The Open Road

Someone needs to let the folks in Raleigh know we're in a down economy still. While much of the tech market lingers in the doldrums, Red Hat announced another strong earnings report for its fiscal third quarter 2010.

Here are some of the headline numbers:

1. Revenue of $194 million, an 18 percent increase year-over-year.
2. Subscription revenue topped $164 million, up 21 percent year-over-year (and 85 percent of the company's revenue).
3. Deferred revenue climbed 23 percent year-over-year to hit $619 million.
4. All 25 accounts up for renewal in the quarter renewed, and at 120 percent of value.

Small wonder, then, that the company elected to repurchase 1.9 million shares of common stock for $52.3 million.

While Red Hat's revenue growth rate has been sliding for some time, as The 451 Group has detailed, Red Hat's prospects remain bright. Piper Jaffray, for example, recently highlighted a range of factors contributing to its "Overweight" rating on Red Hat's stock:

Recent conversations with 40 Red Hat industry contacts point to an improved operating environment, an ongoing acceleration in the pace of Unix-to-Linux migrations, and Q3 results essentially inline with plan. We continue to see longer term catalysts for outperformance based upon the recently introduced virtualization products (RHEV), upsell to the premium priced Advanced Platform, adoption of cloud computing, and broadening awareness of open source offerings

In my own conversations with Red Hat executives, it's clear that the company has plenty of headroom in both its JBoss business (8 of the top 25 deals in the quarter included a JBoss component, and Red Hat CFO Charlie Peters said that it continues to grow faster than Red Hat's core RHEL business), but particularly in its virtualization strategy. Virtualization is effectively a way for Red Hat to sell much more deeply into existing accounts. Much deeper.

But Red Hat is also seeing traction in its nascent cloud-computing initiative. In the third quarter, Red Hat saw a major movie studio building a private cloud with its technology in addition to NTT choosing Red Hat for its cloud infrastructure, plus the signing of a six-figure Red Hat Enterprise Linux-based cloud deal.

Clearly, there is gold in the Linux hills for Red Hat, gold that doesn't seem to be running out, especially as Red Hat improves its ability to get free-riders (CentOS and unpaid RHEL users) to pay, as it did this quarter with two sizable "free-to-paid" deals. The only negative in Red Hat's quarter seems to be a back-loading of revenue, meaning that more deals closed at the end of the quarter than normal.

But Peters said that cash flow for the year would come in at the high end of his former guidance, so things remain on track.

In light of Red Hat's strong performance in its core Linux business, it's somewhat strange to see Novell reorganizing to emphasize its proprietary products instead of hitting hard on its still-solid Linux business.

But perhaps there's only room for one Linux vendor in the data center. Based on the last several years of Red Hat performance, that vendor appears to be Red Hat.

Ubuntu has led the Linux community's efforts to improve on form, not simply function, and thereby make the Linux experience as good or better than Mac OS X in terms of usability. Mark Shuttleworth, founder and CEO of Canonical, the company set up to shepherd development and commercialization of Ubuntu, is the heart of that effort.

As announced on Thursday, however, Shuttleworth is resigning as Canonical CEO to focus on improving the Ubuntu user experience:

From March next year, I'll focus my Canonical energy on product design, partnerships and customers. Those are the areas that I enjoy most and also the areas where I can best shape the impact we have on open source and the technology market.

Is this good or bad for Ubuntu? And what about Canonical?

Canonical is reportedly doing $30 million per year in sales, and is working on some significant projects that may establish it as the de facto Linux distribution for Netbooks, if it isn't already. (Ubuntu is arguably the community choice for personal computers.)

Even so, Linux still has a long way to go to match the user experience of Mac OS X, or even Windows. Shuttleworth has given me a sneak peak of his vision for where Ubuntu can go from a UI perspective.

I was blown away. This is a man who "gets it."

Even so, he and the Ubuntu community still have a ways to go to match Microsoft or Apple in user experience, and certainly in market share. To get there, Ubuntu needs Canonical, and Canonical needs Shuttleworth fixated on improving Ubuntu's user experience.

When I asked what his resignation as CEO means for Ubuntu, and his involvement with it, Shuttleworth responded:

I don't expect to be less visible, just have stronger management for the business units.

As reported by CNET and as reported on Canonical's corporate blog, Jane Silber, currently Canonical's COO, will replace Shuttleworth as CEO. A search for a new COO will commence in the first few months of 2010.

