|Aashay Sanghvi||Apr 28, 2020|
If physical infrastructure like roads, bridges, and canals enables commerce and the movement of goods and people in the physical world, infrastructure software is the backbone of the digital economy, which continues to eat the real economy. At Haystack, we’ve been lucky to work with defining infrastructure software companies like Hashicorp and continue to be excited about opportunities across enterprise IT domains. Infrastructure software has also emerged as a personal interest area for me, primarily inspired by the founders I’ve met shipping software across commercial, open source, and cloud.
I view infrastructure software with a broad lens — programmatically extensible and hardware-independent virtual resources that support the flow, processing, storage, and analysis of data within an organization. It provides the building blocks for developers and enterprises to launch and support software apps without re-writing the same script over and over again. Open source is a broad bucket within infrastructure that attracts capital and talent, but one can’t peg all these tools or companies the same way. As I’m still early into these explorations, the framework will iterate and adapt over time. If you have any questions or suggestions, please don’t hesitate to reach out.
The 30,000 ft. View
Years ago, investors wouldn’t touch open source software businesses. The conventional wisdom was that one could never make money selling to developers, and there were many skeletons in the graveyard that made the point. The notable exception was Red Hat (and perhaps MySQL). Flash forward to the current moment — OSS infrastructure continues to be red-hot in the private markets, despite the COVID-19 outbreak. In the middle of March, Hashicorp announced a raise at a $5.1B valuation. Confluent executed a $250M raise at a $4.5B valuation in the middle of the downturn. It might be easy to say that we live in a world in which all parts of the IT stack should be open source-first, and but odds are this is hyperbole.
We have come to a point in the hype cycle where we’ve over-rotated on the OSS business model. The product is being given away for free, so re-acquainting and understanding the long-run commercial strategy is crucial. But if it works, it really works.
For a genealogy of commercial OSS, I recommend Mike Volpi’s “How open source took over the world.” The tl;dr:
The first-generation of successful companies (a small n) capitalized on delivering almost-ubiquitous projects to the enterprise with services (installation, support, etc.) with the canonical example being Red Hat and Linux.
The second generation (Hortonworks and Cloudera building on Hadoop as examples) were developed within companies and charged customers for licenses to “commercial features.”
The current evolution of open source businesses have open core or hybrid cloud business models, which combine features of the prior two iterations. They progress to market leadership in three phases (deserving of its own post) — incubation & development, traction from individuals to teams within a company, and eventually, monetization & multi-product growth.
As hinted earlier, not all infrastructure software caters itself to being open source. For example, companies built on web app frameworks for programming languages (think Ruby on Rails, Python / Django) have generally not led to large outcomes. Engine Yard tried, but was unable to build an enduring franchise.
There needs to be a lot of “surface area” on which the project can grow and adapt. In this conversation with Matt Turck of FirstMark Capital, Benchmark’s Peter Fenton acknowledges that the two core attributes for open core businesses are 1) production value and 2) a big market that would support platform status. Having production value means the tool supports applications that touch end users, that don’t just sit in development or testing environments. Investors could not have anticipated how large some of these markets would become years ago, but millions of people are continuing to go online across the world. Elad Gil comments, “In general, software markets and businesses are 10X bigger than they were 10-15 years ago. This is due to the liquidity provided by the global internet.” Data processing & storage, compute, APM & observability tend to have the core characteristics Fenton alludes to.
An open core company has more credibility if the primary authors of the project run it. They set the direction and priorities of the company in addition to providing stewardship and trust for the original project. Recent successes emerged from two buckets:
An internal project of a web-scale Internet company
From the hands of an individual product leader and influencer
Jay Kreps, CEO of Confluent, is the primary author of Apache Kafka, a distributed streaming platform. He built the first versions of Kafka inside LinkedIn, trying to optimize the LinkedIn news feed. It was initially released in 2011, but by 2014, Kreps and co-founders Neha Narkhede and Jun Rao left LinkedIn and got Confluent off the ground with the support of Benchmark. By early 2019, Confluent’s bookings had exceeded $100M.
In early 2010, a developer named Shay Banon launched an open source search engine into the world called ElasticSearch. By 2012, the project had been downloaded 1.5M times and was growing at a rate of 200,000 downloads per month. By October of 2018, Elastic N.V., the company governing Elasticsearch and its associated properties, went public as $ESTC, climbing to nearly a market capitalization of $5B on its first day of trading. Within eight years, the project Banon had launched into the world from his laptop served as the backbone for a multi-billion dollar Internet franchise.
Demand Impacting Supply
In order to understand the rush of OSS businesses on the supply side, don’t look further than the architectures and IT stacks of customers that constitute demand. As Kevin Kwok writes in “Aligning Business Models to Markets,”
As the structures of markets change, the optimal business models change with them. Business models are how we align and reconcile the markets needs with the cost and human capital required to provide them. Alignment of markets and the costs to serve them is core. And as either side changes, so to do the business models that are dominant.
The last decade saw the shift from virtual machines and monolithic applications to containers and microservices. This ongoing shift wrestles control away from CIOs, who used to make end all be all vendor choices. Enterprise infrastructure split into a distributed system — modular applications and services working across computing clusters. Individual developers can deploy open source tools on parts of the stack, as some services run like mini-applications with a data layer, networking, and client. Adopting a tool does not mean you have to go all in on day one.
By outlining these preconditions, I hope to provide some nuance and guidance on commercial open source software and its role in enterprise IT. There are a host of ways to dive deeper with OSS — the challenges of monetization (recommend Timescale’s post), providing value to individuals vs. organizations, pricing, the role of community as product managers, and more.