Open Source in the Share of Wallet Wars

On their blogs, Matt Asay and Savio Rodrigues are discussing whether IBM is using open source to diminish competitor margins. I think it is obvious that IBM does this, most notably with its Linux engagement, which is squarely directed against Microsoft (Windows). It is what I call a war over the share of customer’s wallet, and open source plays a major role. The graph below shows how it works.

By “share of wallet” I mean the amount (percentage) of a customer’s IT budget that a vendor can get. Any IT user buys multiple different components, for example, operating system, productivity tools, and business applications, but ideally they only buy one of a given type. They only want one database, not many. So each IT vendor has two types of competitors: those that directly compete with their products, and those that offer ancillary products. You can take on your direct competitors through better sales or service or product. For ancillary products, you need a different strategy.

If you offer a business application, databases and operating systems are ancillary (complementary) product categories for you. You aren’t offering a product in that category, so you can’t make any money of it. You can, however, reduce the amount of money that these other products take out of a customer’s IT budget (wallet) and then convince the customer to spend that extra money on your product. So what you want is to shift money from one component in the solution stack to another component, specifically to the one you are offering.

How do you do this? Well, you diminish the margins of the components that are ancillary to your product, as Matt rightfully points out. Look at the figure above. If you can make the customer spend less money on the database and operating system, then you can possibly gain that money for the application component. So, if you are an application provider, you may want to invest in open source solutions for database and operating systems, if they are cheaper than the leading proprietary solution (which they typically are). This leaves more money on the table for your application.

I think that’s the open secret behind IBM’s Linux engagement. By ensuring that there is a viable competitor to Windows, at least on the server, IBM is keeping Microsoft’s pricing in check, leaving more money to be spent on other software packages. Is there anything wrong with it? Not really, it is just competitive strategy, to the benefit of the customer in this case.

If you want to hear or read more about this, you can turn to an earlier article which discusses the share of wallet wars or catch me next at Agile 2008, where I will be talking about this too.

Posted on

2008-06-18

1. Software Industry, 1.2 Open Source (Industry)

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Dirk Riehle

2008-07-16

Hi James, this is a smart observation, and I agree that more often than not the money is shifted into services rather than more software. I think this is one reason why IBM is such a strong supporter of open source; it plays directly to the strength of its global services arm.
I make the argument here using software because it is the easiest way to explain it. Previously, I used more elaborate economic models of supply and demand in open source, and they are still valid and principally the same, but then, well, more complex to explain.
However, this added complexity is not for nothing. There are actually multiple effects in these economic games: Less money spent on some software components not only makes it possible for customers to buy more, it even makes it possible for vendors to reach more price sensitive customers that were previously out of reach, see the referenced publication above.

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James Dixon

2008-07-16

Hi Dirk,
I agree with your main point and I have been using a diagram like this for a few years when I talk to people about open source and commercial open source implementations. I think it is important to note that the money that is freed up by lowering the cost of the components can be spent (and I contend usually is spent) on services not on product. By spending this money on services instead of product you get a more successful outcome for the project.
If is useful at all I have a paper/wiki on the single vendor commercial open source model called the Beekeeper: http://wiki.pentaho.com/display/BEEKEEPER/
James Dixon

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Morten Blaabjerg

2008-06-25

Great illustration of something which is otherwise hard to illustrate. I bet your talks will give someones somewhere something to think about…
To add to this line of thinking, I believe this strategy can be applied to other types of businesses, especially online, where it is easy to give something away for free. When a company gives something away for free, such as an online service, it is also fighting the “war over the wallet”.
Take Google as an example, which offers a wide range of free online services, in direct competition with “offline” solutions such as MSOffice and Outlook. By providing private users as well as businesses service, they’d otherwise have to pay for, it leaves room for spending that money on, say, online advertising, in Google’s case.

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Reginald Beauchamps

2008-06-22

It’s a myth that open source products are cheaper to buy but have an equal or larger TCO than proprietary software. Microsoft have spent a large amount of money selling this myth, so it is not terribly surprising to find it repeated here.
Many, many people are self taught on the linux side of things at sys admin level and less frequently at developer level. Nonetheless the differential between rates of pay on the windows and unix side are simply controlled by supply and demand.
This was a very interesting article. I see the benefit for IBM post OS/2. Linking this to their ODF strategy, it seems they have some very decent thinkers in their business.

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Dirk Riehle

2008-06-19

Hi Darren, thanks for the comment.
The consulting perspective is actually quite interesting. One might argue that consultants would like all software to be free so that more money is left for consulting and implementation services. However, if everything was open source, the barriers to entry to the consulting services market would go down significantly, as every high-school dropout could set up shop if they only had enough energy to dig into the software. So you’d want to strike a balance between employing open source and relying on (expensive?) proprietary source that protects your market value.

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Darren Hague

2008-06-19

Dirk,
This is also interesting from the implementation consultancy point of view. Although the open source components are cheaper to “buy”, often they require more resources to implement and support (this is partly because many open source products are more focussed on features than on usability or documentation). From a consultancy perspective, this can be a good thing – even if the operating system or database ends up costing them customer nearly as much as the proprietary version, the extra implementation/support money is going to the consultancy instead of to a software vendor.

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