Open Source Strategy Research Blog

Updating business strategy for a world embracing open source

Tuesday, June 1, 2010

Open Source Growth: How Open Source Can Support Traditional Growth Strategies, Mekki MacAulay

This is the draft version of an article I wrote for the June, 2010 issue of OSBR (www.osbr.ca)

“The rules of the game are continually changing. It’s no wonder that participants are now particularly receptive to the siren song: ‘Discard the old, leave your historic core business behind and set out for the promised land’. Sometimes this advice leads to the right course, yet usually it does not solve the fundamental problem and can even aggravate the underlying cause of inadequate profitable growth. The key to unlocking hidden sources of growth and profits is not to abandon the core business, but to focus on it with renewed vigor and a new level of creativity.” Chris Zook & James Allen

Carefully selected open source strategies can help support business growth. By focusing on its core competencies, its competitive advantage, and current market successes, a company can use open source strategies to improve its ability to expand its product base, reach new markets, and diversify through vertical integration. This article discusses three traditional business growth strategies and highlights how an open source angle can help improve their effectiveness, without compromising the core business.

Growth from the Core

Companies must grow to survive, and stay relevant to their customers, investors and employees. Most companies that don’t grow cease to innovate, become stagnant and eventually either cease to be relevant, or go out of business. But growth is a painful process, one that is difficult to navigate. There is a long list of once successful companies that tried to grow and failed, destroying the value they had developed in their core business. It can be tempting, especially for young companies, to jump on the latest trends, or blaze trails into new markets, but this strategy, as Zook and Allen remind us, can lead to a quick demise. Open source, with its promise of quick development cycles, accelerated customer adoption, and low cost can be a component of a viable growth strategy, but businesses must resist the siren call to discard their core business.

Every successful business is based around core products and/or services, customers and competencies. This core is the foundation of the business, and its structural pillar of value generation for all of its stakeholders, investors, customers, and employees. A strong core affords a company cash flow to support its growth efforts, which can be time consuming and expensive. It gives the company a staging ground from which to plan its growth. And, most importantly, it defines the company, its profile, goals and values, all of which are important in long term strategic growth. At the most basic level, the core of a business is what it “knows” and “does really well”. It is what creates value, maintains competitive advantage, and motivates the company to grow.

Growth doesn’t come on its own; it must be earned. Companies earn the right to grow by developing their core business to a point where it is self-sustaining, has relevant products/services with an established customer base and notable market share. Companies that haven’t yet reached this point cannot yet afford to spend their precious resources on growth, and should instead first focus on solidifying the core. Once the core is stable, and the company has the leeway to focus its attention on its next stage of evolution, it is ready to grow. There are several strategies that allow companies to grow without extending too far from their core.

Growth Strategies

There are three major growth strategies that were first described by Igor Ansoff in his 1957 Harvard Business Review article (Strategies for Diversification, Harvard Business Review, 35(5), Sep-Oct 1957, pp.113-124). He explained the dimensions of expansion from a core business with successful products/services and an existing client base. Figure 1 (Adapted from Ansoff, 1957) describes the dimensions of growth from a core business.

Figure 1: Growth Strategies from Core Business

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The first strategy is new product/service development: selling new products/services to the same customer base. This strategy leverages the current customer base, target market demographics, and accessible geographies of the core business and focuses on finding new products/services that meet the current and future needs of customers. This is one of the most common growth strategies and has numerous advantages: the primary one being the ability to query the existing customer base for pain points that have not yet been addressed by an existing product or service. Working with existing customers can yield innovative ideas and help chart out the growth path of the company. It spurs innovation in the company, which can lead to discoveries and advances that solidify and build the company’s stakeholder value and long term industry relevance.

The second strategy is market expansion: selling the same products/services to a new customer base. This strategy leverages the product/service expertise that the company has honed through its core business and focuses on bringing the products/services to new customers in new markets that have previously gone unserved by the company. This strategy’s primary advantage is that it allows the company to focus all of its energy on acquiring new sales instead of research and development. It takes successful products/services and reaches out to new customers who were not previously part of the target market. One of the best ways to execute market expansion is to expand the company into new geographies, such as new cities, provinces, or countries. This expansion may lead to minor tweaks and regionalization of the products/services, but does not stray far from the core business.

