Ready for Prime Time? Open source IP telephony has evolved beyond its early beginnings to include a host of new applications. –

As venture capitalists, we look to invest in new companies that meet certain objectives. They must deploy disruptive technologies providing strong economic benefits to end users, leverage disruptive business models that allow them to succeed before old line companies can respond and they must address large emerging markets.

Open source IP telephony matches up well with these criteria.

Open source IP telephony has evolved beyond its roots in enterprise computing to include Web servers, GRID computing and enterprise storage solutions. The continued development of open source to include other enterprise applications, such as IP telephony, is simply the next step in its evolutionary march. The success of Sistina (a onetime portfolio company of ours that was acquired by Red Hat Inc. last year) and Pingtel Corp. (another portfolio company that has moved to an open source business model) have reinforced our belief that open source is the key in reinvigorating markets grown stagnant.

Over the past several months, I’ve been fortunate enough to meet with some of the world’s largest carriers, numerous enterprise customers, as well as equipment vendors at all stages of development. We discussed how an open source IP telephony solution could impact the market, and we evaluated their interest in seeing an enterprise-grade solution made available. I can tell you this, based on these conversations, the opportunity for open source is significant as the interest was real and immediate.

Based on these conversations, I know there is no question that now is “Prime Time” for venture capital investment in open source IP telephony initiatives.

The Reasons Why

The success of open source solutions and business models is undeniable and can no longer be ignored by venture capitalists. Open source coupled with subscription-based software licenses is now a recognized business model. And it has significant momentum. Linux and Red Hat are two of the best examples of the successful pairing of open source technology with a subscription-based business model.

The Linux adoption continues to accelerate market research predictions that by 2007 up to 27% of all operating systems shipped will be Linux-based. Profitable since the third quarter of 2003, Red Hat’s subscription model has generated six quarters of sequential growth. This positive growth, coupled with shareholder value creation and up to $7.4 billion in market opportunity, have led investors to recently value Red Hat in excess of 25x revenue.

So what does this mean for the broader market and the subscription-based business model? Fundamentally, it means the days where equipment vendors can lock customers in with proprietary solutions are coming to an end. While this trend is well established within the computing and Web server markets, this business model is in its infancy with IP telephony. Thus, there exists a real opportunity for young companies to disenfranchise existing players, dramatically reset industry margin structures and lead a new wave of market opportunity based on cost.

Strong end-user benefits are driving the adoption of open source technology and subscription-based business models for delivering software. The end-user value proposition for open source subscription-based business models is simple: Improve product quality, enhance innovation, reduce cost, drive standards, and eliminate vendor-lock-in. End-users – including large and small enterprises, government agencies, and universities – increasingly are understanding that open source movements accelerate innovation and create more competition.

Subscription-based business models offer end users strong support and better products that are more rigorously tested and reliable. Accordingly, major corporations have consistently reiterated their commitment to deploying open source solutions. IDC reports a 45% to 80% lower total cost of ownership for Linux on Intel architecture over RISC/Unix environments. In a recent IDC survey, more than 40% of the CIOs responded said that Linux is an important part of their IT strategy. Indeed, price-sensitive small and midsize businesses are turning to Linux and other open-source products as a lower-cost alternative to proprietary incumbent offerings, according to a recent report by Jupiter Research.

A Prime-Time Player

Incumbent players in computing and Web server markets have embraced the model – so will IP telephony … eventually: By 1999, IBM was treating Linux as a top-tier operating system and using open-source code as a foundation for some of its own commercial products, including its WebSphere Application Server. IBM recently stated that the company hopes to have 40,000 Linux desktop users within the company by year’s end. Outside of its Open Desktop project, IBM has more than 600 people in 43 locations working on 150 open-source projects. IBM’s embrace of the open-source community – and its $1 billion commitment to Linux – is a clear indicator of the fact that open source business models are ready for prime time.

