Natural Revenue Growth in Open Source Startups

Matt Asay’s comments on Open Source software sales cycles prompted me to send him a long email, some of which he blogged. Yes, I’m the person behind that email to Matt.

Stephen Walli also jumped into the fray with a response to Matt’s comments about the downside of an Open Source business model. Stephen was joking with me on Friday that it’s “pick on Matt week”.

If you read my email to Matt, you’ll see that the main point is centered on the natural revenue growth rate of a startup. All businesses have a natural organic revenue growth rate. The challenge with respect to that is twofold: 1) find the product & business model that maximizes that natural rate, and 2) execute on removing whatever are the natural limiters to that growth rate. Limiters are the scalable part of that natural growth rate. For example, once you have the right product and know the right sales pitch, the limiter may be finding the right people to hear the pitch (e.g. sales leads). Or, if you have the right product, right sales pitch, and know the target customers, the limiter may be how fast you can hire and train the sales people to deliver the right pitch. The limiters in software business are typically leads or sales people. The limiters in a services business are typically the ability to deliver on the services (hiring and training the services delivery people).

When you try to force a business to grow faster than its natural growth rate you usually get into trouble; “unnatural acts” they’re called. Investors and management in any company are going to push the company to grow. That’s normal. But the push needs to be to maximize the natural growth rate, and not grow through unnatural acts simply to meet growth rate demands. It’s a fine distinction, but an important one.

Every business is different, but returning to our theme of Open Source, I have some observations common to many Open Source businesses on revenue growth rates. First, most such businesses use Open Source as a lead generation and demand creation mechanism. They use Open Source to create customer pull for their commercial offering, whether it’s a service and support offering, or a commercial product offering. This is in contrast to a push model which relies on a sales force (or channel) to introduce (“push”) your software to customers. Push and pull models have very different operating characteristics; that is, they have very different cost structures and revenue growth profiles.

I believe that one of the benefits of Open Source models is the ability to create customer pull at low cost. (The changing environment around software development and the software marketplace that has enabled this is a topic I hope to spend some time discussing in the near future.) However, along with that pull model is a delayed (or deferred) revenue growth ramp. Pull in an Open Source model is typically created through widespread adoption and usage of your software. Once the software is widely used, natural customer segments begin to appear. For example, customers that want insurance, indemnification, support, enhanced features, etc. But all those requests from users (pull) depend on their adoption of the software. So the initial focus of an Open source model needs to be customer adoption. And what drives customer adoption of Open source software? A quality product.

Returning to our discussion of natural growth rates, if the product does not have the adoption and usage to generate pull, the model won’t work. The initial temptation is often to fix this problem by creating “push” (i.e. spending money on BMW-driving sales reps to push the product). While push may be an answer, the real answer needs to come from an understanding of why the adoption isn’t there. Why aren’t people downloading, installing and using our product? How can we better understand the needs of the user, and make our software more useful to them so they will want to use. After all, we’re making the software and source code available for free. Price is not a barrier. If people won’t use our software for free, how much good is push really going to do?

One final thought as I wrap this up. Investors and management need to be aligned on the pull model. That means alignment on when revenues ramp (after widespread adoption when pull begins to kick in), and alignment on spending leading up to the revenue ramp. The longer it takes for you to create pull (and the corresponding revenue), the more money you burn through. The company needs to tightly control spending during that initial phase. The company needs to have a laser focus on product; spending on other efforts (e.g. sales) need wait until the customers have proven their interest in the product through adoption. If investors and management push too quickly, they will break the model.