This, I believe, is an opportunity for Canonical to tighten its focus. While Shuttleworth suggests that Silber's appointment "doesn't mark a change of direction," perhaps it should. With over 300 employees and products that span mobile, Netbooks and other personal computers, cloud computing, enterprise servers, and more, Canonical has its fingers in a lot of pots.

It's possible that the operations-minded Silber may channel Ubuntu's ambition into a few products where Ubuntu can dominate.

When I asked her for comment, Silber indicated that the move is more evolutionary than revolutionary:

This move should not be read as a precursor to a paring back in markets or as a dramatic shift in strategy. We continue to be committed to making Ubuntu the best possible platform, and to ensuring that Canonical provides high quality engineering, online and professional services to Ubuntu partners and customers worldwide....

I will still bring an operations discipline to company, but I will assume more responsibility and authority for the overall performance of the company including, I expect, greater participation in executive level sales and business development.

That involvement--i.e., working with customers and hearing them demand focus and discipline--may well prod Silber to instigate the changes she initially has disavowed.

Red Hat is instructive. Though many of us would like to see it broaden its focus, the company remains rooted in the enterprise server and middleware markets. Canonical, in my view, should take a lesson from Red Hat and channel some of its energy into fewer markets, markets where it can thrive.

Regardless of what happens, stay tuned to see how Shuttleworth's design aesthetic, now set to overdrive, can impact the cozy duopolies in "desktop" (Apple and Microsoft), servers (Red Hat and Microsoft), and more. With more time to focus on what customers and partners want, Canonical and Ubuntu may be set to take a more commanding position in the market.

BUENOS AIRES--Open source has successfully navigated its first two phases of development and adoption. We're now entering the third, and possibly final, phase: the time when consumers of open-source software also become producers.

Can enterprise IT make the leap?

Billions of dollars in IT investment are at stake. Perhaps even more importantly, billions of lines of code could be, too. While significant software products are written for sale, arguably much more software is written by enterprise IT to run businesses as diverse as Safeway stores and Barclays banks.

Unlocking and distributing the value of that enterprise IT, developed to run behind the firewall, is the next big step for open source.

As Red Hat's general manager for Latin America, Julian Somodi, and Red Hat's Latin America marketing director, Martin D'Elia, speculated on Thursday at a lunch meeting here in Buenos Aires, open source's greatest value is unlocked when one moves from being a mere consumer of open-source software to also being a co-producer of such software.

It's a message Red Hat CEO Jim Whitehurst has been sounding for the past two years, and it may finally be catching on.

Today, enterprise IT is adopting and using open source on a grand scale. Gartner finds that 85 percent of enterprises are using open source today. (My hunch? The other 15 percent are, too, but the CIOs surveyed simply didn't know.)

The percentage contributing back? I've seen no data on this, but my personal, anecdotal evidence suggests that few enterprises contribute back to open-source projects, for a variety of reasons. Legal is probably the biggest, as enterprise IT weighs the risk of exposing itself to potential lawsuits from faulty or IP-infringing code.

This concern would appear more intractable had the vendor community not already navigated it in the second phase of open-source development. Vendors had the same concerns that plague enterprise IT today, and ultimately discovered that the value of open-source participation trumps its risk.

As a sign that we're coming to the close of this second phase, even laggards like SAP have announced significant progress in their open-source development efforts.

The same benefits that attracted SAP et al. will propel enterprise IT into this third and final phase of open-source participation, too.

Which benefits?

For starters, open-source software development offers a quicker path to resolution of bugs, a recent analysis finds.

It also enables finer-grained control and customization, as the French army has discovered with Mozilla Thunderbird, the customizations of which can be shared so as to offload the burden of supporting the code.

It might well be, as Gartner's Brian Prentice argues, that ultimately only vendors care about open source. But I think this view only rings true if enterprise IT remains blinded to the big benefits that derive from open-source participation, rather than mere consumption.

While not every company will have a great experience all of the time (witness, for example, the problems Farelogix had developing community around its open-source travel management point-of-sale tool), enough enterprises are experimenting that to suggest the third-phase train is leaving the station for good:

JP Morgan Chase led the way by open-sourcing its AMQP project. The Chicago Mercantile Exchange has also jumped into the fray with Linux. Reuters has its OpenCalais project, a project that is even being used here at CNET.

And so on. It's happening. It's real. And for those enterprises that jump into this third phase of open-source participation, the benefits promise to be palpable.

Initially, it appeared that every successful open-source company would be swallowed up through acquisition. That may still happen, but as the mergers and acquisitions route dries up, it's increasingly likely that the best open-source companies could find themselves growing toward an initial public offering.

After all, they may not have any other choice.

