The commoditization of software

software is commoditized by the appearance of open-source software--its low cost serves as a strong challenge to proprietary software companies' business models.

COMMENTARY--For years, hardware companies struggled under pressure from the forces of commoditization, as widespread popularity of standardized operating systems forced them into withering competition, the end result of which was a phenomenal reduction in hardware prices. Today, the shoe is on the other foot, as software is commoditized by the appearance of free (as in cost) open-source software. Constructed through the joint effort of thousands of programmers around the world, its low cost serves as a strong challenge to proprietary software companies' business models.

Commoditization is a powerful force for consumer benefit. In hardware, however, there was never any risk of free hardware pulling the economic rug from under the industry. Commoditization, taken to the point where software is practically free, would run contrary to the interests of software developers who have an interest in earning a living from their craft. In short, a market where the price of software plummets too low will rapidly drain the value of programmers, and hence cost many programmers their jobs and drain the industry of investment as investors chase more lucrative places to put their money.

The "de facto" free nature of open source
The last time I poked my nose into the open source debate, a lot of people pointed out that open source does NOT imply no cost. They noted that licenses can be written in such a way as to require fees which are paid back to the copyright holder. This theoretical possibility, however, does not change the fact that the vast majority of open source software is, in fact, available at no cost.

There are a number of likely reasons for this. Whenever you have access to the source code, cloning is facilitated. AT&T once owned the Unix operating system, yet that didn't stop the rapid propagation of Unix clones once AT&T showed willingness to license the full source to universities. Programming ideas are universal, and there are an unlimited number of ways to represent an idea in code. Thus, with careful attention to detail, developers can clone an entire program without directly copying a single line of code. Such cloning makes it hard to maintain a baseline price, particularly when certain segments of the development community dance to the tune of the free (as in cost) software movement.

Second, open source culture is suffused with a belief in the merits of free, as in cost, software. As I noted last June, Richard Stallman is on record as saying that programmers needed their expectations of compensation readjusted in order to return, Rousseau-like, to some lost state wherein programming Van Goghs do their work for the sheer love of programming. At the time, some responded that I shouldn't pay any attention to the man behind the red curtain as he isn't representative of the open source community at large. Yet, commoditization driven by free software is a growing reality, and every day freer, open source software becomes available on the internet.

It's easy to disagree with specific statements made by Stallman. Yet, it is hard to avoid the fact that these statements, in the aggregate, have shaped the open source culture in such a way to create an emphasis on free, as in cost, software.

The nature of valuation
Value, or the price of a product, is not an inherent attribute of that product. It is the result of the interplay between supply and demand, and is completely divorced from any inherent characteristics of the product in question. Oil costs much the same to extract whether the price is elevated by war fears or low from oversupply. Similarly, the fact that steel prices go up because of a rapid increase in the demand for steel doesn't change much the raw cost of producing that steel.

Expectation, however, also plays a large part in the determination of value. If people expect to pay a high price, they tend not to question it. Any American who has seen the price of Levi Strauss jeans in Europe ($90-$100) has wondered in quieter moments whether they couldn't finance a future trip with a suitcase full of jeans at an entrance to Rome's Termini station. In Switzerland, the price of mixed drinks is astronomical ($10 is typical). A Swiss friend told me that this was a historical anomaly due to former high taxes on hard liquor in Switzerland. The tax today is more reasonable, but the price of mixed drinks in bars remained because the Swiss were used to paying those prices, and so bars were happy to continue charging them.

The same expectation principle applies in the market for software. Tales abound of companies that moved from a revenue model based on advertisements (hence, free access) to one based on end-user fees, only to find that no one was interested in their product anymore. Adobe Photoshop is very expensive (currently $586.99 on Amazon), which is about $300 less than it used to cost) yet it continues to be the best-selling graphics editor on the market. Even Adobe competitors benefit from the price. Paintshop Pro is a relative bargain at $109, but even that price is higher than the software average and is only sustainable due to expectations cultivated by Adobe.

Living in a commodity market
If expectations are created that software isn't something upon which consumers, business or otherwise, should spend much money, then that lowers the value of software, which by extension lowers the value of the programmers who make it. This isn't exclusive to makers of shrink-wrapped software, but applies up and down the supply chain, including even makers of tailor-made software (read: contractors and consultants). If you bought a coat for a buck, would you consider paying $20 to have it let out after too many fried chimichangas dipped in Cheez Whiz added a few inches to your girth, or would you walk out and buy a new one? On the other hand, if you paid $200 for the coat, you might consider paying $20 to have it taken out.

Consider SAP. Major consulting companies earned billions helping large companies customize the SAP product. SAP skills were at the top of the list on any jobs board during the 1990s. SAP was also eye-popping expensive, which justified customization expenditures that often ran into multiple millions.

The operating theory among many open source programmers is that the market for their services will persist because people will want to pay for customization, something that will be easier to afford given cost savings in the base product. I'll grant that customizing software isn't as simple as buying a wider coat, but I reject the notion that companies will spend MORE on customization (or even maintain former budgets) simply because they paid less for the base cost of software. More likely, expectations of software cost will be adjusted downwards, resulting in downward pressure on developer salaries (which is happening) and a greater incentive to sublet customization to the lowest-cost location.

The market for development outsourced to foreign locations is getting a lot of press these days. Certainly the slow economy has a lot to do with the demand. Furthermore, programming skills are more generally available than in the past, which was bound to happen given that nations such as India and China aren't standing still. However, I think the role that software commoditization and its driving force, open source software, is given too little attention. A large component of America's economy is information technology, and free software undermines demand for such products, thus hampering recovery and increasing the attractiveness of outsourced development. Furthermore, given the general lowering of software price expectations initiated by the popularity of free alternatives, interest in outsourced development only rises.

Lastly, high profits attract high levels of investment. RedHat managed a thin profit selling open source software in a fast growing market for Linux, but how does that stack up against Adobe, IBM's software division, Oracle, or even Microsoft? That sort of profitability attracts investment by the bucketful, whereas RedHat's sort won't attract the same levels. Less investment means fewer software jobs, and lower valuation of programmer skills.

As I've noted in the past, software is a strange market. Doctors don't roam the countryside offering free medical services and spewing invective against the evils of the for-profit medical industry. Carpenters aren't forced to contend with a free-carpentry movement, and financial analysts at Merrill Lynch aren't pilloried at "free financial analysis" conventions. For whatever reason, a surprising number of people whose aim is to make a living from programming endeavor to provide free alternatives to product sold by others within the industry.

Free software has the same effect free TVs would have in the market for televisions. The question on the minds of people involved in the production of software (or TVs) should be whether that effect is desirable. As investment in software shrinks, so will the value of developers. That's a reality that even open source developers must face.

John Carroll is a software engineer living in Ireland. He specializes in the design and development of distributed systems using Java and .Net. He is also the founder of Turtleneck Software. We wish to give John a special thanks for his 25th contribution to our forums.