I often hear from enterprise IT focused startups that one of the reasons they are going to be successful is that they will have a lower price than [name of top vendor in their product class]. This is very tempting today because its easy to use commodity hardware, put some software on top, and sell it with healthy margins way below what the larger enterprise server/software/networking/storage vendors do.
Unfortunately these types of product plans usually fail for two reasons. First, using commodity hardware isn't a cost advantage, since its available to anyone. You'll have competition at that lower price point, lots of it.
The second reason is open source and advertising supported online services. Its increasingly hard to find product categories that are not addressed by one or both. To beat free you need to have functionality that people prefer. If you're free too, well you still need to have functionality that people prefer.
If you're reading this and you're from a web company or have experience with open source, all this will seem obvious to you, but judging from the list of recently funded startups, there are many entrepreneurs and VCs that haven't grokked it yet. If you come from the enterprise IT world, either as a vendor or a customer, you might look around at the enterprise's Microsoft .NET web infrastructure, their Oracle database, their EMC storage, and think that open source is just a cute toy used only by the long hairs. The problem is that today the enterprise is a late adopter - not a good indicator of where opportunity lies for startups. The late adopters aren't going to buy your widget because you don't have 50 site references, integration with their legacy stuff, or a sales force that can take them on boondoggles to Pebble Beach. So you have to be able to beat the open source or free online competitor used by the early adopters. The early adopters are other startups, government research labs, academia, and web companies. And the software stack for early adopters is rapidly converging on 100% open source, with whatever they've developed in-house layered on top. On the hardware side, its getting harder and harder to find proprietary stuff beyond Intel servers, SATA disk, and a few routers and load balancers.
So if the product segment you're targeting has open source (or free online) competitors, compare yourself in terms of price performance to the open source solutions, not to the proprietary stuff that the late adopters are buying. Does this mean you have to be open source as well? Maybe. Open source conveys so many benefits beyond price that early adopters now prefer it because of superior (and free) support from the community of users, ease of customization, performance, and quality. If your widget is an order of magnitude better on a dimension critical to users, you might overcome these advantages despite being proprietary, but you better be really sure users value your product.