JBoss, Zimbra, XenSource, and other companies rode an initial surge in interest in open source as a business and development strategy, each selling for hundreds of millions of dollars. Since that time the pace of acquisitions has slowed as would-be buyers hunker down and ride out the recession.

At the same time, open-source companies are reporting record revenue. My own company, Alfresco, has recorded 17 straight growth quarters since the company was founded in 2005, and we're joined by Funambol, Jaspersoft, and others that are reporting upward of 100 percent growth quarter over quarter.

Where does such sales momentum lead? Probably not to acquisitions. Not for many of these companies.

It's likely that within the next few years, the M&A market will open up again. But by that time many of these open-source companies will likely have attained a size that makes it easier for them to go public than to be acquired.

MySQL, which was topping $94 million in sales at the time of its $1 billion acquisition by Sun, is the exception to this rule. There simply aren't very many companies that can afford to spend $1 billion on an acquisition, which means that open-source companies will need to focus on being built to last, not built to flip.

Perhaps this won't sound appealing to the employees of Reductive Labs, Funambol, Pentaho, and other open-source companies. Like their Web 2.0 peers, they almost certainly would love to see a quick exit so that they can buy a cabin up in Tahoe.

But though it may not be ideal for such employees, it's arguably a very good thing for the industry, and for IT buyers. The industry could use another Red Hat. IT buyers, for their parts, would probably love to be able to buy from someone other than Oracle, IBM, and Microsoft.

So settle in for the mid-term march to profitable $100 million open-source companies. At current growth rates, we should start to see IPO action as early as 2012, and perhaps sooner.

Activists worry about the environmental cost of discarded mobile phones, personal computers, and other technology. Perhaps they should also worry about the swelling graveyard of start-ups and tech titans gone bad.

As Le Monde points out (in French), though businesses fail in all areas of the economy, technology ventures, and especially Web start-ups, prove particularly short-lived.

It's Joseph Schumpeter's creative destruction...in overdrive.

Le Monde suggests three reasons: the speed of innovation/evolution (AOL's walled-garden approach meets Yahoo's open-portal approach), the ability of incumbents to crush nascent competitors (Netscape meets Internet Explorer), and the shortcomings of business models (Skype: only $500 million out of more than 520 million subscribers).

These are good points, but perhaps there's another: technology companies are increasingly disposable because they're so darn cheap to create.

This affects start-ups and incumbents alike. For the latter, perhaps the negligible cost of starting a new company fosters the comparative disposability of such start-ups. As Bernard Dalle, a general partner with Index Ventures in London, notes, start-ups need only rent essential infrastructure like hardware and software, and that rent is dirt cheap.

Ideas that couldn't survive a $5 million to $10 million capital-raising process might well weather a friends-and-family round of $50,000...and expire shortly thereafter when the idea proves barren.

But it's also true of the incumbents: Gulliver-esque Microsofts can fight off most of the Lilliputians, but an increasing array of the pesky imps sprout into adulthood (e.g., Google, Salesforce, Facebook).

Unfortunately (or fortunately, depending on your market position), this process of creative destruction may well be accelerating, and open source is one of the primary fuels.

The Linux Foundation's Jim Zemlin insists that the pace and price of innovation today requires open source, a communal effort that isn't bogged down by the bureaucracy or cash constraints of any one company. He may be right.

That certainly seems to be one lesson to take from the success of Linux, Firefox, and other open-source projects, particularly those that are community-led, as opposed to company-led. It's hard to compete with a group of self-selected, highly focused developers who can focus on good code, not good financial quarters.

Now that virtually every technology company depends upon and contributes to open-source software, we may well be laying the foundation for even more industry innovation...and corporate bankruptcies.

Guess what? There's nothing we can do about it. Nor is there anything we should do about it, except focus on building long-term customer value rather than short-term start-up goofiness. That's the way to thrive in the fast-evolving world of technology, because it's the one thing that never changes:

Customers pay for value, and companies that consistently deliver real value acquire the most customers.

Tim O'Reilly points toward this in his call for developers to "work on stuff that matters." It's a reminder but also a warning.

Microsoft is still with us because it has delivered an amazing amount of customer value in its 30-plus years. The same is true of IBM, Oracle, SAP, and other industry incumbents.

But it's equally true of relatively new companies like Salesforce, Red Hat, and Google, which have eschewed gimmicky software and flimsy business strategies to give customers tangible, ongoing value. None of these companies sought an early exit through acquisition. None of them were content to build for the quick flip.

