The Open Road

Novell has been positioning itself as the Avis of Linux, a distant but gaining Red Hat competitor that "tries harder." Like Oracle, Novell argues that it can give customers Red Hat value at a lower price.

There's just one problem with this marketing spin: the "low-cost alternative" to Red Hat isn't Novell. It's CentOS. And CentOS is free as in $0.00.

It's true that adoption of unpaid Linux like CentOS is booming, and that this no-cost alternative to more expensive solutions like Red Hat is a real threat to Red Hat. This is no doubt why Red Hat has made "free-to-paid" a core element of its ongoing strategy, as related in its recent earnings call.

But it's a much bigger threat to Novell and Oracle, both of whom are trying to position themselves as cheaper alternatives to Red Hat Enterprise Linux.

If a customer really wants Red Hat at a lower price, they're not going to move to an incompatible distribution that may or may not run their applications properly. They're going to jump to CentOS, which is basically a carbon copy of RHEL, minus the trademarks (and price tag).

Oracle, for its part, is clearly not in the Linux market. It's in the market to eradicate Red Hat, so as to claim top-to-bottom control of its software stack. But even as Oracle tries to squeeze Red Hat into oblivion, CentOS provides an excellent hedge against commercial competition from Oracle (and Novell), making its pitch ring hollow.

CentOS: Red Hat's biggest annoyance and greatest friend?

It's not dissimilar to the role that piracy plays for protecting Microsoft's Windows dominance against Linux, especially in emerging markets. Quite possibly the worst thing that Microsoft could do, as IDC has also suggested, is to succeed in its anti-piracy efforts.

Were Microsoft to raise its pricing above $0.00 in such markets, suddenly Linux would look like a much better alternative.

Back to Novell and Oracle. It's not enough to try harder. Red Hat has created a dominant global brand that CIOs trust. It's not worth a few dollars here and there to disrupt that to shift to SUSE or Oracle Enterprise Linux.

Not when those CIOs can shave 100 percent of their RHEL subscription costs by moving to CentOS.

I know some CIOs who have, but they tend to be enterprises with lots of developers that are comfortable supporting themselves. Fortunately for Red Hat, few CIOs care to take that risk. Unfortunately for Novell and Oracle, those who do want to save all of their Linux subscription fees, not just some of them.

At the recent Red Hat Summit, company CEO Jim Whitehurst quipped that "flat is the new up," but he clearly wasn't referring to Red Hat. On Wednesday Red Hat announced another strong quarter, with revenue of $183.6 million for the company's second fiscal quarter of 2010.

That's a rise of 12 percent compared with the same period last year. Despite the company's against-the-grain performance in a weak market, however, it may need to invest more in its middleware business to ensure future growth.

But first, the good news. Of Red Hat's total revenue, roughly 85 percent, or $156.3 million, came from subscription revenue. That's an increase of 15 percent compared with the year-ago period. Putting this into context, IDC projects Linux subscription revenue to top $1 billion by 2012. Red Hat should claim virtually all of this at its current pace of growth.

Customers seem content to pay Red Hat for free software that they could get more cheaply elsewhere. While recent IDC data hint at hard times to come for commercial Linux vendors, it hasn't hit Red Hat. Not yet. The company is still a darling with CIOs.

And it may not for some time, with Red Hat reporting deferred revenue of $581 million, up 17 percent compared with the same period last year. The company is increasingly profitable, too. It reported net income of $28.9 million, or 15 cents a share, compared with $21.1 million, or 10 cents a share, for the year-ago quarter.

