Supporting an Open-Source Software Products Company with Service Revenuesby Allen Shaheen (allen@arsdigita.com), Philip Greenspun (philg@mit.edu) Submitted on: 2000-01-01
ArsDigita : ArsDigita Systems Journal : One article
Philip Greenspun is a computer science researcher at the Massachusetts
Institute of Technology, specializing in software engineering for Web
applications. He founded ArsDigita in 1997. His personal Web site is
http://philip.greenspun.com/.
In a world of diverging information system requirements, open source
is an unstoppable competitive edge. A closed-source system can only
solve those problems that its designers envisioned. When new business
processes are developed semi-annually, it is impossible for software
that was designed six months earlier to address the new needs. An
open-source system won't meet the new business needs out of the box,
but it can be rapidly extended for the adopting organization until it
works for their specific needs. As information system designs
continue to diverge, organizations will become increasingly skeptical
about the claims of any software vendor. Instead of vendors getting
paid for shipping a CD-ROM that customers start using, enterprise
software companies will be paying customers to invest in
experimenting with their proposed solution.
Where software has become standardized and commoditized, closed source
systems are much more effective solutions. However, as hardware
becomes ever cheaper the transaction and actual costs of licensing
closed-source systems become glaring. In the presence of a
well-specified standard, such as the Unix operating system or the SQL
language, the revolutionary coordinated distributed programmers method
that produced the Linux operating system are extremely effective and
eventually will produce an acceptable competitor to closed-source
packaged systems. An acceptable, free, and infinitely flexible
open-source solution will be an irresistably attractive competitor to
a traditional licensed software vendor.
We started ArsDigita in the late 1990s, towards the end of a glorious
30-year period in which fabulous wealth was generated from
closed-source software products. Conventional wisdom, freely and
forcefully offerred to us by a range of industry pundits and venture
capitalists, would have been to sell packaged software and hang on to
the source code. Our collaborative commerce system, the ArsDigita
Community System, would then join the ranks of database-backed systems
supporting the Web sites of a handful of Global 2000 companies. As
the market shifted toward open source, we'd adapt to making a profit
in that market.
We rejected this wisdom. Our goal was to build a strong standalone
enterprise software company for the Year 2010. We wanted to get very
good at inhabiting our adult form and not spend time and effort being
successful at a larval stage with closed-source license revenue.
Eschewing the easy path necessarily put pressure on us to develop a
strong and growing service revenue stream. After all, if the software
is free, just how can one make money? This article explains how
revolutionary service revenue growth was achieved at Cambridge
Technology Partners and how we are doing it at ArsDigita.
In 1991, a group of senior executives at Cambridge
Technology Partners (CTP) was figuring out how to break past the
traditional model of the professional services business. At the time,
CTP had the following strategic strengths:
The problem we faced was growth and scalability. We felt that the
long-term survival of the company depended on reaching and sustaining
a 50-100% compound annual growth rate, in an industry where firms
were typically growing at half that rate. Growth by acquisitions was a
possibility, but we felt the impact on company culture would be too
severe. In the end, we decided that CTP could achieve accelerated growth by
two parallel means: specialization and a product-distribution
methodology. Specialization requires identifying the key processes that define
an IT service company and creating specialized groups within the
company to excel in the execution of each of them. The glue that ties
these specialized groups together is a culture of high quality
service for clients, satisfaction for employees, and aggressive growth
for shareholders or partners. The product-distribution methodology -- essentially, adapting the
strategies of a product company to a service business -- requires four
things: a clear message of what solution the firm is world-class in, a
distinct marketing organization for building market share and
mind share, a distinct sales organization, and a
"productized" front-end service offering that is easy to
articulate and sell to clients and simple and low risk for the sales
organization to sell. The rapid growth and scaling enabled by specialization and a
product-distribution methodology has meant that IT services firms can
achieve critical mass in a relatively short period of time. In five
years CTP grew from 120 people and $12M in annual revenues to over
2000 professionals and $300M in revenues. And over the past 10 years,
the number of professional IT services firms publicly traded or
targeting IPOs has increased from a handful in 1990 to over 40 in
2000. The ability of these firms to gain critical mass rapidly with
both clients and staff using the methods described in this article has
been critical to their success.
