Open Source vs Closed Source – How to Compete with an Open Source Project

A company with a solid open source project competing against a traditional closed-source product seems impossible to beat.

I read this article wherein the author lays out this scenario:

Suppose one could divide a software
market—say network management—between
two products. One did everything
possible and cost $1 million, and the
other only did 10% as much, but was
free and open.

The price tag of the commercial
solution would automatically filter
out a large number of users, and those
people would have to turn to open
source. But some users would be
satisfied with the 10% functionality
and choose it outright.

For example, I have an original
Macintosh computer on my desk. It runs
a word processor called MacWrite. It
does everything, with the exception of
spell check, that I need a word
processor to do. I can format
paragraphs, choose fonts, make text
bold or italic, and even paste in
pictures and graphs. All in a "what
you see is what you get" user
interface.

It takes up 76K of disk space. That's
"K" as in "kilobyte."

Compare that to Microsoft Word. I
think the last time I installed just
Word it was around 30MB, many times
larger than MacWrite, but I don't use
it for much more than I use MacWrite.
Like me, many users are happy with
basic functionality. They don’t need
all the bells and whistles.

But back to my analogy. In the
beginning, the commercial company
would probably ignore the open source
project. It represents no threat to
their revenue stream, so why should
they pay attention to an upstart?

If this project is healthy and
sustainable, however, in a year or so
perhaps it does 15%-20% of what the
commercial product does. This should
bleed a few more users from their
business, and maybe now they start to
pay attention.

Most likely, this attention would take
the form of marketing against the
project. They would claim it is too
small or too underpowered to take
seriously. And in the short run this
would probably work. But the mere fact
that they acknowledged the project
would pique interest. Some people
would determine for themselves that it
was neither too small nor too
underpowered and would start using it.

Another year or two goes by and now
the project is up to 50% of the
functionality of the commercial
product. People start joining the
project in droves. The commercial
company now has to do something. What
do they do? They add more features.

Remember, the commercial product
already did 100% of what people
needed. So what kind of features could
they add? Unnecessary ones. They might
change the look of the user interface
or add features outside of network
management. In any case, this
development will cost money, and that
will start to eat into the company's
margins.

Finally, with a healthy community and
this influx of new users, the open
source project will eventually
approach 80%-90% of what the
commercial product does. Having
exhausted all avenues of generating
revenue, the commercial company still
has one final option: put the screws
to their remaining customers. Find
ways to charge them more, to eek out
what they can from their investment,
which ultimately will drive their
clients away.

Farfetched? I don't think so. There
are only two main requirements:

First, find a market where open source
provides a compelling alternative,
such as network management.

Second, build a sustainable community
around the open source project.

It seems very plausible. If you were the closed-source company, how would you compete??