So, yes, technology may be a veritable boneyard of failed companies, and essential ingredients like open source may accelerate the demise of start-ups and incumbents alike. But those companies that use such ingredients to deliver above-average customer value are going to endure...and thrive.

Follow me on Twitter @mjasay.

Open source, like digital media, doesn't suck money out of hitherto profitable industries. Instead, the opening up of software and information simply changes where the money gets made.

This is obvious to the Googles of the world. It's probably equally obvious to the Microsofts of the world. The difference is that the latter can see the train coming but is powerless to stop it, and the former is driving the train.

The evidence for this is increasingly clear and is driven by a shift in how content is sold and consumed. The problem is neatly summarized by Google CEO Eric Schmidt in a Wall Street Journal op-ed piece directed at the newspaper industry:

[T]he Internet has broken down the entire news package with articles read individually, reached from a blog or search engine, and abandoned if there is no good reason to hang around once the story is finished. It's what we have come to call internally the atomic unit of consumption.

That newspaper was "the package," but is increasingly too slow and out-of-sync with how people prefer to discover news content. New packaging is rising, including Google News, that will shift who makes money on news content.

Reporters will still get paid. They'll just have a new employer on their payroll check. Maybe it will be Google.

News isn't dead. Paper is.

Think about what is happening in music. I could download New Order's "Regret" for free using LimeWire, but I bought it on iTunes because of the "packaging" which makes my experience easy, high-quality, and legal.

Still, the primary drivers are ease and quality.

Such packaging is worth a lot of money--and to an entirely new breed of vendor--as a quick look at Google's latest income statement suggests.

It's happening in software, too, particularly in open-source software. Red Hat is an example of a company that does a great job of turning software license into an ongoing service contract that enterprises buy. It does this by packaging the power of others' development in the form of a subscription, as Red Hat CEO Jim Whitehurst recently highlighted.

But Red Hat is just Open Source 1.5. Open Source 2.0 looks more like Google or IBM. For every dollar Red Hat makes selling subscriptions to use open-source software like Linux and JBoss, both Google and IBM make multiples of that dollar using open-source software to sell something else, something they've packaged in hardware or Web-based services.

The hardware is running open source. The services are based on open source. The money is made in the packaging of open source.

... Read more

President Obama is gathering 100 leaders from across the U.S. for his jobs summit in Washington on Thursday to brainstorm how to create new jobs.

While the list of invitees is heavy on academics, labor unions, and business, it appears only two people from technology made an early invitation list: Eric Schmidt, CEO of Google, and Jim Whitehurst, CEO of Red Hat.

FedEx. Yes. Nucor. Yes. But no Microsoft. No Oracle. No Salesforce.com. What gives?

Yes, Schmidt is a key advisor to Obama. But his invitation, along with Whitehurst's, could have a lot to do with the fact that Google and Red Hat, unlike many of their peers, are actively hiring.

Red Hat and Google have thrived through the recession, perhaps suggesting that they have a clue as to what it will take to create new jobs in a tough economy, one that has seen 23 straight months of job losses.

Intriguingly, Google's hiring may be crimped more by a desire not to aggregate all of the best and brightest than an inability to do so, as evinced by Google Vice President Bradley Horowitz's comments at Supernova this week.

When I asked Whitehurst on Wednesday what he thought the two companies had in common, he was quick to respond: "open source."

It's an interesting observation. While the two companies use open source in different ways, their business models are actually more similar than different, and both depend on open source.

As I've written, both Google and Red Hat (along with Facebook and other new-school "software" companies) depend upon and help to create abundance--of code, of Web sites, of information--and then make money by filtering that abundance.

It's a model that works, and it's a model that heavily depends upon and contributes to open-source software.

It would be going too far to suggest that open source is the critical component of any successful technology business today, especially as just about every company now includes it in their offerings in some way. Plus, CIOs have discovered other ways to stretch IT budgets and keep their workers on the payroll, as Gartner advises.

But the mentality of open source--more with less, sharing code and expertise--does seem to be a hallmark of successful technology companies, and particularly at Google and Red Hat.

In the past week, the open-source business community appears to have reached consensus: making money from open-source software is a bad model, but making money with open source is golden.

This can't be good for Microsoft.

Microsoft has long maintained that as the open-source industry has matured, it has become more and more like the commercial world it sought to leave behind. Fundamental freedoms of open source, like the right to modify source code, are signed away to secure a support contract with Red Hat or another vendor.

In many ways, Microsoft was right. Unfortunately for the Redmond giant, however, the new consensus should lead to less commercialization of open source, and more commercialization around open source. There's a big difference, and it's one that threatens to seriously undermine Microsoft and every other traditional software vendor.

