This article is part of our Innovation in America series, in which Foolish writers highlight examples of innovation going on today and what they see coming in the future.
Amazing innovation leads to incredible business opportunities. Strong business begets awesome stock returns. That’s why finding the most innovative companies today will lead you straight to market-stomping stocks over the long run. Today, I’ll guide you through the history and the mystery of open-source development. This story is bigger than you mught think — and all-American despite some European roots.
The idea that launched a thousand stocks
“If you have an apple and I have an apple and we exchange these apples, then you and I will still each have one apple,” said George Bernard Shaw. “But if you have an idea and I have an idea and we exchange these ideas, then each of us will have two ideas.”
That’s exactly what makes the open-source innovation movement so powerful.
Enlist unpaid volunteers to develop your product, and then give it away for free. This is essentially the open-source model of software development, born by part-time hackers and computer-science students and grown into a multibillion-dollar business. It’s the wisdom of the crowds at its finest — tap the enthusiasm of brilliant programmers with a desire to change the world, and wrap it in your own brand of support services. What you get is a unique combination of rock-solid quality and incredible innovation.
History of open-source
Sharing of ideas is hardly a new concept, but the open-source movement as we know it today started with Linux.
Progenitor Linus Torvalds was but a Finnish college student when he started adapting the Minix operating system to run on standard PC hardware. Going in alone, the system would be unusable today — but Torvalds released his work on the budding Internet in the early 1990s and was quickly joined by a veritable army of hobby coders. If you think you haven’t seen Linux working yet, you just haven’t looked closely enough: You’ll probably find Linux in your Internet router, your Blu-ray player, and at your local ATM. And if you own an Android smartphone, that platform is built on Linux with just a dash of Java.
Linux servers also manage many of the world’s most popular websites. And behind the scenes, this former hobbyist platform is growing like gangbusters. According to market research firm IDC, Linux increased its revenue share of the enterprise computing market in 2011. Traditional Unix systems and Microsoft (Nasdaq: MSFT ) Windows shrank.
In plain English, Linux is big business these days. And it couldn’t have happened without the open-source development model driving its rapid innovation.
By the way, although Torvalds was been born in Finland, the heart of the Linux movement is beating in America — Torvalds moved to California, then on to Oregon, to keep a close connection to the movement he founded. This is where innovation happens.
Emerging American giants
The biggest name in Linux is Research Triangle stalwart Red Hat (NYSE: RHT ) . The software vendor has been part of the Linux movement since 1993 and is by far the largest player in terms of revenue today. Last quarter, the company crossed the $1 billion milestone in annual revenue. Red Hat reports earnings again after Wednesday’s closing bell; look for the growth trend to continue there.
Based in Fort Lauderdale, Fla., Citrix Systems (Nasdaq: CTXS ) also swears by open-source development. It’s the business behind the Xen virtualization platform, which powers cloud services around the world. One very prominent example is Amazon.com‘s so-called Elastic Computing Cloud, which runs half a million Xen servers on top of Red Hat systems.
You really can’t blame Microsoft and the Unix giants for sweating bullets over open-source software. In the early 1990s, servers were either Unix or mainframes with a sprinkling of AS/400 systems. Windows displaced the Unix hegemony to become the top server software by 2006 with $17.7 billion in system sales.
And now, the baton is passing to Linux.
All the major server vendors sell their hardware running Linux these days, at the expense of fewer big-iron machines using proprietary Unix variants or Windows. Linux owned 20.7% of server revenue in IDC’s latest report, compared with 50.2% for Windows and just 18.3% in the Unix corner of the market. If these trends continue, Red Hat and Citrix are poised to stop fighting The Man, so to speak — in a few years, they will be The Man to beat.
And as these businesses scale up, the lightweight open-source model helps them become fantastically profitable. Red Hat’s 84.2% gross margin puts traditional powerhouses like Microsoft to shame. Citrix jumps even higher with an 89.2% gross margin today. Again, these companies lean on an army of volunteers. They do contribute a lot to that community — boosting the ever-accelerating virtuous cycle of building new things on existing ideas — but largely serve to package and polish their products rather than building them from scratch. In the end, much of the money comes from high-quality support services.
You ain’t seen nothin’ yet
Open-source innovation is easily applied to software development — a realm where ideas can multiply without worrying about building and testing expensive gadgets. But there’s more: Enthusiasts are working on open-source microprocessor designs, beer, and even pharmaceutical drug development.
And even the open-source beer is just the beginning. You may have heard of 3-D printing specialists 3D Systems (NYSE: DDD ) and Stratasys (Nasdaq: SSYS ) — their machines can print out pretty much any solid object you can imagine. Three-dimensional printers hold the promise of extending the open-source ideal into the hardware realm in a big way. The vendors are working hard to make 3-D printers more affordable and ubiquitous: Starter systems have dropped from $10,000 to $1,500 in the past three years.
Imagine what happens when these incredible machines become affordable to your average engineering student and design geek. I’m not even going to predict the innovations that will spring from printable open-source objects — with the digital object designs shared and improved like software. I’m just preparing to have my mind blown on a regular basis.
Our top analysts just compiled a special report on 3-D printing, which dives into much finer detail on how the technology is changing our world. The report on the new industrial revolution is yours for the asking, but hurry up and grab your copy right now — it won’t be free forever!
Read more about innovation today and its future in America; head back to the series intro for links to the entire series.