Subject: Re: Paying for development on a services model?
From: Ben_Tilly@trepp.com
Date: Tue, 9 Oct 2001 15:53:09 -0400


Zimran Ahmed wrote:
> --- Ben_Tilly@trepp.com wrote:
> >
> > Larry Augustin wrote:
> > like.  Gross margins
> > > are 18.5%, low in general, but not unusual for an
> > IT services consulting
> > > business.  EDS spends nothing on R&D (they don't
> > have a product).  4.6%
> > > goes to S&M, and EDS returns 9.4% in operating
> > margin.
>
> -key difference here is that EDS does not develop
> code. If you develop code, you *have* to amortize away
> some of that cost through versioning. This rules out
> pure open source strategies (especially based on the
> GPL) but is possible with mixed source solutions.
>
> I don't think it's possible to amortize away the cost
> of development WITHOUT versioning and therefore going
> mixed source. This suggests that OSS service firms
> shouldn't fund development.

My original email cited counterexamples to your theory.

Cygnus Software managed to develop GPLed software, for profit, and did
so for many years until they were purchased by Red Hat.  Had they not
been purchased by Red Hat, I believe that they still would be doing
fine.

> > People who failed to appreciate Stephen Turnbull's
> > point about the
> > fundamental economic weakness of FSB models should
>
> its not a fundamental economic weakness. Compare what
> would happen if these two companies went head to head
> -- EDS would eat Microsoft's lunch if Windows was open
> the way EDS related services are. You can't compare
> gross (or net) margins in this way -- different
> businesses.

I beg to differ.

Suppose that EDS and Microsoft were interested in entering some third
area of business.  Given the razor thin margins that EDS has, they
would have trouble aquiring cash on hand to make a significant initial
investment.  Microsoft has much less of a problem getting together the
resources to enter a new market.  Indeed that level of up front hit is
something they have to do as a matter of course.

[...]
> Saying that proprietary software has higher margins
> than service is correct, but it is not a "financial
> weakness." Does Dell have a "financial weakness"
> because it creates commodity PCs while Compaq makes
> "premium" PCs? Competition attacks margins. Microsoft
> cannot defend its margins against competitors willing
> to do the same work for less.

Both OEMs have PC business with very thin margins.  The fact that they
brand themselves differently doesn't change the fact that both walk a
razor thing edge. For an indication what this means, consider what
happens when Microsoft negotiates with any OEM.  Microsoft has a good
margin.  The OEM does not.  And Microsoft has the power to decide
which OEM gets the best margin, and uses that ruthlessly.

For instance IBM is unable to compete in the commodity PC business,
not because they are unable to run a good business, but because
Microsoft is unwilling to give them terms where they could make a
profit there.

> The high margins in software (to those firms that win)
> reflect that proprietary, lock-in nature of those
> products. Nothing more, nothing less.

What do you think everyone is saying?  Your ability to extract good
profit margins depends on having barriers to entry.  Open Source
lowers barriers to entry.  It therefore reduces your possible profit
margin.  Conversely an open source company that wants to get a better
profit margin needs to find or create a barrier to entry.

[...]
> > > This makes for an interesting point.  Companies
> > like Dell and EDS that
> > > are the most likely supporters of free software
> > (because it does not
> > > compete with them) are also the least likely to
>
> ANY COMPANY THAT CREATES A COMPLEMENTARY GOOD TO OSS
> WANTS TO SUPPORT OSS. This includes hardware
> manufacturers, service providers, etc. etc. etc. Even
> software application developers (eg. Autocad) would
> prefer it is the underlying OS was free. Anyone who
> wants to sell something complementary to operating
> systems wants the operating system to be free. the
> only people who don't want an operating system to be
> free are those who sell operating systems. they want
> everything else to be free (which is why Microsoft
> commodified away the PC).

Wrong.

Any company that creates a complementary good to OSS would like to see
OSS software be viable.  They do not necessarily want to see it enough
to support OSS.  Indeed given a choice, they don't want to write any
supporting OSS components.  Secondly even if someone is willing and
able to write OSS supporting software, it is not necessarily in the
company's interest that it happen.  (Indeed many companies have been
rather unhappy that their products were reverse engineered, and many
more go so far as to develop and release binary only drivers in the
hope of keeping that from happening.)

However even if they do find it worthwhile to support OSS, and they
like the idea so much that they spent their own buck doing it, it
makes sense for them to make their declared interest as narrow as
possible.  For instance a company that sells joysticks may find it
worthwhile to write drivers.  But said company would be insane to
spend serious money porting popular Windows titles.

[...]

Cheers,
Ben