July 23, 2004

'Creative destruction' and the future of the software industry

Author: Anthony L. Awtrey, I.D.E.A.L. Technology Corporation

The way that software is being produced and acquired is changing rapidly. The availability of high quality software, often for no licensing costs and with very user-friendly license terms, is challenging commercial companies producing products in the same software category. This new type of software is called either Free Software or Open Source Software (it will be referred to in this document as Free/Open Source Software) and is being attacked by the incumbent software product vendors as if it were a threat to the free market itself. The software industry is actually going through a well-known free market process that was first identified by the famed economist Joseph A. Schumpeter in 1942. It is called the process of creative destruction.
âThe opening up of new markets and the organizational development from the craft shop and factory to such concerns as US Steel illustrate the process of industrial mutation that incessantly revolutionizes the economic structure from within, incessantly destroying the old one, incessantly creating a new one ... [The process] must be seen in its role in the perennial gale of creative destruction; it cannot be understood on the hypothesis that there is a perennial lull.â

Quote from âThe Process of Creative Destructionâ by Joseph A. Schumpeter, 1942

Commodification exists in every market, and its tenets are practiced daily by successful businesses. The cliches, âDon't reinvent the wheel,â and, âTime is money,â were born from a drive to reduce tasks to their lowest common denominators; to be fast and efficient; to commodify. Through the process of commodification, old ways of doing things are improved and new innovations are forged upon existing commodity building blocks. This process is healthy for the market and provides consumers with economic security. Software that meets the most needs will have a strong commodity presence that will provide the foundation for future innovations.

Wise companies are positioning themselves to take advantage of the disruption, inevitable market expansion, and opportunity that commodification brings with it.

Commodification and Software

Thomas Edison did not invent the light bulb. He improved the invention and successfully marketed it, along with his electric power distribution model, but the incandescent filament bulb and its predecessor, the arc light, were around for about 50 years prior to Edison's design. The current market for light bulbs is still dominated by the legacy of Edison's old company in the form of General Electric, but many other companies including Sylvania and Philips compete for market share in this commodity market. Free market forces have produced standardized light bulbs and sockets which allow many different bulb and fixture manufacturers to provide a variety of interchangeable lighting products to meet consumer demand.

Producing a software product and bringing it to market is different when compared to doing the same with a typical manufactured good, but the process of commodification in software still has many of the hallmarks of other kinds of products.

One obvious theme carried over to software is the necessity to have agreed-upon standards as enablers. Software development standards can be languages like C++ or Java, frameworks like CORBA or even communications standards like 802.11 and TCP/IP. As with any other commodity, the value is not really the standard itself, but rather the value network it creates when it is widely used. Standards support modularity and fungibility, which allow competition to fuel innovation, improve product quality, and provide price pressure.

A common element of commodification seen in manufacturing is this commodity-driven modularity and fungibility. Manufacturers must continually strive for and improve upon efficiencies in production.

Modularity and fungibility provide a means for manufactures to develop repeatable, well-oiled processes that result in the most-efficient, cost-effective methods to produce the next widget. However, this involves large capital outlays for property, plant, equipment, and people. The next widget off the line always comes at a marginal cost. In contrast, software âmanufacturingâ does not have the same physical resource constraints to production or delivery. Software can be downloaded from a website thousands of times without any significant resource use. The modularity and fungibility of commodity software, combined with the absence of large upfront investment, enables fast market entry and rapid innovation that is difficult for manufactures of tangible goods to emulate. In addition, manufacturing markets generally only have two primary participants: The manufacturer and the consumer. In the software industry, it is much more common to have varying categories of producers, consumers and, most often, combinations of both. It is this last category, user-developers, that drives Free/Open Source Software development and software commodification.

The Stirring Breeze

When a company such as Microsoft attacks Free/Open Source Software products and methodologies, it is attacking and alienating people who might be valuable customers and partners. When commercial software vendors abuse software, communication, and data standards with proprietary extensions in an attempt to hijack the value network surrounding these standards, they are contributing to and accelerating their own extinction. Many companies and individuals that develop and support Free/Open Source Software do so not only because it is less expensive in the long term, but because it allows them to regain control over the critical software value network that vendors have abused for years.

Commercial software vendors are fighting the commodification force that Free/Open Source Software represents. They are starting to feel the stirring of the breeze that will soon become Joseph Schumpeter's gale. These changes do not necessarily mean that those software vendors will go out of business; like Edison's legacy in General Electric, they will be transformed and tamed by the market in the face of new competition that leverages commodified software tools.