Historically, professional services organizations have been
partnerships. In this structure, the organization was built upon the
foundation of highly skilled individuals groomed and promoted on the
basis of their expertise developed over a long apprenticeship. Senior
partners nurture and develop client relationships over a long period
of time. By virtue of their long service, these partners have deep
knowledge of their clients' business and strong relationships within
the client organization. The model requires that partners run the
business. It also requires that each partner is an "all-around
athlete" skilled in operations, business development, general
management, and client relationship building. Growing a professional services organization via the partner model
is a structured process with a clear direction and path. For the
employee, the goal is to become a full partner charting the direction
of the organization and sharing in its profits. An employee must build
experience in the operations of the firm, gain delivery management
experience, build up solid client industry expertise, and round out
that experience over time with business development skills. Since the
process is structured and lengthy, the growth rate of the firm mirrors
the lengthy apprenticeship process. In such firms the growth of the organization as well as its
economic model is often described by the pyramid structure, which
models both the ratio between junior and senior firm members
(partners), and how these different levels of staff are deployed on
client projects. The pyramid also represents the number of client
relationships, project teams, and general staff that a partner manages
as part of his or her practice. How many individuals does the pyramid encompass? In many of the
larger IT professional services firms, a partner is typically expected
to "leverage" a group of between 40 to 80
professionals. Thus, the pyramid has one partner at the top developing
business, managing a series of client relationships, and managing a
staff that in turn manages and delivers engagements. Also displayed are the core processes on which each
staff group focuses: In the early 1990s a number of professional services firms led by
CTP challenged their industry's idea of sustainable
growth rates. These systems integration and software consulting firms
saw that the growth rate of a traditional professional services firm
was constrained by its ability to hire, develop, and retain partners --
a difficult and lengthy activity, because partners were expected to be
world class in all the core processes of delivery, project/program
management, and business development. These relatively new professional services firms aimed to scale
rapidly by building separate world-class groups around each core
process (delivery, management, and business development) and applying
distribution strategies long used by product companies. The first strategy, specialization, replaced the traditional
pyramid of the IT services firms with three interrelated pyramids,
representing separate groups within the firm as shown in the figure
above. Each group (business development, management, and delivery)
would aspire to achieve excellence in their respective area and grow
their area as rapidly as possible by focusing on their core
activity. CTP and other young IT services firms (such as Sapient Corporation)
also applied the approach of having a business development group
distinct from operations. At CTP, senior management soon realized that
the success of the business development group would be greatly
enhanced by applying distribution methods long used by product
companies: Let's examine each of these methods in our industry context. In order to succeed the firm needs a message that is clear and
easily understandable by four groups: The message must clearly and concisely state what the firm is world
class at -- a statement that differentiates this firm and its methods,
people, and tools from the crowd. CTP, for example, articulated its
focus as "Customized Rapid Development of Strategic
Application." In many cases we shortened this to "Rapid
Application Development," a crisp statement of the firm's
expertise. We defined "Strategic Applications" as
revenue-creating applications rather than those intended purely for
cost-cutting. Examples: executive decision support systems, customer
relationship management applications, order entry, order management,
and sales force systems. In addition to a clear message, the firm needs to articulate its
perspective on the market, which includes the historical context,
need, and benefits associated with its chosen market focus. For
example, ArsDigita Corporation is a rapidly growing enterprise
software firm that builds software solutions to enable
"Collaborative Commerce." The historical context
comes from the development of the Web as an enabler of on-line
communities, and the power associated with rapidly bringing people
together to share experiences, opinions, and general content via the
Web. The need comes from the fact that users revisit sites that have a
purposeful community associated with them, where they can interact
with others of similar interests, and where the site is valuable
purely for its information and content. The benefit comes from
increased site traffic, longer interaction time by users, greater
revenue generated, and ultimately a higher degree of user loyalty to
the site based on the depth of the community and the richness of the
content. Once a firm develops message, differentiation, and perspective, it
must distribute them to a wide and broad audience. The goal is to
build up mind share so that the perception of the firm is at least 10
times larger than the actual market share, creating future demand into
which the firm can grow. The mass distribution of the message is the
responsibility of a distinct marketing organization. Marketing is also
responsible for gathering and distributing to the sales organization
the benefit of mass distribution, namely, business leads and potential
new clients of the firm. CTP achieved mass distribution of its message through: CTP developed its most effective partnering programs with hardware