As part of its quarterly earnings call, Red Hat executives revealed a range of reasons to think its business is on track:

• All top-25 customer accounts renewed, and at 120 percent of the prior year's value. Most customers are expanding their adoption of Red Hat, and more and more are upgrading to Advanced Platform.
• Only three of its top-300 customers up for renewal didn't renew in the quarter, and two of those have returned to Red Hat after the quarter closed.
• Two deals were over $5 million, while 10 deals hit $1 million. Red Hat EMEA (Europe, Middle East, Africa) closed its biggest deal ever in the quarter.
• Of the top 30 deals, 23 included Red Hat Enterprise Linux (RHEL) Advanced Platform, and five included a JBoss component. This suggests that Red Hat's big customers are upgrading to Advanced Platform, according to Red Hat CFO Charlie Peters.
• JBoss continues to grow much faster than the core RHEL business.
• Deal length extended to 22 months from 19 months last quarter, reflecting
• One former Red Hat customer, a large financial services company (almost certainly Credit Suisse), dropped Novell's SUSE Linux and returned to Red Hat with a big order in the quarter. Credit Suisse is one of the companies Novell pulled away from Red Hat by using Microsoft-subsidized coupons, but Peters indicated that the customer had returned because of Red Hat's superior value. It appears that Red Hat is a better value than free.
• Red Hat is taking share from its competitors rather than seeing an increase in net new server purchases.

Despite the mostly sunny skies, Red Hat's slowing revenue growth remains a concern. The trend kicked off in 2005 and has continued apace since then despite a brief respite in 2007, as The 451 Group reports.

Of course, as Red Hat gets bigger, and as the economy remains stagnant, it's normal that Red Hat's revenue growth will slow.

But it's also normal that as it slows, companies like Red Hat will look for increased growth beyond their core businesses. Oracle is perhaps the most obvious example of this.

Red Hat doesn't need to get into video game consoles (e.g., Microsoft's Xbox) or hardware (e.g., Oracle's pending acquisition of Sun) or a variety of businesses far afield from its core infrastructure business. After all, Red Hat clearly has a lot of room to grow its JBoss/middleware business, and arguably needn't acquire its way to that growth.

But it does need to significantly change the way it views its channel partners.

Red Hat's traditional Linux partners are absolutely the wrong group to be selling its middleware offerings, a fact that took Red Hat some time to digest. Now, however, Red Hat seems to be getting the picture and has launched its Catalyst Program to sell turnkey open-source solutions through a growing ecosystem of value-added resellers (VARs).

Catalyst, however, is still in its infancy. It remains to be seen whether this program will stick, as Red Hat has moved away from ecosystem efforts like its Red Hat Exchange in the past.

For Red Hat's sake, it should stick with this one. Through Catalyst and other means, Red Hat needs to place more emphasis on the world outside of Linux. The company believes that virtualization and cloud computing are big opportunities, and they are, but these are mostly ways to build upon RHEL, rather than ways to extend its reach into fast-growing, diverse markets.

Red Hat is an execution machine and will undoubtedly be able to continue to grow its Linux business, and possibly to accelerate that growth again through enhanced investments in virtualization and cloud computing. But the real growth for the company is a bit higher up the stack in its middleware business.

Peters said that the company is investing significantly more in JBoss than RHEL, proportionate to the revenue each brings. That's good, but also obvious, given that Red Hat's JBoss business is comparatively small to its RHEL business. It may be time to invest even more in JBoss.

Red Hat announced a range of cool new products and technologies last week at Red Hat Summit, but the most potent message emerging from the conference may well have been 'Diplomacy be damned!' Red Hat has generally opted to publicly ignore competitors, but not anymore. The company singled out Microsoft and Oracle, in particular. Is this a new, combative Red Hat?

Red Hat's DeltaCloud was the big technical news, offering a "common API to blend public and private clouds." It also announced a new Catalyst program to corral a partner ecosystem around its infrastructure products.

But for me, it was Red Hat's swipes at its competitors that are possibly more momentous. It's not that Red Hat never criticizes competitors: in 2006, for example, Red Hat declared the imminent death (wrongly, as it turns out) of Novell.

But there's a difference between criticizing pure competitors and those companies, like Oracle, that Red Hat both competes with in some markets and partners in others.

Hence, when Red Hat's executive vice president of products and technologies, Paul Cormier, singled out Microsoft Azure for its potential to lock in customers, this was an easy jab at a company that drives no Red Hat revenue.

Red Hat CEO Jim Whitehurst's scorn for Oracle's technology strategy, however, has the potential to damage the companies' partnership:

Do you want to buy into Larry Ellison's vision of what your IT infrastructure should be and what functionality you should provide to your customers, or should you listen to your customers and be flexible?

