Lance Armstrong. Bernie Madoff. Barry Bonds. Raj Rajaratnam. Ray Nagin. Whether it is sports, business, or politics, it seems in every walk of life, people are playing fast and loose with the law, with ethics, and with morality. Even in the software business we have some shady practices and some shady business models.

Pump and Dump

Many well known VC’s and early stage investors who have active blog followings use their clout to oversell their particular investments. Some call it a “pump and dump”; well-connected venture capitalists spot a burgeoning tech company, hype its imminent meteoric rise, then cash out during the IPO–all without any real idea of how well the company will perform.

The year before Groupon filed for an IPO, early investor Theodore Leonsis was talking excitedly about his new investment: “Is there a hotter company anywhere these days?” Leonsis didn’t even wait until the IPO to cash out.  Zynga is another investment story that gives our industry a bad name. Fred Wilson of Union Square Ventures was positively glowing: “Zynga has build the largest social game network in the short period of six months.” He and his company made a ten-fold return on their initial $5 million investment when they cashed out in April.

Groupon and Zynga’s stock between their IPO and todayGroupon and Zynga’s stock between their IPO and today

If a company is overvalued at its IPO it creates a cascade of distrust and anger toward the Internet and software industries. It never ceases to amaze me how biased people can be once they have an economic interest in the company; some investors will even use their clout to have us believe that an 18 month old company with ten employees and no revenue is worth 1 billion dollars. Yet, these individuals were investors in Instagram and it was perfectly logical to them – all of them.

Proprietary Software and the License Model
Open Source Software and the Subscription Model

There are business models that are good for a particular vendor to maximize revenue and profits and there are business models that are good for the long term health of the industry and for the customers.

The software industry was built on building proprietary software – Microsoft pioneered it and companies like Oracle and SAP still continue it. We are now finding out that an open source development model is much better for customers – who have access to the source code should something happen to the vendor of the software – and to the industry at large as it heightens innovation. I am confident in claiming that proprietary solutions are not any more effective than open source.  In ISC’s space – nameserver software there are companies who sell proprietary solutions (Nominum) and companies like ISC who make our software open source. Our product  BIND (9 and 10) allows customers the  ability to take advantage of all of our continued development work – code that we write out of a desire to improve our software, not just improve our revenue stream.

The other half of the old model revolves around licensing software for large amounts of money upfront.  Maintenance and support are charged  separately and the costs increase as the number of servers and users expand. The subscription model does away with any initial sticker shock, leaving just world-class support plus all the benefits of working with open source software.

Whether it is the “Pump and Dump” method or proprietary software with an enterprise license model, the methods I outlined above have a very appealing aspect: they work. Insofar as your goal is to make as much money as possible, they are likely the most efficient.

In both cases, however, these businesses are violating their customers’ trust, which in my view is the key currency for businesses. Building trust between a business and its customers is the difference between long-term company sustainability and trading at 25% of your initial offering price.

I believe the future of software is with open source development coupled with a subscription based payment system. Those vendors who do not understand this and the benefits for the customer base and for the industry may win in the short run but may not be sustainable in the long run.

Personally, I’m invested in this business model because its good for our customers and good for the industry. At ISC we give users flexible, customizable critical Internet infrastructure without massive upfront costs or proprietary lock-ins. We believe in supporting our community by giving back and creating a total cost of ownership that is in some cases 25 % of our proprietary  competitors.  Growth here might not net you 300 times your initial investment, but it will help both of us rest a little easier tonight.