This wholesale adoption of the open source model is encouraging to venture investors as it underscores the value that can be created by young companies that address gaps within established player’s product offerings. Clearly, startup companies are more adept of jumping ahead of the market curve and presenting real opportunities for more established players to enter emerging markets with best-of-breed technologies more quickly.

The major telephony systems vendors that have been slow to embrace open standards will almost certainly not deploy open source solutions in the near term. And they will not adopt subscription-based business models, either. At the heart of the issue is proprietary call control. Proprietary call control is essential to the business models of traditional vendors such as Avaya, Nortel and Cisco. Traditional vendors have leveraged proprietary call control to lock customers into vendor-specific environments for handsets, switches, and feature servers. This is just the opposite of current generation networking and data center environments, in which TCP/IP, HTML, SMTP and many other standards dominate.

Not surprisingly, the pace of innovation and cost reduction in these markets is faster and more pervasive than in enterprise telephony. This lack of momentum from the major vendors creates unprecedented opportunity for young companies that combine business-grade solutions with a sound open source business plan to positively impact the market.

A great example of this is Apache. The Web server market was stagnating when the founders of Apache applied the open source business model to this market. They now command greater than 65% market share. In the telephony market, the most recent example is Pingtel, a VC-backed company that decided to launch all its assets into open source as a means to pre-empt the larger players from owning proprietary call control.

Proprietary call control between switches, phones and feature servers is the most significant obstacle in integrating voice into the user’s Internet experience. It is important to recognize that open source IP telephony provides the most effective technical vehicle and business model to establish standards based and ubiquitous call control quickly and cost effectively. Commoditizing call control and offering it to the industry as a stable, reliable and independent platform on which to build distributed applications will have a profound effect on the telephony industry.

This new freedom creates significant opportunities for young companies to create new standards-based applications, or products that enterprise customers or value added resellers could use to build higher-quality, lower-cost solutions. Instead of being locked into phones, PBX, gateways and media servers from one vendor, new products can be integrated into a complete system based on specific value each product brings.

Combining open source with a disruptive technology, such as the IETF’s Session Initiation Protocol (SIP), encourages innovation, lowers cost, raises quality, and eliminates vendor lock-in. It delivers a compelling business proposition to system integrators and value-added resellers, and it provides a framework for multi-vendor interoperability to give customers choices.

New open source VoIP companies can be established before the traditional enterprise telephony vendors can respond. To meet the ultimate needs of end users, traditional telephony system vendors must radically change their products, business models and cost structures. As noted above, the cornerstone of the enterprise telephony industry – proprietary call control – must be eliminated. And, proprietary hardware and software must give way to standard Linux servers combined with standards-based and interoperable applications, phones, and gateways.

These changes are much too big to be made quickly and efficiently by the current crop of industry leaders. Given the glacial pace of the incumbent vendors, the next generation of startups will drive industry evolution for the benefit of end users.

Finally, the addressable market for open source IP telephony is large and growing and will expand to include other services. A voice-enabled Internet experience will cross devices, geographies and networks and offer a ubiquitous service similar to email and accessible to all at an affordable cost. New applications – such as messaging, presence, collaboration and multi media conferencing – will complement the basic IP voice service and create a new and global communications culture.

Enterprise telephony is a significant market that is projected to reach more than $4.5 billion in annual revenue by 2007, according to InStat/MDR. Proprietary VoIP systems adoption continues to exceed expectation. There is a large addressable market for open source IP telephony, especially as it expands to include new and emerging communications applications.

Companies with open source IP telephony are providing key technologies that will advance the adoption of enterprise grade open source alternatives to proprietary, single vendor solutions.

Will the market take time to develop? Certainly but with the requisite infusion of venture capital, and the right combination of talent, technology and resources, it will be one of the most enjoyable and interesting rides as it does.

Zenas Hutcheson is managing general partner of Vesbridge Partners, a Westboro, Mass.-based venture firm. Founded in 2004, the firm builds on its rich history of investing as the telecom and IT arm of St. Paul Venture Capital in early-stage, U.S.-based companies, primarily in communications, health care and software industries.