This second critique has more sting because Red Hat and Oracle partner as much as they compete. Oracle first caused waves in the partnership by cloning Red Hat Enterprise Linux and undercutting Red Hat's pricing, but Red Hat's response ("It's a fork and not a particularly good one") was relatively muted. It had to be: Oracle's database certification for RHEL has long been a driver of RHEL sales.

Is this a sign of a new Red Hat, one that will not only talk down competitors but also be willing to take them down by entering competitor-partners' product markets?

I hope so. There's no way for Red Hat to grow without stepping on partners' toes. I'm not suggesting Red Hat should declare war on its partners, but it certainly needs to be willing to make partners uncomfortable, as it did by acquiring JBoss. It's a sign of a more competitive Red Hat.

Follow me on Twitter @mjasay.

Ten years ago today, on August 11, 1999, Red Hat saw its shares triple in an initial public offering that ushered in a new era of commercial open-source prosperity.

Iain Gray, then a Sun employee and now Red Hat's vice president of Global Support, writes nostalgically: "I remember sitting in the Sun office in UK watching the stock skyrocket, thinking the world had gone mad."

Indeed it had. Soon Red Hat's stock was to plummet to earth but not before the company learned a valuable lesson: there must be more than hype to make open source grow.

Red Hat's S-1, the document filed with the Securities and Exchange Commission registering its intent to sell its shares on the public market, was filled with desire to use the IPO cash to improve its brand, expand professional services, and to improve its Web site to "create the definitive online destination for the open source community."

Very little attention was paid to the nuts and bolts of actually making money. In fact, as LWN.net pointed out back in 1999, "Nowhere in the [S-1] filing is anything about 'make more money selling our distribution.' Red Hat clearly sees its future elsewhere."

Not for long. Whatever Red Hat's vision of its business model in 1999, it soon realized that it needed to spin value far beyond a strong brand. The company recognized in its S-1 filing that "if faster Internet connections become widely available, more users may download the distribution from the net, and fewer will buy it."

That worry absolutely proved to be true, leading Red Hat to introduce (the initially proprietary) Red Hat Network in 2000 and in March 2002 upped the ante with Advanced Server, which later became Red Hat Enterprise Linux.

Over the past 10 years, Red Hat has maintained its investment in strong branding, but has focused even more on its core distribution and the value therein, investing more than $100 million each year to improve Linux and its distribution thereof.

The results speak for themselves. Red Hat demonstrated that anyone can be rich for a day with a hype-based IPO launch, but it has more importantly proved that there's a whole lot of substance to open source over the past 10 years. Red Hat has made a massive impact on the software industry, not the least being making open source palatable to the enterprise buyer, to the extent that now open-source competitors are giving Red Hat a run for its money.

There could be no better testament to Red Hat's influence and importance.

Follow me on Twitter @mjasay.

Red Hat stands alone as the only significant public open-source company. Is this a testament to its execution, or is it a hint that open source is not well-suited to big business?

While I believe that open source will increasingly be the heart of many big technology businesses, it will almost certainly feed new entrants to markets, not incumbent vendors.

Looking at Red Hat's report on its most recent fiscal year (FY 2009), however, suggests that for these new entrants, open source can be a very profitable business indeed. I've already reported on the high-level financial results.

What is particularly intriguing is the data behind those results:

• Red Hat is forecasting $720 million to $735 million in FY 2010, an annual growth rate of 10 percent to 13 percent over 2009.
• 40,000 new Red Hat Enterprise Linux customers in FY 2009, the "vast majority of which are...customers that are starting off small." Lots of room to grow, in other words.
• Nearly half of Red Hat's top-100 renewal customers upgraded to or increased the number of RHEL advanced platform servers in their Data Centers. (In its fiscal Q4 2009, Red Hat renewed each of its top-25 contracts up for renewal at 132 percent of the prior year's value.)
• 30 percent of Red Hat's largest 30 deals included a Middleware (JBoss, usually) component.
• Average contract lasts 23 to 24 months, with pricing remaining "consistent for the last several years."
• Channel bookings grew 23 percent in FY 2009, while Red Hat more than doubled its number of partners to 4,500.
• In fiscal Q4 2009, Red Hat closed two large deals, one of which was a multi-year, multi-million dollar deal that represented its largest conversion from free-to-paid (a key initiative for FY 2010) as well as a six-figure conversion deal with another customer.
• 57 percent of bookings came from the Americas, 28 percent from EMEA, and 15 percent from APAC.
• The recession has not "changed the length of [Red Hat's] sales cycle in any meaningful way."
• Subscription gross margin improved 60 basis points over the year to approximately 94 percent while training and services gross margin improved approximately 280 basis points from Q4 last year, driven mainly by better utilization and higher gross margins from the Amentra business.
• Red Hat ended its fiscal year with $846 million in cash and investments and is now debt free.

