Why making your product's code free is a competitive advantage

Title-shift photography of html code: Open source companies have a competitive advantage.

Open source companies have a competitive advantage. Image: Unsplash/Markus Spiske

Arnav Sahu
Investor, Y Combinator
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  • Giving code away for free gives companies a competitive advantage.
  • There are three key benefits of an open source venture, including crowd-sourced product development, bottom-up sales and generating trust among the developer community.
  • While companies are vulnerable to their code being copied by competitors, the truth is that customers and the community still favour those who created a product's code and can retain loyalty despite being up against bigger players.

Conventional wisdom suggests that successful software companies are built on proprietary data and code. However, in the past few years, the success of open source (OS) business models has challenged that view.

OS companies collaboratively build products with the community and share their code in public repositories (such as GitHub) for anyone worldwide to see, download and use for free. Multi-billion-dollar public OS companies such as Hashicorp, JFrog, Elastic, MongoDB and Gitlab have demonstrated the power of embracing this new community-led model. It is crazy to think that giving away your product's code for free has now become a competitive business advantage.

Market capitalization of the major publicly traded open source companies ($ in billions). Data as of 11 August 2022.
Market capitalization of the major publicly traded open source companies ($ in billions). Data as of 11 August 2022. Image: CapitalIQ
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The pitch for open source

In my view, the three key advantages of building open source companies are:

  • Crowd-sourced product development
  • Bottom-up sales
  • Trust from the developer community

In particular, the open source model has opened interesting sales, go-to-market (GTM) and distribution opportunities.

Crowd-sourced product development

First, OS companies rely on the contributions of the broader developer community. Any developer around the world can contribute, particularly around integrations and bugs (with the approval of the core authors of the OS project). Developers that make community contributions are also incentivized to evangelize the OS project. Often in job interviews, developers can use the number and quality of contributions they make to prestigious OS projects as an important calling card. After all, community contributions from across the world enable OS companies to build new features and integrations faster.

Bottom-up sales of open source products

Second, open source serves as a lead generation engine for sales. Anyone can download and use the software for free: users can see the code and configure it to their environments. This capability enables open source companies to acquire a vast user base. That is especially helpful in enterprise infrastructure buying decisions where it can be hard to convince a high-profile customer to run their infrastructure on a young startup.

Trust in the developer community

However, if the customer already has many developers in the organization already using the free OS software and can see the code and test and configure it to their needs, it's an easier decision for the chief information officer or chief technology officer to trust the startup in the buying decision. Users have already gone through a six to 12-month journey with the free version of the product.

The company journey

Unlike typical software companies, open source startups must go through two stages of company-building:

  • Building a product that users would download and use for free
  • Building paid features

For example, Kafka is a popular open source data streaming project commercialized by a company called Confluent, which offers paid features on top of the free project. In this regard, the sales journey for an open source company is often less about acquiring new customers and more about conversion sales, converting existing free users through add-on paid features.

This bottom-up sales motion makes the open source business model particularly attractive because it is much cheaper and easier to upsell an existing user than acquire a new one.

Some primary ways of monetizing open source software are services, open-core and SaaS. First, open source companies offer support and services to help customers implement and install open source software.

Second, in an open-core model, companies sell a set of additional enterprise features on top of the free version. Such features include security controls, monitoring, analytics and dash-boarding, team collaboration and auditing. The vast majority of functionality is left in the open source project, while the paid version comes with features an enterprise buyer cares about.

This bottom-up sales motion makes the open source business model particularly attractive because it is much cheaper and easier to upsell an existing user than acquire a new one.

Arnav Sahu, Investor, Y Combinator

Third, in the SaaS (software-as-a-service) model, the open source vendor will host and manage the software for the customer. SaaS contrasts with the old way, where customers would self-manage (download the open source code and manage the software themselves in their own data centre).

A good analogy is the difference between buying the cloud version of Microsoft Word online versus the old way of purchasing the Microsoft Word CD and installing it on your desktop.

The biggest advantage of the SaaS model for a customer is that it abstracts all the complexity of managing the infrastructure. This SaaS model also expanded the market opportunity. It enabled small to medium-sized businesses and mid-market customers to adopt OS products because they do not have the time or resources to self-manage products; with SaaS, they get a fully hosted, out-of-box solution.

As the open source ecosystem matured, cloud providers (such as AWS, Azure) became more competitive, which critics thought could signal the end of the open source companies. Since the open source code can be downloaded for free, the cloud providers took that code and built a set of enterprise, paid features on top of an open source project.

Instead of buying the paid features for the Kafka project from Confluent (the authors and creators of the project), customers could buy the paid features directly from AWS, which would often discount the price as part of a broader cross-selling strategy.

Why open source models are defensible

Critics questioned why anyone would want to build an open source company if someone else could copy that free code and sell paid features on top?

While cloud providers have seen some success in this strategy, critics underestimated the power of the community. Most customers still prefer to buy software from the company that has the original creators of the open source project. The community view these creators as the "moral and spiritual centre" of the project; therefore, project originators can influence a product's roadmap and direction. With the notable exception of GitHub, most successful open source companies have at least one original contributor in the company.

Historically, giving away your code free in the software industry would be considered laughable. However, today, starting an open source company has a clear business advantage.

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