companies have definitely responded to the evolution of the industry."

Over the course of the decade the open-source realm has become an incubator for innovative business models. Venture capital money will continue to fuel developments.

For example, Zend Technologies Ltd. develops Web applications based on the open source hypertext preprocessor programming language known as PHP. It has received $36.7 million in venture capital, including funding from Azure and Index.

Zend has adopted a hybrid business model, participating in the PHP open source community and improving the underlying code, while also offering proprietary Web applications and development tools, said Andi Gutmans, the company's co-founder and vice president of technology.

"The big benefit we get from open source is, first of all, we have a huge community that helps us to develop (PHP). We have a very large R&D team, so to speak," Gutmans said.

Zend's proprietary products give the company a unique value in the marketplace. For instance, Zend Studio 5.5, launched Dec. 6, offers full lifecycle management of PHP-based Web applications.

Members of the PHP community also are a ripe market for Zend's commercial products, Gutmans said.

By basing applications on top of open-source software, companies get a built-in adoption and distribution channel, according to Pradeep Tagare, an investment manager specializing in open source at Intel Capital, which also invested in Zend.