The third strategy is diversification: expanding into new businesses, most often through vertical integration in the supplier chain. Most companies that are in a position to grow are part of a supplier chain that funnels a raw product/service and progressively refines it until it reaches the client. A vertical integration strategy is effectively a combination of the previous two strategies that still leverages the core business. It proposes expanding into a new customer market where the new customer is the current core business. This approach is advantageous as the needs of the customer are well understood. It proposes new products/services at the same time, where the new products/services are those that are consumed by the core business. This approach has the advantage in that the pain points that the products/services address and use of these products/services are well understood. By acquiring a company upstream in the supplier chain, a successful intermediary can expand its influence and control over the supplier chain while acquiring more of the net value created in the chain.

Open source can play a creative role in each of these strategies to improve their effectiveness and likelihood of success.

Open Source and Growth via New Product/Service Development

New product/service development implicitly implies innovation. Traditionally, innovation occurs through internal research and development, requires time and effort, and very few ideas make it all the way to the customer. Increasingly, companies are moving towards an open source innovation strategy to address some of these issues. In his 2003 book Open Innovation (http://www.openinnovation.net), Henry Chesbrough compares the traditional model of closed, intra-company innovation and open innovation principles. Table 1 compares these principles.

Table 1: Comparing Closed vs Open Innovation Principles

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The advantages of an open source innovation strategy are clear: there are numerous existing product/service ideas, allowing a company to identify new opportunities and capture a portion of the value generated without having to generate the ideas from scratch. This strategy allows the company to focus its resources on the correct execution of the idea that leads to a product/service.

Open innovation principles lead to strategies that complement, and depend on, the core business. The focus shifts away from coming up with innovative products/services to positioning the company to acquire value from existing product/service ideas. Depending on the core business, the best way to acquire value from an existing idea may be through the ability to deliver that idea better than anyone else to an existing market. Such an approach leads to a distribution focus. Another core business might have strengths in development and may take a base idea and improve it threefold, selling a new and improved version to an underserved market. Such an approach leads to a development focus.

In some cases, it is possible to take the open source strategy even farther, right through to collaborative and distributed development. This is possible where the core business has a positioning that can partner with customers, or other industry participants who are not in direct competition, to work collaboratively on product/service development for mutual gain. A common example is partnerships between a company and a government agency. By opening up new product/service development to participation by a government agency, a company can benefit from the free innovation and development work of the agency, while earning revenue through support services, specific feature development, and in-depth product expertise–all the while safe in its knowledge that a government agency is not likely to suddenly go into the product/service business in direct competition.

This approach can also lead to mutually profitable associations in a broader, more distributed context. In such models, the products/services that are collectively designed and developed in the open source community are at one participation layer for the company seeking to grow. The growth takes place at a different layer, typically with revenue-generating services overlaid on the new product/service development. The new product/service development becomes an extension of the core business that improves its revenue generation potential. One example is the Symbian (http://www.symbian.org) cellular phone operating system which Nokia recently acquired and promptly released as open source. The core business of Nokia is selling cell phones. By engaging in new product development and improvement of Symbian, and allowing the community to improve it via distributed development, Nokia increases the value of its cell phone production, bringing more features and services to its customers. Such an approach can lead to company growth just as surely as if they had developed a whole new cell phone from scratch.

Another successful open source strategy for new product/service development hinges on the idea of distributed platform development. This strategy focuses on building and offering new products/services that meet a specific need, such as that of the customers of the core business, by creating a platform that is shared by other developers who target other customer markets. It protects the company’s core business by modularizing and opening a portion of the product/service that is not the core competency of the business and not part of its competitive advantage. This approach allows the company to focus on its value-add (its competitive advantage) while effectively outsourcing the foundation upon which it is built. It also allows the company to develop and leverage a brand surrounding the platform. This brand becomes an asset whose value could exceed traditional products/services. An example of such platform brand value is Sun Microsystem’s (now Oracle) Java platform. The Java brand enjoys high recognition and is associated with a broad range of products and services, from desktop applications, to web services, to cell phone games. Sun’s open source platform development strategy led to the effective creation of a “new product” for the company in the form of a brand, and they captured value through the lucrative licensing of the brand.

