Investing in Open Source — Can a Brick Fly?

VC investment in GPL projects. The very idea recalls an old military saying about the F-14 Tomcat (or, some claim, the F-4 Phantom): “America’s proof that given a big enough engine, even a brick can fly.”

Certain GPL investments similarly remain commercially airborne with immense investor thrust behind them. But this will be unusual, and the main result will simply be to consume a lot of fuel. Software has been so successful for VCs for so long that it’s taking an inordinately long time for them to recognize the sea change: GPL closes down the old opportunities in software, and creates new opportunities that are not in software, at least not directly. Why? Basic microeconomics, and basic Michael Porter.

Software investments traditionally generate returns in two possible ways. First, you can create high customer switching costs through software complexity and/or ownership of proprietary interchange formats. Second, if you can capture enough of the market to permit enormous fixed investment in your source base, outspending any other potential entrant — economies of scale.

GPL does away with both of these possibilities. Economies of scale become impossible, because your fixed investment is automatically shared for free, no matter how large. Switching costs become nearly zero, because file formats and feature sets are no longer proprietary. In both cases, no matter how big you get, any 15-year-old in his bedroom can download your source code and compete with you.

This does not eliminate market power, it just moves it around. Anybody in the business of selling licensed software (Microsoft, Oracle, etc.) is in decline. They can’t possibly compete with a price of zero — all they can do is slow down the transition through FUD and customer relationships. Over time, all such product business will turn into service businesses.

But the biggest companies can mine their patents. A likely endpoint for Microsoft, 15 years from now, is as a seller of services and a licensor of its vast patent library. How large that business may be is not knowable.

And users of open source will thrive, when they can set up switching costs that are not related to the software itself. Google, eBay and Amazon all have this quality.

Nothing in this article should be construed as yet another dull argument about who is evil and who isn’t. I happen to think Google may become a larger, more powerful monopoly than Microsoft at its peak. That is not to say Google or Microsoft are good or bad — I’ll leave the moralization to the guys at Slashdot, because they’re so good at it.

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