One of Red Hat's big initiatives for FY 2010 is to increase the rate of adoption of its for-fee products from prospects still using for-free versions of its software (Fedora, CentOS, etc.), a process it only started in late 2008. As Red Hat CEO Jim Whitehurst notes in the earnings call, enterprises often find it "very expensive" to support themselves. As the data above suggests, Red Hat is getting better at convincing them to move to Red Hat's subscription offerings.

As the economy continues to sour, it's likely that Red Hat, and not its proprietary peers, will disproportionately benefit, especially as Red Hat learns to upgrade accounts from "free" to "fee." Whitehurst notes:

We've seen a lot of interest from customers in open source as their budgets have gotten tight. We see that interest continuing and a lot of discussions started then are just now coming to fruition. So, I haven't seen real reduction in tight budgets, maybe there is not the same quiet level of desperation in people's voices but budgets are tight this year, Budgets are set and we think that's good for us at open source.

Or, rather, it's probably particularly good for those vendors that treat open source as core, not complement. Like Red Hat.

Follow me on Twitter @mjasay.

For years, Microsoft has insisted that open-source vendors acknowledge that its patent portfolio is a precursor to interoperability discussions. On Monday, Microsoft shed that charade and announced an interoperability alliance with Red Hat for virtualization.

The deal includes several key components, all related to virtualization:

• Red Hat will validate Windows Server guests to be supported on Red Hat Enterprise virtualization technologies.
• Microsoft will validate Red Hat Enterprise Linux server guests to be supported on Windows Server Hyper-V and Microsoft Hyper-V Server.
• Once each company completes testing, customers with valid support agreements will receive coordinated technical support for running Windows Server operating systems virtualized on Red Hat Enterprise virtualization, and for running Red Hat Enterprise Linux virtualized on Windows Server Hyper-V and Microsoft Hyper-V Server.

Pretty straightforward, as interoperability should be, and driven by customer demand for Microsoft technologies running alongside Red Hat's, according to Mike Neil, general manager of Virtualization Strategy at Microsoft. The top Linux vendor partnered with Microsoft: this is a major win for customers.

Crucially, Red Hat's interoperability deal with Microsoft does not include any patent covenants, the ingredient that torpedoed Novell with the open-source community:

The agreements establish coordinated technical support for Microsoft and Red Hat's mutual customers using server virtualization, and the activities included in these agreements do not require the sharing of IP. Therefore, the agreements do not include any patent or open source licensing rights, and additionally contain no financial clauses, other than industry-standard certification/validation testing fees.

Red Hat has long argued that patent discussions only cloud true interoperability, which is best managed through open source and open standards.

While Red Hat has flirted with such interoperability before by joining with Microsoft in the somewhat toothless Vendor Interop Alliance, this is its first direct interoperability initiative with Microsoft.

What most people don't know is that Red Hat had been discussing interoperability initiatives with Microsoft for a year before Novell and Microsoft tied the knot, but Microsoft ultimately derailed the talks by trying to introduce a covenant not to sue over patents, similar to what it ended up negotiating with Novell. Red Hat rejected this unnecessary inclusion, left the bargaining table, and Microsoft connected with Novell to use interoperability as an excuse to attack open source.

Monday, Red Hat and Microsoft have together demonstrated that interoperability can exist independent of back-room dealings over patents. Microsoft has increasingly been forced to open its stance on patents by the European Commission, anyway, proving Red Hat's resolute stance against patents was the right one. But this announcement suggests that Microsoft is maturing in its views on how to interact with open-source vendors.

