New breed of open source upstarts eye rising revenues and IPOs

Can big businesses be built on the idea of giving away software free of charge?

That paradox has stumped some of Silicon Valley's smartest investors since "open source" software broke on to the tech scene, with the rise of the Linux operating system 15 years ago.

Red Hat, which grew by selling maintenance and support to companies that used Linux, is now worth nearly $14bn. But other hopefuls fell by the wayside - even as open-source came to infiltrate many parts of the IT world, thanks to projects such as Linux and the Apache software used in most web servers.

Now, investors are lining up to have another go, as a new breed of open source companies report rising revenues and plan initial public offerings. And this time, they think they have better ways of turning the popularity of open source into profits.

Open source software companies rely on networks of volunteer developers to help write their code and build an initial user base. They then aim to turn users into customers, giving the software away free while selling support services or add-ons.

Unfortunately for the upstarts, many big tech companies have co-opted open source themselves, to fill gaps in their own technology - and have added support for the code to their own business plans. Even Oracle and Microsoft, the most directly threatened by free software, have adjusted their strategies to accommodate aspects of open source.

However, while the first wave of open source relied on making free versions of existing programs without adding much new, Mike Volpi, a partner at venture capital firm Index Ventures says new approaches are emerging with the growth of cloud computing and "big data" analysis. He says that some developments in open source software are not being matched in the traditional world of commercial code.

For example, Hadoop - code developed at Yahoo before it was released in open source form - is becoming a foundational technology for the era of big data. Hadoop was designed to handle the masses of data stored in the sort of distributed computing systems pioneered by large internet companies and now found in wider corporate use.

Earlier this year, Cloudera, one of the companies trying to build a business on Hadoop, declared itself the second open source company to hit $100m in annual revenue, after Red Hat.

Open source is also proliferating in databases designed to support applications that run in the cloud. MongoDB, the standard-bearer for this wave of so-called NoSQL database companies, was valued at nearly $2bn in a round of fundraising earlier this year. Along with Cloudera - which has raised $1.2bn, much of it from Intel, and been valued privately at more than $4bn - it is at the forefront of a wave of IPOs anticipated for next year.

Critics, though, point to the past failure of open source developers to make much of a dent in the sector. Their technology "is not tested, it's not hardened, and they have this new business model that's totally unproven", says Gary Bloom, chief executive of MarkLogic, a NoSQL company that still takes the traditional approach of selling licences to its products. MarkLogic's own revenues last year were "well north of $100m" and the 14-year-old company is also eying an IPO, he adds.

In recent years, though, being able to reach a mass user base with free software proved a bigger lure - even if turning reach into revenue has been a challenge. "If the cost of entry to our technology was $100,000 a server, not many people would be in a position to use it," argues Kelly Stirman, head of strategy at Mongo. There are "hundreds of thousands of deployments" of the company's free software, he says, though it has only 2,000 paying customers.

Ben Golub, chief executive of open source company Docker, suggests the new wave of developers have learnt the lessons of the past and are adding commercial tools and services to the mix.

One opportunity lies in the need for add-on technologies to monitor and control IT systems. Mongo, for example, lets users run management software on eight servers free of charge, but makes them pay $50 a server to add more.

A further opportunity comes from running the software on their own servers and providing a service to users through the cloud. Docker, for instance, sells a hosted service to small businesses that do not want to take on the work of managing their own IT.

Even so, some are still relying on the old model of offering free software but selling the maintenance and support. This is clearest in the Hadoop market, where Hortonworks - which last year became the first open source company since Red Hat to IPO - has stuck to the older business model in contrast to rivals Cloudera and MapR.

Whatever their business model, the new generation of open source companies will have to move fast to avoid being crowded out by established tech giants.

Big players' influence is clearest in the development of OpenStack, a package of software designed as a foundation for cloud computing. IBM and Hewlett-Packard have turned to OpenStack to support their own ambitions against cloud companies including Amazon and Microsoft.

"Everyone has an axe to grind on it," says Mr Volpi, which has slowed progress. "There is a reasonable amount of frustration over the speed with which it is being implemented."

It may sound like an opportunity for focused open source companies. But history suggests that even if their software catches on, commercial success may be elusive.

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