and infrastructure companies such as Sun and HP and with application
software vendors such as Seibel Systems. (Attempts at partnering with
management consulting firms were generally unsuccessful.) Such
programs were very focused on business development and were measured
on the number of clients or potential clients that were touched by the
process, the number of hard leads developed, the number of closed
deals, and ultimately the revenue value of those deals. Depending upon
the scale and importance of the relationship, one marketing person was
typically responsible for 2-3 major relationships. Next, CTP focused on the development and delivery of sales
seminars, focused on a particular need or opportunity such as
"improving customer service responsiveness" or
"accelerating product or program launches." The seminars
were jointly marketed and delivered over several months in dozens of
cities with the local operations of both the firm and the partner
organization supporting with speakers and cases, and corporate content
and coordination provided by the marketing group. The industry analyst and press relations were also handled with
dedicated marketing staff, with help from external PR agencies. This
internal PR group was dedicated to developing 3-5 analyst
relationships deeply and ensuring that press releases were coordinated
and timed with major events. CTP, for example, chose quality over
quantity, developing strong relationships with a few industry analysts
able to understand the company, its strategy, and its services
well. Finally, marketing was tasked with sending the press an almost
constant stream of news items, drawing from client contracts, client
launches, new office openings, participation on industry panels,
internal promotions, strategic hires, and the achievement of general
growth milestones. Building an efficient distribution channel with both industry
partners and an aggressive sales force requires that the firm's
service offering be easily articulated, focused, and
priced. Professional service firms like CTP had a problem in that their
fundamental service was custom software development. The fact that
every application was made to meet the individual needs of a
particular client demanded a more complete understanding of the
clients' business, and a more complex articulation of the service. Take the bidding process as an example. At CTP, bidding a project
accurately required specialized experts within the company who were
highly leveraged and unavailable for every sales and partner call. CTP
solved this problem by developing two well-defined and short duration
service offerings. These services lasted 1 to 3 weeks and resulted in
a clear set of deliverables that were easy to articulate and did not
vary greatly from client to client. These services were referred to as
the "Scoping" and "Rapid Solutions Workshop"
(prototyping) phases of the project, used early on in the client
relationship at low cost. The aims were to: These two services enabled the sales organization and partners to
sell CTP services rapidly and easily without requiring extensive
support from scarce operations people. The risk of selling a poor piece
of work was reduced by the fact that these services were of a short
duration, had clearly defined deliverables, and could draw on extra
professionals as needed for the short term. Thus with a clear set of deliverables derived from the twin
exploratory services, the sales force could be confident in what they
were selling, the operations group could be comfortable that they
understood the scope of work needed, and management could be
comfortable that there was a low risk of a major financial problem due
to a poorly sold or managed engagement. Ultimately, building a rapidly growing IT practice requires an
aggressive and focused sales organization. All of the previous
activities are meant to make the sales organization's job easier,
faster, and more efficient. In the traditional world of partner-driven organizations, client
acquisition was left to the partners of the firm. The new model
required that an effective sales organization be built up rapidly to
fulfill the role partners would have played. At CTP, we developed a
geographically based, professional sales force in a very short period
of time with an aggressive hiring campaign. We offered sales
professionals lucrative commission plans, stock options, the
opportunity of selling strategic solutions to clients, and the chance
to grow their own geographic sales region. This was an innovative
concept at the time and enabled CTP to attract a large number of sales
professionals quickly. CTP's standard plan for the development of a new office called for
a local sales person to be hired first, typically a seasoned sales
professional with knowledge of the IT industry, extensive local
(geographic) contacts, and a proven sales track record. This strategy
enabled CTP's rapid growth, as there were always new geographic
markets to enter. Initially, the sales organization was focused towards the
development of new client relationships rather than expanding existing
client relationships. Once the first major project with the client was
sold, the sales person was driven by the compensation plan to seek new
business with a new department of that client, or a new client
altogether, rather than continue to work on enhancing the current
relationship. Although this program was highly effective in the early
stages of CTP's growth, it was not conducive to long term
relationships with clients or to the long term growth of the
company. Better programs organize their business development functions
around industries or specific application areas of interest to
clients. Examples of application areas are: customer relationship
management, e-commerce, or on-line community development. Structuring the sales force along industry lines allows it to
develop more expertise and relationship knowledge directly related to
its target client base. However, this strategy requires more
investment in personnel and training as industry expertise is
generally scarce, comes as a result of experience and extensive
training, and ultimately requires a higher compensation structure than
hiring and retaining generalists.
