The New Dot-Economy

Like.com is exploring a new idea -- using visual recognition software to automatically find images on the Web that resemble each other. Other start-ups are pursuing older ideas using cheaper technology, exposing such industry giants as Microsoft, Cisco, SAP and Oracle to unprecedented competition.

In the early years of the Internet boom, established companies came to fear the rise of rivals with new ideas, at times just a couple of young engineers working out of a dorm room or garage. Now, a new idea is no longer essential, because the massive cost reductions mean start-ups can enter the marketplace simply by offering cheaper wares.

"When factors of production are in flux, they require new mind-sets," said Robert Metcalfe, general manager of Polaris Venture Partners and an inventor of the Ethernet networking technology. "That's an opportunity for new companies who get it. It doesn't necessarily mean they win and that big companies squander the opportunity. But it happens."

The three friends who founded Zimbra in 2003 during brainstorming sessions in a California coffeehouse saw the potential of using free software tools. They used this software, developed by volunteers and available on the Web, to create Zimbra's e-mail product and began selling it in February for barely two-thirds of what Microsoft charges. Since then, Zimbra's software has reached more than 4 million paid e-mail accounts at more than 1,000 businesses and organizations, including universities and H&R Block.

Zimbra has raised about $30.5 million in venture capital, including $14.5 million earlier this year. But its costs have remained so low that it has not spent any of the $14.5 million -- and still has money left over from previous investment rounds, said chief executive Satish Dharmaraj.

Microsoft remains the heavyweight of business e-mail, with 140 million users. But some analysts think the shifting economics eventually could pose a problem for Microsoft and other industry leaders. For one thing, incumbents with profitable businesses face obstacles to exploiting lower-cost technologies. Most large software makers, for example, sell programs based on proprietary code. Exploiting free, open-source software to sell cheaper versions could cannibalize their established products and cut profits, provoking resistance from shareholders and employees.

"They're going down a road that has big, deep ruts in it. Getting out of those ruts is very hard," said Forest Baskett, a general partner of New Enterprise Associates, a venture capital firm.

Yet the giants of technology are hardly standing still. Some analysts point to Cisco, in particular, as a company trying to adapt.

For years, Cisco has called itself "the plumber of the Internet" because it makes most of the technology that routes data through local and global networks. Its high-performance devices called routers dominate their industry and bring in nearly $6 billion in revenue annually. Cisco and its rivals, including Juniper Networks, mostly sell router packages that combine hardware and software into a single product.

But Vyatta, founded two years ago by Leinwand, slashed the cost of routers by selling the software and hardware separately. It exploited computer-chip advances that have allowed cheaper machines, such as those sold by Dell, to support routing, and lowered software costs by using free development tools.

As a result, Vyatta's customers can pay $1,000 for a Dell computer and another $500 for an annual subscription to Vyatta software -- a sharp discount off the prevailing router price of about $4,500.

While Cisco's routers still dominate the market, the company has not ignored the growing demand for cheaper products.

Three years ago, as more people set up computer networks at home, it bought a 15-year-old company called Linksys that was a leader in low-cost routers and turned it into a division that sells the devices using open-source software and off-the-shelf processors -- not unlike Vyatta. Mike Volpi, a senior vice president at Cisco, estimated that Linksys now commands about half of its market segment.

"We have been challenged by many start-ups in the past and managed to get through," he said, playing down Vyatta's attack on the market.

Leinwand set up Vyatta two years ago after colleagues at other companies told him they were looking for cheap routing software to run on standard computers.

By the time Vyatta got its first customer, in July, its workforce was still fewer than 20 people. The marketing chief took the first order on a Post-it note.

Among the initial customers was Adify, an online advertising service that tried a Vyatta router in a low-risk part of its operation in July, even though its executives were skeptical of open-source software. The trial went so well that Charles Stewart, Adify's vice president for operations, said he ripped out a strategically located Cisco router in November and replaced it with Vyatta's product.

Kelly Herrell, Vyatta's chief executive, acknowledged that Cisco and Juniper still hold an advantage at the top end of the market, where standard computers cannot yet support the most sophisticated networking needs. But in the middle of the market, standard hardware and Vyatta's software can satisfy the needs of most businesses, he added.

"I'd rather start at the bottom and work my way up," he said.