I was recently catching up on my blog reading and saw Matt Asay's article Making Sales While Making Friends. Through his work at Novell and now at Alfresco, Matt has developed deep experience in this business so his thoughts on the topic of how open source software companies work are definitely worth hearing.
Matt's core model is that a community of open source software consumer is composed of "friends" and "customers." Friends are the people that use your software, customers are the ones that pay you for it. I think it goes without saying that you hope that your customers are also your friends. I like this perspective. Although I didn't see the OSCOM presentation that the article is based on (I am sorry I missed it), Matt's blog post implies that the primary value of friends is that they are potential customers. While I don't disagree with that point (companies need revenue to pay their employees and grow), I think that friends offer much more than just potential customer conversions.
A strong community of users (regardless of whether they pay) brings new ideas, testers, buzz, market share (so that other software component builders recognize your software as something worth integrating with), and sometimes contributions to the software. I agree with Matt's point that you need to have modest expectations for external contributions especially when you start out. You need to get the software to a point where it is close enough for people to take it the last mile before you can get anyone interested in it. Also, communities are fickle things and building an active, contributing community can be like catching lightening in a bottle (unless you are Microsoft and you can build something like MSDN and constantly pump money into it).
So you need to convert some percentage of friends into paying customers. I guess it is really a question of percentages. If you can live with a low conversion rate, friends that don't and won't convert start to look a lot less like freeloaders and more of an opportunity to tap other forms of value from. The conversion rate depends on what kind of software you are providing. Something like Firefox is a simple application that everyone needs. Gazillions of people download Firefox so Mozilla only needs a small percentage people to donate money or improvements to the project. Many of the people that do not donate code or money, build Firefox extensions which bring other forms of value to the Firefox community.
Probably most open source companies are not attempting to be like Mozilla. Mozilla is a non-profit (yet with a for profit subsidiary - figure that). Mozilla's purpose in life is not to make money but to make an alternative browser that is not controlled by Microsoft. Many companies and individuals benefit from the existence of Firefox and support the project in different ways. So assuming that you are funded by someone that wants a return on their money (VC or your in-laws) how do you manage your open source company to profitability? You need to keep your costs low. Open source creates an economy where potential customers can self select. You don't need and can't afford an expensive sales force or marketing department. You don't want to waste your resources selling to friends that are not likely to buy. But you do want to invest your resources in encouraging behaviors that your non-buying friends are more likely to engage in. eZ systems has a points program where partners can get points for various contributions (answering questions on the forum, attending training sessions, submitting sites to the references section, fixing bugs, writing documentation, etc.). Points reduce the cost of services that eZ systems sells: training, support, monitoring, etc. It seems like a pretty good system but I don't know how it is working in practice. Perhaps someone from eZ can chime in here.
These companies need to make the dollars and cents work. We learned from the bubble that you can't lose money on every transaction and make it up on volume. But you can challenge conventional wisdom on what kind of conversion rates you need and the cost of reaching customers. Anyway, I find this stuff immensely interesting. If you do too, you should read Matt (http://asay.blogspot.com/) and Stephe Walli (http://stephesblog.blogs.com/) who has really helped me understand this market - or contributed to my delusion ;)