Goldman Sachs software research analyst Rick Sherlund recently published a research note on the software industry showing that software companies are now using virtually all of the revenue generated by software license fees for sales and marketing. According to the report, S&M as a percentage of license revenue has increased to 76% in 2004 from 65% in 200.
Sherlund speculates that this trend will spur industry consolidation, as it becomes cheaper to gain customers through acquisition rather than through traditional S&M. Fewer dollars are also available for R&D as the percantage of dollars spent on S&M grows. Companies will have less to invest (as a percentage of revenue) in R&D, and be more likely to acquire new technology.
The increased spending on S&M is in part being driven by more dependence on annuity maintenance revenue. According to Sherlund, in effect maintenance is subsidizing new license revenue generation activity for some of the more mature companies. Larger up-front S&M costs are justified by a larger lifetime customer value from maintenance.
I don't disagree with Sherlund's conclusions. However, I think he's missing another result from this trend: the economics of Open Source companies become more favorable as S&M costs increase for proprietary software vendors.
One of the major advantages of the Open Source model is a built-in lead generation mechanism. Companies such as Zend, JBoss, MySQL, and SugarCRM gain significant economic leverage because of their installed base of free users. Lead generation is essentially free; just follow the existing user base! There's no need to introduce the product to the customer. There's no need for pilots in the sales cycle. The customer already knows the product and already has experience with it. The sales job becomes converting users of the free version to the commercial version.
The difficulty of making that conversion should not be underestimated. However, I suspect that it's much less costly than the traditional enterprise software sales process. Further, the trend towards maintenance supports the Open Source model and conversion to the commercial version. Customers have shown a willingness to pay reasonable fees for ongoing maintenance and support.
The business model contrast becomes:
| Proprietary | Open Source | |
| Pay a large upfront software license fee to support the initial sales and marketing of the product. Make money off the ongoing maintenance fee. | Give away the product for free, and use the free user base to drive the initial sales and marketing of the product. Make money off the ongoing maintenance fee. |
Interesting comparison, isn't it? The second model begins to look awfully attractive. Economically it's less expensive to the customer because it eliminates the up-front license fee.
Who would have thought that Open Source would be all about sales and marketing?