Open business models and venture investments

Open business model adoption versus closed business model adoption – which entrepreneurial ventures are more likely to secure venture financing? A recent working paper a group by researchers from Politecnico diMilano, Ecole polytechnique fédérale de Lausanne, Sweden’s Royal Institute of Technology and York University examines these questions and provides valuable insights on how the business model adopted by entrepreneurial ventures to commercialise their technology influences the venture capital (VC) selection process.

See graphs from this article here and here.

The research study is based on a sample of 6,555 investments in 514 software start ups that received the first round of VC finance in the period 1994 to 2008. Of these ventures, 124 adopted an open business model based on open-source software, while the remaining start ups adopted a closed business model based on internal innovation activities leading to the development and sale of proprietary software.

The majority of technology-based ventures have traditionally focused on creating value through closed business models. However, over the past few years, a variety of analysts and industry experts have observed how increasing competition and product development costs have led to more and more entrepreneurial ventures, especially in the infomation and communications technology sector, to open up their business model. Past research, as noted by the authors of the study, shows that adopting open business models involves a complex trade-off between value generation and value capture.

In other terms, while the adoption of open business models may help entrepreneurs in creating value through increasing innovative performance, reducing costs considerably and improving the quality of products, these benefits are invariably accompanied by greater organisational complexity and important implications for the viability and long-term sustainability of the revenue generation models. For such reasons, one may expect that ventures adopting open business models are more likely to experience important difficulties in attracting the financial resources and partners necessary for growth. They might be seen as less attractive, more uncertain, business opportunities.

Interestingly, the study finds that software entrepreneurial ventures that adopted an open business model receive funding from higher-quality VCs, with VC quality being measured by general experience, industry-specialisation, initial public offering success, raised capital and connectedness in syndication network. As noted by the authors: “The result can be driven from two different explanations. First, higher-quality VCs possess resources and expertise that can help them tolerate higher risk and help them deal with the complexity of open-source software business. Second, higher-quality VCs are able to screen more efficiently and are more likely to select higher-quality entrepreneurial ventures.” Moreover, the study reveals that staging more frequently is a common investment practice adopted to derisk investment in the open entrepreneurial ventures and to leverage the superior coaching, monitoring and networking abilities of high-quality investors.

Reference

Colombo, MG, Cumming, D, Mohammadi, A, Rossi-Lamastra, C and Wadhwa, A (2014) Open business models and venture capital finance. CESIS electronic working paper series, Royal Institute of Technology, Stockholm, Sweden.

Open business models and venture financing

To provide more insights on the open-source and open-source software ecosystem, it is important to understand the scale and scope on a global basis, as well as its impact and challenges on industries and companies today and in the future. This includes also the 2020 outlook on the “internet of everything” (IoE) and its proliferation across new and traditional products and industries, as well as the current venture funding, which helps fuel this future growth.

Open source driven by the IoE value

From 2013-22, $14.4 trillion of value (net profit) is at stake for enterprises globally – driven by IoE.

Asset utilisation ($2.5 trillion) – IoE reducesselling, general and administrative expenses and cost of goods sold by improving business process execution and capital efficiency.
Employee productivity ($2.5 trillion) – IoE creates labour efficiencies that result in fewer or more productive man-hours.
Employee productivity ($2.7 trillion) – IoE eliminates waste and improves process efficiency.
Customer experience ($3.7 trillion) – IoE increases customer lifetime value and grows market share by adding more customers.
Innovation and time to market ($3 trillion) – IoE increases the return on research and development investments, reduces time to market, and creates more revenue streams from new business models.

Drivers of IoE

Cisco estimates that 99.4% of physical objects are still unconnected in 2013.

Powerful technology trends – including dramatic increases in processing power, storage and bandwidth at ever lower cost, plus the rapid growth of cloud, social media and mobile computing, combined with the convergence of hardware and software in more powerful ways.
Barriers to connectedness keep dropping – driven by the new internet protocol.
Form factors continue to shrink – ranging from solar cells, batteries, sensors, memory, antennas and other non-visible things in future.
Business value creation – through the IoE connections and the intelligence created from it.

Open source creates new communities

Open source is enjoying a proliferation that starts with a growing number of developers at grassroots level. Many of them then join enterprises themselves engaging in open source projects. Increasingly, these enterprises have started to organise themselves more actively, as they realise the importance of open source innovation to jumpstart careers and kick-start projects. Open source is consuming the software world as the inherent quality, functionality, and increasingly ease of deployment creates a powerful gravitational pull on people and industries. This self-reinforcing virtuous cycle will result in the most exciting applications having an open source foundation.This is why many of the leading technology areas treat open source as their “foundational platform”.

Connections that matter the most?

By definition, the IoE includes three types of connection – machine-to-machine (M2M), person to machine or machine to person (P2M or M2P) and person-to-person (P2P). Combined P2M and P2P connections will constitute 55% of the total IoE value at stake($14.4 trillion) by 2022, while M2M make the remaining 45%. While M2M connections are fast becoming a sizeable source of value, the end result of these connections is ultimately to benefit people. The following is the expected IoE economy value at stake by 2022:

M2M (machine to machine $6.372 trillion (45%).
M2P or P2M (machine to people and vice versa) $3.501 trillion (24%).
P2P (people to people) $4.519 trillion (31%).

Open source and IoE keep evolving

“Software is eating the world,” said Marc Andreessen. Next-generation companies, such as Amazon, Google and Netflix, handle development in fundamentally different ways in leveraging open-source software. “Open Source makes up 30% or more of the codes at Global 2000 organizations,” according to open-source software logistics company Black Duck, which also claims open-source projects have grown globally from 175,000 in 2007 to 1 million in 2013 and are expected to reach 1.75 million in 2015. The open-source software licence spectrum is key to the proliferation of open source throughout every industry, according to Mark Radcliffe, a partner at law firm DLA Piper.

Source: Martin Haemmig and www.blackducksoftware.com/resources/ (2014 survey)Graphs and tables cannot be reproduced without written approval from Martin Haemmig.

Boris Battistini is a senior research fellow at ETH Zurich and a project leader of the Corporate Venturing Research Initiative with Bain & Co (email: bbattistini@ethz.ch). Martin Haemmig is an adjunct professor at Cetim at UniBWMunich and Leiden University (email: martinhaemmig@cetim.org)

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