Open-source business models: Riding the future of enterprise infra market

By Arnav Sahu

  • 19 Jul 2022
Arnav Sahu, investor, Y Combinator Continuity

In the past few years, open-source (OS) business models have become widely successful in disrupting the enterprise infrastructure market. It’s crazy to think that giving away your code for free is actually a competitive business advantage. 

OS companies that have gone public such as Hashicorp, JFrog, Elastic, MongoDB, Gitlab have shown blueprints on how to build and scale open-source business models.

The benefits of building an open-source company are widely documented. In my mind, the two key advantages are (1) Crowdsourcing product development, (2) Lead-generation for sales. In particular, the open-source model has opened all sorts of GTM (go-to-market) distribution opportunities.

First, OS companies rely on contributions of the broader developer community. Any developer around the world can contribute, particularly around integrations, bugs etc (with the approval of the core authors of the OS project). Developers that make community contributions are also incentivized to evangelize the OS project. Often in job interviews, developers can use the number and quality of contributions they make to prestigious OS projects, as an important calling card. Community contributions enable OS companies to build new features and integrations faster. Moreover, OS companies can be global from day 1 and built from anywhere. In India, for example, OS companies like Hasura attract contributions from all over the world.

Secondly, open-source serves as a lead generation engine for sales. The beauty of OS software is that anyone can download and use the software for free. This enables open-source companies to acquire a vast free user base. Unlike freemium models (eg - Zoom, Slack), users can actually see the code and configure it to their own environments. This is especially helpful in enterprise infrastructure buying decisions - where it can be hard to convince a large customer to run their infrastructure on a young startup. However, if the customer already has many developers in the organization already using the free OS software, can see the code, test and configure to their needs, it’s an easier decision for the chief investment officer or chief technology officer to trust the startup in the buying decision. Users have already gone through a 6–12-month journey with the software. In this regard, the GTM journey for an open-source company is often less about acquiring new customers, but more about conversion sales - upselling existing free users through add-on paid features. This bottoms-up sales motion makes the open-source business model particularly attractive because it is much cheaper and easier to upsell a user, than acquire a new one.

There are a few primary ways of monetizing open-source software - services, open-core and software-as-a-service (SaaS). First, open-source companies (eg - Redhat) offer support and services to help customers implement and install open-source software. Second, in an open-core model, companies sell a set of additional enterprise features on top of the free version - the vast majority of functionality is left in the open-source version, while the paid version comes with features an enterprise buyer cares about. Such features include security controls, monitoring, analytics and dashboarding, team collaboration, auditing etc. The open-core model is the most popular model today. In the context of deployment models, a customer has two options - they can self-manage (download the open-source code and manage the software themselves in their own data centre) or buy SaaS. Customers that self-manage are responsible for uptime, scaling, security and management. Larger customers (example - financial institutions) often prefer to self-host infrastructure products because they have the engineering resources to do so, and gives them more control over security.

In the SaaS model, the open-source vendor will host and manage the software for the customer. The biggest advantage is that it abstracts away all the complexity of managing the infrastructure - it’s an out-of-box offering. In the early days of open-source software, self-managed deployments were common. Historically, OS startups started by selling self-managed deployments made the transition to SaaS (eg - Elastic, MongoDB) later in the company journey. Today, open-source startups offer a SaaS product much earlier in the company journey. In many ways, SaaS open-source models expanded the market opportunity - it enabled SMBs and mid-market customers to adopt OS products, because they do not have the time or resources to self-manage - with SaaS, they get a fully hosted, out-of-box solution.

As the open-source ecosystem matured, cloud providers became more competitive. They built their own SaaS offerings as a wrapper around the OS product, which could be downloaded for free. Instead of buying the SaaS product from the company that built the open-source project and wrote the code, customers could instead buy it from AWS (eg - buying AWS Kafka vs Kafka from Confluent). Critics thought this could signal the end of open-source - why would anyone write OS code if the cloud providers could simply take that code and build their own SaaS product on top? However, while cloud providers have seen moderate success in this strategy, several customers often still prefer to buy software from the original creators of the OS project. The authors of the OS project have final say on the contributions to the code base, and can hence, influence its product roadmap better. They act as the moral and spiritual center of the project in the eyes of the community. With the notable exception of Github, most successful open-source companies have at least 1 original contributor in the company..

Historically, giving away your code for free in the software industry would historically be considered laughable. Today, it’s actually a business advantage to start an open-source company.

Arnav Sahu is an investor at Y Combinator Continuity, which primarily supports accelerator Y Combinator alumni companies.