Consumers today are finding that using modular, standards-based Free/Open Source Software is less expensive than investing in a relationship with a software vendor that makes monolithic, proprietary products. Forward-looking technology consumers are not only taking advantage of the availability of general-purpose Free/Open Source Software, but are asking how to accelerate the process of software commodification in more specialized areas of software development.

Free/Open Source Software has demonstrated its value in the market through successful projects including the Free Software Foundation's GNU Project, the Linux operating system, and the Apache Web server. The existence of these products has not immediately destroyed the value of similar commercial products, but it has created a layer of commodity functionality that is available, usually for free. If a software vendor would like to charge $150 for their operating system, they must now offer a significantly better product than the Free/Open Source commodity version.

The Impending Gale

With each iteration of disruptive change that sweeps though a market, old ways of doing things are improved, new products are introduced, and more products in the market become commodities. The computer and software industry has already seen at least two such commodity disruptions. The first obvious disruption came with the invention of the personal computer, which allowed users to interact more directly with their computers. The second happened with the rise of the Internet and the commodification of network protocols, tools and software, which allowed users to communicate and share data no matter what computing platform they used. The current iteration is bringing disruptive changes to the market for application development tools, operating systems, and office productivity tools.

With each cycle of disruptive change, the computer has moved closer to the user and allowed users greater control over their ability to create and manage data essential to their lives. Each cycle has also relied upon the presence of the enabling standardization of hardware, interfaces or networking protocols from previous cycles. Each cycle incrementally creates another set of commodities, which in turn provide the foundation for the next wave of disruptive changes. Ubiquitous personal computers created the market interest for networked communication to share data. Commodity personal computers and networked communication created the opportunity for worldwide, distributed software development, which has enabled the existence and proliferation of the current Free/Open Source community.

From the beginning, Free/Open Source Software has been about solving immediate problems. The idea that someone is dreamily writing code thinking about the good they are doing for humanity is a myth. The reality is much more pragmatic; the people who have the problem are responsible for solving it.

Before the Free/Open Source Software movement, they could purchase software to solve their problem from a vendor or write the solution entirely from scratch. Now, with freely available software development tools and operating systems to run them on, people are busy forming communities to help solve their problems. Companies and people who needed a good web server worked together to build the Apache web server. Companies and people who needed a solid operating system worked with Linus Torvalds to develop the Linux kernel. With the tools to solve problems freely available, and if enough people have the same needs, a Free/Open Source community can be quickly built. If vendors want customers to buy their product instead of investing in the development of a competing Free/Open Source solution, they must offer real value, fair licensing, and honest pricing. Alternatively, the vendors can embrace the philosophy of freedom and start the community themselves.

Developing software using Free/Open Source tools and a collaborative model gives customers more economic security. In one real-world example, the most popular implementation of the X Window system is a project called XFree86. The leader of the XFree86 development team recently made changes to the XFree86 license that would have arguably placed unwelcome burdens on users and distributors of the software. People who disagreed with the decision took code from before the license change and started a new development effort. This new development effort, called XOrg and hosted by FreeDesktop.org, is already in full production and is attracting support from most popular GNU/Linux distributions. This is an economic version of ânatural selection."

As the market continues to embrace this model of development, the software that meets the most needs will have strong commodity presence. Free/Open Source Projects like OpenOffice.org and the K Desktop Environment are gaining more recognition every day. They are sponsored in part by commercial companies looking to satisfy their own needs and, as a result, are producing software to satisfy the immediate needs of many, many people. The fact that these Free/Open Source products exist separately from any specific vendor means that customers can get competitive bids for support, offer requests for proposals to have features added or even specifically hire staff to work on leveraging and customizing these products.

The most exciting part of the commodification process is that each cycle of disruptive change is usually accompanied with a tremendous market expansion. This expansion was seen when the VCR was introduced and spawned several billion-dollar industries. It happened again when three senior managers left Texas Instruments in 1982 to form Compaq Computer Corporation and helped ignite the personal computer revolution. It happened again with the commodification of networked communications and the Internet.

In the current software revolution, savvy companies are squaring their sails to capture the anticipated gale brought by Free/Open Source Software. Unlike the dot com boom, this expansion will be real, with well understood economics at work creating value -- and shifting the rules of the software market in favor of the consumer.

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