That is, unless Microsoft responds in kind.

The new consensus

This consensus has been articulated by TechDirt, Redmonk's Stephen O'Grady, GigaOm, and here on The Open Road.

In fact, it's a drum I've been beating for over a year as Tim O'Reilly's wisdom on the topic finally caught up with my 33MHz brain.

There are fundamental, strategic benefits to open source: ease of distribution, friction-less adoption, costs, etc. There are also serious downsides when it comes to selling it: people chafe at paying for something if they can get it, or something similar to it, for free.

Such problems don't plague companies like Google, which distributes open-source software to drive more adoption of its proprietary advertising or SaaS services. Even Red Hat isn't really in the software business: not with its Linux distribution, anyway. It's in the business of providing certification and update services; of managing the complexity of an operating system.

It's a great business, but if you had to choose between Google's sales or Red Hat's, it's a no-brainer.

Microsoft's response

As this lightbulb goes on across the industry, companies like Microsoft, which insist on direct monetization of software, with little in the way of open-source complements to fuel adoption (or simply undermine competitors), are going to struggle. More and more companies will give away Microsoft's core business as open-source complements to their own.

So, here's a suggestion for Microsoft as just one good way to respond: open-source Internet Explorer.

Forget Office. Forget Windows. Forget all those other billion-dollar cash cows. Microsoft has no revenue directly tied to Internet Explorer, but IE is the gateway to the next phase of Microsoft's growth. Open-source it.

Cut Google's Chrome and Chrome OS off at the knees. Undermine Mozilla Firefox's raison d'etre. Give the European Commission a reason to love you.

More importantly, give developers something to embrace and extend. Microsoft has been steadily losing browser market share as Firefox eats into it. In some countries, like Germany, Firefox has even surpassed IE's market share.

Fight fire with fire. IE is still the world's most popular browser. Make it the world's most open browser, too.

Every Microsoft business could benefit from this move. Even if one assumes that Microsoft isn't ready to take the plunge and fully open up the development process around IE, here's some comfort: neither has Google around Chrome. Microsoft can still steer the IE ship, even if it were open source.

Microsoft needs a proactive open-source strategy, rather than the reactive policy it has had to date. Open source is a threat, yes, but it's a threat to everyone, especially as the industry collectively comes to grips with open source as a business enabler, rather than as a product to sell.

If Microsoft wants to win big in the new world of Web-based software, it needs a bold strategy. Open-sourcing IE is the starting point.

Follow me on Twitter @mjasay.

With open-source software businesses, you have two options. Actually, three, but the third belongs to Red Hat, and it applies to roughly no one else.

The first option is to sell support for open-source software. This option is generally advocated by those who have never grown a business beyond $10 million. It's a terrible model unless your only aspiration in life is to run a services company.

Hence, the support model might be good for Accenture or systems integrator, if they want to take on the burden of support, but it's a poor model for Red Hat, MindTouch, Microsoft, or other software company.

The second option is to contribute heavily to open source but not build your revenue model around monetizing that software directly. This is what the New York Times points to in its Sunday expose of allegedly fizzling open-source business models.

Open source can drive adoption like little else. It's not, however, necessarily a great driver of revenue. For that, you need to be selling something beyond the source code, and that "something" is often going to be proprietary, be it hardware, software, or a service.

Google is the master of this model. It gets roundly criticized for its half-open, half-closed open-source efforts, but the reality is that Google's products--Chrome OS, Android, etc.--are open enough to facilitate adoption without giving away the keys to the car, which drives wherever Google wants it to go.

That's the way successful companies are run: they take ownership of what they ship. They are influenced by but not controlled by the mystical whims of The Community.

Even Red Hat, which piggybacks on a lot of Linux kernel development, increasingly includes more home-grown software in its distribution and takes great pains to certify its Red Hat Enterprise Linux will work in the most demanding environments before putting its brand on the label.

Some, including me, have wrongly concluded that Red Hat's business model would apply to other product markets beyond the operating system. It doesn't. It only applies where the moving parts in the product are complex, multitudinous, and frequently changing.

For everything else, there's Option 1 (if you want a business that doesn't scale well or possibly at all) or Option 2 (which is really no different from the old proprietary model except that it effectively uses open-source complements to lower engineering costs and possibly sales/marketing costs).

Even Option 2 won't work if you under-invest in marketing and development, as Symbian is learning to its hurt. It turns out that there is no free lunch, even in the land of free software. It always takes work. And money. Lots of both, actually.