The Venture Capital Reluctance Toward Linux

Posted by tadelste on Nov 1, 2005 9:11 PM EDT; By Tom Adelstein
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Aside from the general unwillingness of VC's to invest in startups, Linux is a no go. Many factors come into play with the primary lack of an exit strategy topping the list. When will Linux companies see the light at the end of the tunel? Or will they?

The $40 million or so Novell paid for Ximian got Boston area VC's Charles River and Battery Ventures out of a sour looking Linux investment in August 2003. Other venture capitalists from angels to the mega-billion dollar funders like Kleiner Perkins may have felt a little envy. They all found themselves in a game of musical chairs when the band stopped playing in 2001. In retrospect those days seem akward.

With Red Hat looking like a potential institutional stock and Novell peeping around the corner again, one might think that Linux companies would have a chance at serious financing. Don't count on it. Venture Capital firms have little to no interest in Linux.

While they might invest in a law firm intending to sue for patent infringements, their current interest in open source company fundings doesn't couple with Linux per se. IBM's acquisition of Gluecode Software, an open source developer of business infrastructure started a mini-shuffle in California a few months back. Then some financing rounds for Funambol and Jaspersoft got the press hot and bothered.

Those deals did not involve Linux distributors. If you want to make money with Linux you'll have to find a way to create a real business that generates revenue and cash flow. You might get a few meetings by visiting VC's but that's the most you can expect.

But I thought the market was heating up

Think again. Open source makes some sense because it alters the paradigm of business models. But when it comes to generating demand for products and services, analysts should know the economics do not work.

Some VC's believe the market turned hot this year. Certainly interest has increased. And some believe business models like those of MySQL and JBoss now resolve the biggest issues for the VCs: How to make money on something developed and distributed for free?

The biggest problem facing everyone is the ecosystem founded around Microsoft during the last two decades. If that ecosystem erodes, then Linux businesses can start to look for investment dollars again, especially in vertical market offerings. Let's take a look.

The vast Microsoft ecosystem

You might have seen arguments about cost savings presented to the major PC manufacturers, governments, schools and enterprises. Technical people realize the cost savings argument runs true. Unfortunately, technically-inclined people don't usually have control over expenditures.

Start with PC Manufacturers and you'll see that they have trouble with declining costs. Trouble you say? Yes. Each year they have to sell more units to make the same amount of money they did the previous year. Imagine if they didn't have to include the cost of an operating system or productivity suite.

This year, every PC manufacturer will expect revenue per unit to actually increase because laptops and notebooks have started replacing desktops. You can buy a desktop for $150 to $350 almost anywhere. But by the time you invest in a comparable mobile computer, you'll spend close to a thousand dollars.

Microsoft Windows and Office bundled into the sales price keeps those per unit revenue figures in-line. Without that, Wall Street will hammer your company's fundamentals and your key people will lose perhaps billions of dollars in wealth in the aggregate.

Call that the Wall Street Factor

Public financed institutions

Governments, schools and enterprises using an annual budget model will not sit down and figure out how to reduce the amount of money they received in the previous fiscal year. Forget it, it will not happen. Instead, these institutions want to get more budget money.

I have witnessed with my own eyes the budgeting process many times over the years. I've watched procurement officers and directors throw money away on line items in the budget, because if they didn't, they would not get as much funding in the coming year as in the past year.

From the other side of the aisle, I've taken orders from departments who had extra money in their budget who ordered products they would never use just to spend the money. Did they do something wrong?

By spending the last pennies in the budget, they followed the letter of the law but maybe not the spirit. You don't usually get to roll over your budget like you do your cell phone minutes. That's a fallacy in the system.

This year, one of my favorite open source state agencies rolled out Windows XP and Office 2003 rather than lose their budget money. They were afraid the state might cut their budget and so, they didn't want to see that happen. When I got news of it, I didn't say a word. No use crying over spilled milk in state with massive budget deficits. But, I'll probably always remember the director saying that this might be the last year they'll be able to do that, so why not?

Call that the institutional budget cutting factor.

The channel - VARs, resellers and ISVs

If you have ever been one of these, you know that you are tied to your primary vendor because all your money comes from reselling or selling into their product offerings. The channel rules. The channel's primary vendor rules. Even IBM business partners don't sell much Linux. They don't know how. Their customers don't understand and neither do the resellers. If IBM offers them a year-end bonus for selling Linux with one of their servers, they'll sell it for the 8 to 12% spiff. But, they don't really understand what they're selling.

Call that the channel factor.

This cannot last

I was an accountant working in the technology field when DOS systems got hammered by Windows' Graphical User Interfaces. Accounting in the enterprise relied on Novell and DOS. No one wanted Windows or NT. The wanted Novell's free Btrieve Database Engine with Great Plains and Timberline. Novell's NetWare OS and Btrieve's file manager were the most popular network and database platform for low-cost, PC LAN-based workgroup accounting into the early 1990's.

I heard and saw emotional outbursts, chairs flying through the air, fist fights, screaming and yelling when people began to suggest a change to Windows NT. In spite of all that, it happened. People eventually gave up on Netware and bought Microsoft.

Before Netware, the same kind of thing happened to mini-computer based systems. I saw DEC, IBM System 3 through 38, Bouroughs, Unysis, Data General, Texas Instruments and others go away when PC's started taking over. What about their revenues per unit and such? Hey, when it's over it's over.

If you think Microsoft is a horrible monopolist in restraint of free trade, you're right. But the IBM of 15 years ago and prior makes Microsoft look like a pen of new born puppies. Even that IBM fell.

Venture Capitalists: Rethink Linux

Who can blame the VC's for acting as if they drive their cars with their hands on their rear view mirrors? Hey, they lost money. But, when they lost money, they were out of control. That's right, they lost money. They put in their executives to run the companies, capitalized top-line revenue and thought the bubble would never burst. Now, they're stuck in the past.

Dell, HP, Lenovo, Gateway, Acer and their outsource partners will eventually wind up in the musical chair game. People will start looking for technologists again. The IT industry will grow again. Wall Street will stop driving the insanity again. Where will you be when that happens?

I do not expect Venture capitalists to develop sophisticated business plans using Linux as the linchpin of their plan. They could and eventually they will. Linux works with too many technologies and Linux companies have more drive than Microsoft right now.

Linux companies play to win. Microsoft and its ecosystem play not to lose. Ask Bill Parcells or Bill Belichick about playing not to lose. Hey, ask an elementary school soccer player about that.

It's time for the VC's to find some new blood. Linux companies can make you money. But don't wait for them to come around. Do what you used to do when the banks competed for your business: Go find a hungry, Linux guy who knows how to orchestrate a winning business and give him or her what he or she needs.

Why? Because as Bob Dylan once sang, "The times they are a-changing."

» Read more about: Story Type: LXer Features, News Story; Groups: HP, IBM, JBoss, Microsoft, MySQL, Novell, Red Hat, Ximian

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