A second benefit of services centered around a product is that it
tends to push all the people in the organization toward the same set
of tools. At ArsDigita, for example, we have deep expertise on three
continents in how to achieve 24x7 reliability of Web services based on
Solaris, Oracle, and the ArsDigita Community System. Quite a few
problems have stumped project teams but none have proved beyond the
reach of the project team plus help from an expert in another
ArsDigita office. How did the project team find the right expert
within our 230-person organization? The expert's name was on a piece
of source code in our product or on the documentation for a module.
Finally a product+service company has unique opportunities to improve
productivity and therefore revenue per programmer. Every time we add
new features to the ArsDigita Community System we are adding value for
the customer. A pure services firm can add value by training people
or giving them more experience but those efforts may prove illusory in
a world of highly mobile workers. The value and therefore prices of a
community of practice should go up as the quality of the tools and
methods used by that community is improved.
At this point the thoughtful reader will ask "Why do you have to
release this product externally? Could you not achieve all the same
benefits by having an internally developed and internally released
code base?" Theoretically it would be possible to build a community
of practice around an internal-use only product. However, consider
how such a product might evolve shielded from the discipline of the
marketplace. Also, why would a really strong software developer want
to work on a product that hardly anyone ever got to use? Programmers
have big egos and want the world to appreciate their accomplishment.
Note that Microsoft has no trouble attracting great developers. They
are confident that their work on a Microsoft product will be widely
distributed. An open-source product is even more attractive to
programmers. They can be sure that their work will get the widest
possible distribution. This is such a powerful lure that thousands of
superb programmers worldwide have voluntarily contributed to Linux.
ArsDigita's early growth from $2 million/year to $32 million/year in
revenue in 18 months shows the inherent natural power of service
revenue growth tied to an open-source enterprise software product.
The most powerful software firms of the coming decade will be ones
that combine a universally adopted open-source enterprise software
product with the best practices learned from the pure IT services
firms.
I worry that if performed as part of an initial sales phase, by groups that are incented for sales and not responsible for the outcome of the project, there would be incentives to make actual costs seem lower than they are in order to "win sales." If you want delivery of the actual service to be profitable for the company, and well received by your customer, than it is necessary for these scoping tasks to be performed by a team that receives "negative feedback" (in the control theory sense), or incentives for accuracy (in the IBM sense). This would seem to make the splitting of these pyramids into separate teams of specialists more difficult. This is a problem that many organizations share.
Can someone comment on such issues have been addressed?
Larval Stage
You face these problems as a small firm
1. need to differentiate in a very crowded market
Therefore you should embrace open source
1. because an open source enterprise solution is different
Adult Stage
You face these problems as a big firm
1. need to seek a broader market
These problems will be better addressed with a closed-source version
of the software
1. because you can license it for to third-party distribution channels
Managing the Transition
The transition from larval to adult stage could cause a loss of identity
as sure as that faced by a caterpillar which becomes a moth. This
loss of identity could be significant if it disrupts the firm's differentiation
in the marketplace or reduces its employee morale. This problem may
be addressed by transitioning the codebase to a different set of technologies
supporting binary compilation while leaving behind a basic functional open
source shell. This shell may function as the caterpillar's coccoon
and give comfort to those customers and employees who miss the caterpillar
itself. Meantime marketing must focus on differentiation the newly
minted moth.
Objections
It must be noted that this plan only works if your product is not
dependent on a classic open source model. Linux, Apache, Perl,
and other classic open-source products were notable because a distributed
group of self-managed laborers successfully tackled broad technical problems
without any obvious financial incentive. These products are dependent
on a grass roots development community. By contrast, your firm employs
a cloistered group of well-paid and well-managed developers (see "Managing
Software Engineers" by Philip Greenspun in the ArsDigita Systems Journal,
http://www.arsdigita.com/asj/managing-software-engineers/)
to serve a small but profitable industry niche. Therefore your product
is not dependent on the open source developer community. I believe
this ensures that your firm may transition from an open source to a closed
source product without substantial harm to your enterprise. Your
closing observation that the benefits of open source are theoretically
acheivable with a closed source product borrowing open source methodology
would seem to indicate that you support this conclusion. In any case,
the discipline and exposure of the market will hew either type of product
equally.
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