It also suggests that Red Hat is maturing in its realization that it must interoperate with the old world of proprietary software even as it attempts to forge a new one of open-source software. Red Hat has long depended upon proprietary software: Red Hat Enterprise Linux's success has derived from its support for Oracle and other proprietary vendors.

Both Red Hat and Microsoft on Monday lowered their guns long enough for customers to win. They did so without encumbering interoperability with patents, which will be critical to ensuring that Microsoft can lower its guard further to welcoming open-source solutions to the Windows fold as a full partner.

Follow me on Twitter at mjasay.

Red Hat has set the standard for world class software support, consistently earning top marks with CIOs for its efforts. On Thursday, however, Red Hat outdid itself, introducing a new product support plan called Extended Update Support. In a nutshell, Extended Update Support enables customers to run their mission-critical systems for longer stretches of time without having to take production systems offline to update them.

From the announcement:

Extended Update Support allows a customer with a large mission-critical deployment to reduce server administration and management costs by standardizing on a single update release of Red Hat Enterprise Linux for up to 18 months--all while preserving stability and data security.

As Red Hat explains, most software companies allow customers to standardize on a minor, "point" release for 6 to 9 months, or at most 12 months. Through its Extended Update Support program, however, Red Hat is letting customers pick a Red Hat Enterprise Linux build and stick with it for up to 18 months, up to three times the industry average. That means less downtime and less need to re-validate software stacks running on RHEL.

The Register provides some additional insight:

While Red Hat commits seven years of support for a major RHEL version, the dot releases within the versions change about every six months. Within those dot releases, the company ensures application compatibility because it doesn't change the runtime environment, the area where the Linux kernel interacts with applications. So even if there are patches for security or bugs and whatnot in the dot release, customers do not have to go through application testing and certification, which can take many months, as long as they stay within a RHEL version.

This is a great service to Red Hat's customers, and provides further evidence that Red Hat's subscription model helps it to be more attuned to customer needs. Red Hat isn't selling an upfront license: it's selling the continued value of an ongoing subscription. By tuning that value to actual customer needs--in this case, the need to disturb production systems as little as possible to reduce risk and save money--Red Hat ensures renewals.

Subscription models align vendor interests with customer interests. Red Hat's Extended Update Support for Red Hat Enterprise Linux is setting the pace. It will be interesting to see who follows.

I've been pining lately for greater enterprise participation in open source, following the lead set by Red Hat CEO Jim Whitehurst, and so was excited to see the recent news that the Chicago Mercantile Exchange (CME) has joined the Linux Foundation. For CME, time is money, with a record 2.2 billion contracts in 2007 worth more than $1.2 quadrillion, all running on Linux (Red Hat Enterprise Linux, in this case).

But what does CME get from joining the Linux Foundation?

By joining the Linux Foundation, CME Group will be able to collaborate with key Linux developer and vendors. CME Group's Vinod Kutty, associate director and head of distributed computing R&D, will become chair of the Linux Foundation's End User Council. The Council is a group of the largest Linux end users who use the forum to collaborate and educate themselves on technical, legal and community efforts.

In other words, CME wants to be both a producer and a consumer of open-source software, and specifically Linux in this case. CME has been a longstanding user of Linux, deriving considerable value from Red Hat Enterprise Linux since at least 2004. Now it's time to start giving something back.

One reason for the rise of Linux is its impeccable security credentials. Sure, Microsoft has been trying to convince people for years that Windows is more secure, but it's hard to convince people against the facts of their daily experience. For 70 percent of IT workers recently surveyed, therefore, it was a no-brainer: Red Hat Enterprise Linux is more secure than Windows. Period.

Granted, this survey measured beliefs about Red Hat Enterprise Linux security rather than actual security, but perception is actually worth more in the market than established facts. People buy based on their perceptions. Just ask Microsoft's customers over the past three decades.

Another open-source advantage that is broadly recognized by the survey participants is security. Over 70 percent said that Red Hat Linux is less vulnerable to security issues than Microsoft's operating system.

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