Open Source and Growth via Market Expansion

When seeking to expand into new customer markets, one of the biggest challenges is customer adoption. An open source strategy can help improve the adoption of a product (and, in turn, an overarching service) in a new market through viral redistribution. By encouraging end users to redistribute the product, a world of mouth effect quickly leads to exponential increases in awareness, the first step in market penetration. Companies must be careful to pay close attention to the market response immediately after a product release as the needs of this new market may be substantially different from the needs of the market that was previously addressed by the core business. This strategy works particularly well if the core business operates at different layers, where one product, or part of a product, can be open sourced to bring new clients to the company. This way, revenue is still generated by the other parts of the core business, be it support services, network infrastructure, or complementary products. The open source product will bring the new market to the company, and the core business has to deliver something of value to that new market in order to capitalize on the new market. An example of such value is releasing a basic, open version of a product to a new, overserved market, and offering a fully-featured closed version of the product to customers who require additional functionality. This strategy can lead to increased brand recognition and can devalue competing products, both of which can lead to market expansion.

One way to reach new geographies with existing products/services is to localize them by adapting the language, interface, and features to be suitable for a different geographic and linguistic environment. This process can be time and resource consuming and, to be successful, it is important that the company understands the specific linguistic, cultural and functional needs of unfamiliar markets. One way to address these challenges is to open up the product/services for distributed, collaborative localizing, typically by modularizing all the regionally-specific components into a generic framework called a locale. Locales can be developed by participants in underserved markets who would benefit from access to products/services that weren’t initially written for them. Mozilla’s Firefox web browser is one of the most successful examples of such a strategy, with locales available for over 70 different languages and regional needs. It is likely that this localization strategy played a role in its rapid adoption, grabbing a sizable share of new markets where localized versions of Microsoft’s Internet Explorer were not available. Figure 2, from Mozilla’s Q1 2010 Analyst Report on the State of the Internet (http://blog.mozilla.com/metrics/2010/03/31/mozillas-q1-2010-analyst-report-state-of-the-internet), shows the international usage statistics for Mozilla Firefox, highlighting the success of its localization efforts.

Figure 2: Firefox Worldwide Market Share

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Open Source and Growth via Vertical Integration

A supply chain is a set of companies that work to progressively refine a product/service from basic principles, such as raw materials or consulting, until it is ready for consumption by an end user. Each company in the chain adds some value to the product or service and, in turn, extracts some value from the supply chain. This value extraction is not uniform as different companies at different places in the supply chain extra different amounts of value. In typical supply chains, there is one company that extracts the lion’s share of the value. Yet, this position is precarious. If it extracts too much value, there may not be enough resources to support the rest of the supply chain which could collapse. Such a collapse can happen even when there is high demand, especially if a product/service is disrupted. The key to company survival and growth is to gradually move towards the most profitable place in the supply chain, the place where the most value can be extracted. An open source strategy can help with this supply chain positioning by acting as a funnel of resources to the desired value extraction point in the supply chain. This strategy must be carefully executed in order to not destroy the core business.

One approach to shifting the value extraction point in the supply chain is to introduce an open source product/service that is positioned to compete with products offered at that level of the supply chain. This introduction is effectively signaling to the market that, since an open source product is replacing a paid product, the value-added is elsewhere in the supplier chain. This may lead to a devaluation of the other products at that position. The core business must, at the same time, focus on research and innovation to introduce new products/services that refocus and capture customer attention. This diversification strategy leverages the loss leader (http://en.wikipedia.org/wiki/Loss_leader) open source strategy, while positioning the loss leader elsewhere in the supply, outside of the core business, insulating it from devaluation effects. This strategy is being experimented with in the Netbook supply chain. Several Netbook manufacturers have moved to release open source embedded operating systems for their devices that offer basic functionality such as web browsing and media playback. This strategy is testing the ability to weaken Microsoft’s dominant position in the supply chain while funnelling the value to device manufacturers who previously could only extract a small percentage of the total value generated by the supply chain.

Greg Wallace describes (http://linux.sys-con.com/node/173425) a similar effect in the customer relationship management (CRM) system supply chain based on the strategic choices of open source company SugarCRM (http://www.sugarcrm.com). By moving the focus away from hardware and software and towards value added services in the CRM supply chain, SugarCRM positioned itself as the leader in customization services, its core business, extracting the lion’s share of revenue from the supply chain. Figure 3 describes the evolution in the CRM supply chain in terms of value.

Figure 3: Evolution of CRM Supply Chain

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In Closing

Growth is challenging. While open source strategies can give a competitive edge, not all circumstances and companies can leverage these strategies. They are highly dependent on the nature of the core business, the products/services offered by the company, its environment, customers, and supply chain. Every company is different and should devise a strategy that is the right fit for its situation and goals. An open source strategy should be looked at as another tool in the toolbox of strategic growth planning, and not as a one-size-fits-all roadmap.

posted by Mekki at 12:09 pm  

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