A "Perfect Storm" Moment for Multibillion-Dollar Open Source Companies

At Index Ventures, we have been investing in open source for 12 years, and we’ve never seen such a “perfect storm” moment for open source companies to make the jump from scrappy-and-free to large-and-profitable. With today’s news that Hortonworks, one of our investments, has raised another $100 million in funding, it’s clear that the industry is finally ready to accept and value open source startups as real businesses poised for long-term growth.

Why — after decades of entrepreneurs trying to use free open source technology to build profit-generating companies — is now the breakout moment for billion-dollar open source companies?

Open source, by its very nature, is communal, free or low-cost, hacker-driven, and even anarchist in its approach. So, at first glance, it may seem counterintuitive that a free movement for the “common good” could form the basis for a highly profitable industry. Up until this year, Red Hat was one of the few open source companies with a market capitalization in the billions, but we are already seeing more open source success stories with Hortonworks, Elasticsearch and many others.

Several factors have coalesced to create an ideal environment for open source companies to succeed as profitable businesses. First, we should talk about where the open source industry was, and how we got to this turning point.

When the software industry got off the ground 50 years ago, it was almost entirely closed source. Early software companies “wrote it, compiled it, and shipped it,” and this packaged software model dominated for decades, creating behemoths like Microsoft and Oracle. But software developers realized there had to be a better and cheaper way to get software into the hands of users. Buying packaged software and continual upgrades was extremely expensive, as well as cumbersome and high maintenance, so users were searching for better alternatives.

The open source movement arose when developers realized they could create software in a community-driven environment, letting everyone add knowledge in return for sharing in the collective product. However, early open source platforms like Linux were scrappy and cheap, built entirely for and by techies, making them hard to use within large companies that needed structure and control.

Now, open source software is cheap but robust, easy to use, but also technically advanced. The time is now to make money in open source, and here are six reasons why:

Open source is cutting-edge

For years, open source applications were “cheap and cheerful” versions of expensive packaged software. Linux was a free operating system that emerged as the leader of the Unix versions, and MySQL was a free cousin to expensive database software. Today, developers are using open source to develop cutting-edge software in its own right. Dozens of Big Data startups have based their business models on the open source data processing framework Hadoop, and many other startups are creating industry-leading apps entirely built in open source. Elasticsearch, for example, didn’t just use Lucene open source to create a “cheap and light” search technology, they built an entirely new type of a product that lets companies get real-time actionable insights from almost any type of structured and unstructured data source.

Open source is enterprise class

In the past, the biggest complaint about open source technology was that it wasn’t suitable for the enterprise. Sure, it was great for hackers and geeks, but it wasn’t robust, secure and scalable enough for large-scale corporate deployments. Companies needed to spend millions for Microsoft and Oracle licenses; that was just expected. Today, companies are ready and willing to embrace open source applications; they’re tired of shelling out millions for complex, proprietary solutions that make them dependent on single companies, and they know they can get the same, or better, functionality from open source apps at a fraction of the price. Today’s open source applications are enterprise-ready, offering all the “-bilities” of packaged software, including reliability, availability, serviceability and scalability. They come with front-end dashboards that are easy to use, and offer back-end security, management and monitoring.

Systems are becoming complex

The first open source technology was mostly self-contained OS and database software residing on single servers. A user downloaded MySQL to a server and managed it locally. Now, with the near-ubiquity of broadband and the cloud, open source platforms are becoming vast multi-node systems. Startups today can take advantage of low-cost distributed computing to build and release sophisticated open source software. They can use the cloud for easy distribution, control and updates. A cloud-based distributed model enables open source technologies to scale to new heights. Yahoo now runs Hadoop across 40,000 servers to manage its massively complex distributed-data system. This type of massive-scale open source deployment was unthinkable 10 years ago.

Monetization models are working

With cloud-based delivery, open source monetization models have finally gone mainstream. Freemium models now being used by most software firms and app developers were pioneered by the open source community. The tenet of open source has always been to give away the “open core” for free, and then charge for additional features. Enterprise customers are clearly willing to pay for extra features, such as management, monitoring, dashboards and security. Even when customers buy these add-ons, open source solutions still cost a fraction of what traditional “packaged” products do. Open source companies can also charge for consulting, training, service, connectors and components, much like SaaS vendors do. These dual revenue streams will generate revenue and profits for today’s open source leaders.

Open source startups now control their destiny

The first wave of open source leaders, including Red Hat, relied almost entirely on the community to build their products. Their product development was truly communitarian. Today’s most promising open source companies do about 80 percent of their development in-house, with some contributions from the community. This gives the companies more control over their product features and roadmaps, enabling them to provide personalized, enterprise-class support to customers.

Adoption has reached critical mass

Spurred by all the elements above, we’ve reached an unprecedented level of adoption of open source in the enterprise. Some 86 percent of companies in non-technical industries now use open source, and that number is probably 100 percent within technology companies. The try-before-you-buy freemium model has done much to propel open source to new heights. Companies can try a simple version of an open source app for free, and if they like it, can pay for value-added enterprise features. There is virtually no risk with this model, and most companies that try open source tend to stick with it. And, lastly, the cloud has enabled open source companies to have their software rapidly deployed into production. They can get instant visibility into what’s not working, gather valuable data on how customers use their products, and fix snafus as they occur. Quite simply, open source apps are now not just good, but great.

Index has backed more than 20 open source companies over the years. We believe open source will be a dominant software development and distribution strategy of the future, especially in certain categories such as big data and infrastructure, and will generate billions of dollars in equity value for investors and entrepreneurs alike.

Mike Volpi is a partner at Index Ventures, a multi-stage international VC firm with offices in San Francisco, London and Geneva. He currently serves on the boards of Big Switch Networks, elasticsearch, Fuze, Hortonworks, Lookout, Mashape, Path, Pure Storage, Sonos, SoundCloud, Wealthfront and Zuora. Previously, he held a number of executive positions, including chief strategy officer at Cisco. Reach him @mavolpi.

This article originally appeared on Recode.net.

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