Canonical’s services play: Revenue windfall or trap?

It’s tough to compete in an industry where your customers expect your product to be free. Such is the case with software, where giveaways have seemingly become the norm. (Try selling a Web browser or an audio player in 2010.) Some developers have turned to advertising to underwrite their efforts. More recently, a few software vendors have begun offering Internet services as a way to add value to their products and raise revenue. But the latter model is not without its pitfalls.

Take Canonical, for example. The company behind the Ubuntu Linux distribution now offers cloud-based data synchronization services under the Ubuntu One brand. You can get 2GB of storage for free; $10 per month gets you 50GB. Soon Canonical will be expanding its offering to include contact synchronization for smartphones — also for a fee — and an Ubuntu One Music Store as a Linux-based competitor to iTunes.

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These are bold moves, to be sure. Canonical seems to be borrowing a page from Microsoft’s playbook, where “software plus services” is the new mantra. But there’s just one problem: For a small company whose core competency is software development, an online service-based business is a whole new ballgame. Software vendors who hope to follow in Canonical’s footsteps should tread carefully.

Small software firms: Few prospects for growth As popular as Ubuntu Linux has become, it’s not hard to see why Canonical is searching for new revenue opportunities. Dot-com billionaire Mark Shuttleworth founded the company on his personal fortune, and his investment has largely sustained it to date. But Shuttleworth stepped down from the CEO role in December to make room for “a more commercial focus at the top.”

Canonical was founded as a classic commercial open source venture. Until now, its core business has been providing commercial support and maintenance for Ubuntu, typically for enterprise customers. It has done reasonably well; in January 2009, Shuttleworth reported that its annual revenue was approaching $30 million. By comparison, for the fiscal year that ended Feb. 28, 2009, revenues for Red Hat, the leading commercial Linux vendor, topped $652 million.

Canonical’s woes echo those of the commercial open source software industry as a whole. Ubuntu aims to be the most user-friendly desktop Linux; its motto is “Ubuntu just works.” But the easier the product is to use, the less need there is for commercial support. Most customers get their questions answered on blogs and online forums. Red Hat sees a tidy profit from its strong enterprise customer base, which uses the product in mission-critical data centers. But Canonical — like most commercial open source ventures — will never get as big as Red Hat selling commercial support to desktop users.

These problems aren’t limited to open source companies. Any fledgling software venture faces an uphill battle when trying to gain a foothold with new business customers, who often fall back on large vendors out of a desire for “one throat to choke” for service and support. Little wonder that the “software plus services” model seems so tempting: Give away the product and have customers pay for value-added services.

The perils of services The problem with a late-inning shift to a services-based model, however, is that offering online services is a fundamentally different business than developing software. I’m reminded of all the failed e-commerce startups of the dot-com boom: Running a Website is one thing, but moving products to customers is quite another. Similarly, a software company that pins its revenue hopes on services may find itself ill equipped for the job.

For starters, a software company’s biggest expenditure is staff. Online services, on the other hand, take a lot of infrastructure, and that can be expensive. It’s possible to lease space in someone else’s data center (or cloud), but even that takes money — and the more customers you get, the more money it requires. Should the company hire developers this year or invest in data center infrastructure? If Internet services are the main source of revenue, the answer would seem to be the latter — to the detriment of the software business.

Over time, this dichotomy can have an insidious effect on strategic planning. Even privately held companies have investors to appease. The more software is seen as a loss leader, the more pressure there is to maximize profits from services. That can lead to decisions that harm the software business in the long term — and remember, “software plus services” doesn’t work if there’s no software.

Can small players navigate the new market? That’s not to disparage the Ubuntu One services. On the whole, Canonical’s choices are good. Other OS vendors, including Microsoft and Apple, already offer similar services, and still others are available from independent vendors. Making equivalent services available for Ubuntu will be beneficial for Linux as well as Canonical’s bottom line.

But the wealth of options may prove to be a wrench in Canonical’s plans. Faced with a burgeoning market for online services, customers are likely to fall back on established brands, rather than niche players. For example, even a die-hard Ubuntu user might opt for a more cross-platform data synchronization service — such as Dropbox — rather than Ubuntu One’s Linux-only offering.

Winning customers away from iTunes, Amazon.com, and other established music vendors will be an even tougher challenge for the Ubuntu One Music Store. Solid marketing will be the key to garnering customers for these services — but that’s an altogether different task than marketing innovative software.

Perhaps the biggest challenge of all for Canonical, however, will be learning how to be a good custodian of all the data customers will inevitably place in its care. Once the Ubuntu One synchronization service for mobile devices goes live, for example, customers will begin sending their entire mobile address books to Canonical’s servers, including the names, addresses, and phone numbers of friends, family, lovers, business partners, and other contacts. That’s incredibly valuable information to phishers and cyber criminals. Is Canonical’s data center secure enough for the task?

The more you consider the implications, the more it becomes clear that an online services business is a very different animal than a small software company. Offering Internet services presents unique challenges, costs, concerns, and risks. Large companies, such as Apple and Microsoft, are able to adapt quickly to the new model. Maybe Canonical will, too. Other, smaller players may decide that it’s more prudent to stick to what they know best.

This article, “Canonical’s services play: Revenue windfall or trap?,” originally appeared at InfoWorld.com. Read more of Neil McAllister’s Fatal Exception blog and follow the latest news in software development at InfoWorld.com.