Subject: Re: "Reasonable Profits"
From: (Frank Hecker)
Date: Tue, 01 Sep 1998 09:12:05 -0400

D. V. Henkel-Wallace wrote:
> Let me posit two classes of business model.

Maybe it's just me, but I find it more clear to think of these models
not in terms of the intent of the business proprietors (as you seem to
be doing) but in terms of the range of pricing, gross margins, and
profits that are achievable and (in an important sense) justifiable
given the environment you are in (which for our purposes includes not
only the customers but also the developer community helping to create

> The first is the "small time operator" or "tinker" or consultant
> model. This model says "generate enough cash to cover one (or X)
> person's living expenses."

Or as I would put it, pricing of goods and services is closely tied to
the cost to provide them, and gross margins are relatively low.

> The second is the traditional corporate model.

In my terms, the traditional software industry model specifically.

> This model says "revenues should grow non-linearly with the labour
> expended."

Or as I think of it, pricing of goods of services is not closely tied to
the cost to provide them, but rather is based on some independent
measure of value as perceived by (and justifiable to) customers.  If
this value is much higher than the (incremental) cost to provide the
goods and services, then gross margins are high and once fixed costs are
covered you have a situation where additional revenue goes straight to
profits, leading to your becoming a successful software company.

It's worth noting that it's also possible that the perceived value may
not be higher than the incremental cost, in which case the company can't
achieve the theoretical high gross margins in practice, and if the
company then fails to cover its (often high) fixed costs it becomes an
unsuccessful software company.

It's a truism that the shape of the traditional software industry has
been dictated by the combination of near-zero incremental costs (e.g.,
to distribute software), high fixed costs (in large part driven by
intellectual property restrictions and practices that force new entrants
to do lots of reimplementation), and the ways in which customers assign
perceived value to software (in particular by the perceived value of
having the same software as everyone else).

> The problem with the "pay me enough to make me my costs and X rate
> of return" is that it's fundamentally the labour theory of value,
> and there's more to value than can be encompassed by that bankrupt
> 18th-century approach.

I agree with you about value being more complicated than that, but I
believe the bigger issue here is what you go on to point out:

> Maybe it works for consultants (though even they tend to be
> arbitraging their knowledge vs the customers' gaps) but it doesn't
> work on large scale risk/investment projects.

By which I think you mean that resources (investment dollars and skilled
people) are much more attracted to companies that can operate with high
gross margins (driven by what I call "value-based" pricing) and
potentially high profitability, as opposed to companies that have to
settle for lower gross margins and thus lower potential profits because
(for one reason or another) they have to price based more on actual
cost.  Hence Microsoft is a more attractive investment opportunity than
(say) EDS.

> I think it also confuses the gratis and libre properties of the
> software.

Yes, but I think these aspects are in fact linked, that being libre
directly drives being gratis or near-gratis, at least for the actual
software in question.  The key to me is that you can't employ
"value-based" pricing for libre software to the extent or in the manner
you can in the traditional software business model, not because you
can't justify it to the customer but because you can't justify it to the
people creating the software in the first place.

I won't bore you here with my full thoughts on this; I've written about
this elsewhere and will refer you to that (see below).

> It's really a gratis software issue, and I think gratis (qua gratis)
> software is by definition antithetical to anything but the
> consultant approach unless the value recovery lies elsewhere (in
> which case you wouldn't be an FSB anyway)

I agree with your first point (about value recovery needing to lie
elsewhere) but I don't think that that implies not being an FSB in some
important sense.  The "traditional" FSB models are important models, but
are not necessarily the only ones, and other models are worth exploring
to see if they can be successful and still keep the core of what makes
free (libre) software important and interesting in the first place.

To respond to John Gilmore's point about "people who are more interested
in tearing down free software businesses than in building them": I in
fact believe that it is definitely worth looking at building FSBs, or
businesses that have significant FSB aspects.  I believe this is
important for practical reasons (e.g., the quality of software produced
by the free software development process), for idealistic reasons (e.g.,
building businesses whose practices you can justify to both their
customers and to their "work force", whether formal employees or not),
and for economic reasons (e.g., because such businesses can make money
for their employees and investors).  I also believe that the software
industry is evolving in a way that will very likely significantly
increase the importance of FSBs and quasi-FSBs in the coming century.

For anyone who's interested, I've written at (much) greater length on
FSB-related issues in a draft paper

It's primarily directed to people at traditional software companies
(naturally enough, given my situation and the paper's origins), but it
may be of interest to others as well.  For those who were there, this is
a greatly expanded (albeit still unfinished) version of the presentation
and draft paper that I distributed at Uniforum in Ocean City last May.

Frank Hecker          Pre-sales support, Netscape government sales