Are open source vendors more capital efficient?

Analyzing revenue results of representative open source and commercial vendors tells an interesting story
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Reading Mark's guest post led to Dave's post on "Finding the right open-source price." Dave wrote:

Customers expect open-source alternatives to be 10 percent to 20 percent of the cost of the proprietary product, which means that open-source companies need to be 80 percent to 90 percent more capital-efficient.

What does 80 to 90 percent more capital efficient really mean? Well, if it takes a commercial vendor 60 cents in expenses to drive $1 in revenue, then an open source vendor must only spend 6 to 12 cents in expenses to drive the same $1 in revenue.

The argument is that commercial vendors spend on items such as advertising, marketing, R&D, and most importantly, expensive direct sales representatives. We're told that open source vendors spend significantly less on these items, and hence can be more capital efficient. These costs make up the difference between the costs of doing business as a commercial vendor vs. an open source vendor.

Somehow, those numbers didn't seem right to me. So I looked at revenue results from Red Hat and Microsoft. (I quickly looked at Oracle, IBM, and Novell and found the same general trend as what I describe below.) See if you can guess which vendor's results are in Table 1 vs. Table 2. Note: the figures are percentages of Total Revenue.

Give up? Table 1 contains Microsoft's results and Table 2 contains Red Hat's results. Notice that Red Hat's operating expenses (a good proxy for the cost of doing business) are over 85 percent of revenue. Said differently, Red Hat needs to spend at least 85 cents for every $1 in revenue it brings in. This figure is just over 60 cents for Microsoft for every $1 in revenue.

Based on the data, I find it difficult to conclude that an open source vendor can truly be "more capital efficient" than a commercial vendor. Well, at least a mature open source vendor, which is what all startup open source vendors hope to become some day. This begs the question of whether open source vendors should compete largely on price (I remain convinced that the answer is no) if their proportional costs of doing business are not going to be significantly lower than that of a commercial vendor in the long run.

[Update: I compared Red Hat to Tibco as per Zack's suggestion that MSFT was not a good comparison.

p.s.: I should state: "The postings on this site are my own and don't necessarily represent IBM's positions, strategies, or opinions."

Part two: Are open source vendors more capital efficient?

Analyzing Red Hat to a vendor its size, Tibco, does not support the claim of mature open source vendors being more capital efficient than commercial software peers

In my previous post, I compared Red Hat's financials to Microsoft's results to test whether open source vendors are more capital efficient than commercial vendors. I was not able to conclude that they are.

However, Zack suggested:

I'm not sure this is a fair comparison. Microsoft's scale is several orders of magnitude larger than Red Hat. If you want to do a fair comparison, use companies with similar scale in terms of revenue, employees, etc.

Very valid point. So I quickly looked at Tibco, a commercial software vendor whose revenue is within $150 million of Red Hat's, have a similar employee base of approximately 2,200 and were founded within two years of each other. Here's what I found (percentages are percent of total revenue):

Red Hat's operating expenses are 87 percent of revenue compared to 90 percent for Tibco. If Tibco did not amortize acquired intangible assets, then the operating expenses would be 87 percent in FY2008. Both vendors spend just over 35 percent of revenue on sales and marketing and a little more than 17 percent on R&D. Tibco appears to have a more slightly efficient organization as their general and administrative costs are 8 percent of revenue, half of Red Hat's 16 percent. Keep in mind both vendors have the same employee size and close to the same revenue base.

Based on this comparison, I still can not conclude unequivocally that mature open source vendors are more capital-efficient than commercial software vendors.

p.s.: I should state: "The postings on this site are my own and don't necessarily represent IBM's positions, strategies or opinions."

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BY Savio Rodrigues
Source：InfoWorld

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