Now, that?s a promising headline.

My original inspiration was zeevveez’s post ?How to Make Money off Open Source or off Web 2.0??.

His article goes in the direction rather unexpected from the title. Nonetheless, it reminded me of my master thesis, where I was investigating how open source companies make money and how differently from the ones based on the commercial software. I was using Microsoft and Red Hat as case study subjects.

David J. Teece created a framework helpful to understand how companies make profit out of their innovations. Below a quick description of the model and then a trial run against commercial the software industry, the open source companies, and, to justify the title, the Web2.0 companies.

According to Teece, the elements which are decisive to how much you earn from the innovation include:

• Appropriability regime, consisting of copyrights, patents, trade secrets. All of this makes it harder to imitate your innovation.
• Complementary assets, since almost always your innovation requires other assets/capabilities to be successful. E.g. distribution channels, software or hardware components supporting the innovation, etc.
• Dominant design paradigm; after initial period, the industry centers around the solution(s) commonly accepted as a standard. Non-standard alternatives die away.

Presently I will try to make some practical use of this framework.

How do you make money when you are Microsoft?

1. Retain copyrights to your software, and in addition to that, file for patent protection
2. Ensure the broadest possible support from hardware vendors and ISPs (complementary assets)
3. Leveraging on 2), make your operating system a standard platform (dominant paradigm)
4. Charge users for licenses and commercial support

Even if you think copyrights and other IP protections are crucial to Microsoft, it is the standard that the firm promoted that made it so profitable in the first place. To make Windows a standard, Microsoft ensured that there was a critical mass of compatible hardware and software applications written on top of the OS.

How do you make money when you are Red Hat?

1. Maintain copyrights just to selected proprietary applications, e.g. for software updating and management
2. Ensure the broadest possible support from hardware vendors and ISPs (complementary assets)
3. Leveraging on 2), make your operating system a standard platform (dominant paradigm)
4. Charge users for commercial support

Even if the appropriability regime is so much different compared to Microsoft (most of software that Red Hat provides is under GPL license), the key is also to establish a dominant standard by ensuring an extensive base of compatible hardware and applications.

How do you make money when you are a Web2.0 company?

Zeevveez writes:

Web 2.0 and Open Source are idealistic non-profit creations. We are talking here about peer production of encyclopedias, sharing of links and photos, volunteering to write newspaper articles, developing better software and building a better world on the ruins of the capitalist money-centered Web 1.0 close source monster.

I would make a distinction here. People may be idealistic, as in the case of Open Source or Wikipedia, and for sure they gladly accept services they don’t have to pay for. But that doesn?t mean the Web2.0 companies share this sentiment. They want as much profit as Web1.0 companies and possibly even more.

Due to emphasized “social” aspect of Web2.0 companies, the network effect is essential for most of them. That’s how they can realize profits, then:

1. Ensure the largest possible user base and consequently appropriate volume of content, to introduce network effect (complementary assets)
2. Leveraging on 2), make your service a standard (dominant paradigm)
3. Charge users for value-added services, gain money from advertisements

Appropriability regime may be different for companies, depending on the nature of their technology. Search engine inner workings may be simple to protect, while web interface would be a likely subject to imitation.

The overall appropriation mechanism remained the same through all the cases. As far as “web2.0″ companies, most of them are still in pre-paradigmatic era, fighting for a critical mass to establish themselves as a standard in their respective niches.

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