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Red Hat’s success aside, it’s hard to profit from free

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Red Hat, which just reported a profit of $47.9 million (or 26 cents a share) on revenue of $456 million for its third quarter, has managed to pull off a tricky feat: It’s been able to make money off of free, well, open-source, software. (It’s profit for the year-ago quarter was $52 million.)

In a blog post, [company]Red Hat [/company]CEO Jim Whitehurst said the old days when IT pros risked their careers by betting on open source rather than proprietary software are over. That old adage that you can’t be fired for buying [company]IBM[/company] should be updated, I guess.

In what looks something like a victory lap, Whitehurst wrote that every company now runs some sort of open source software. He wrote:

Many of us remember the now infamous “Halloween Documents,” the classic quote from former Microsoft CEO Steve Ballmer describing Linux as a “cancer,” and comments made by former Microsoft CEO Bill Gates, saying, “So certainly we think of [Linux] as a competitor in the student and hobbyist market. But I really do not think in the commercial market, we’ll see it [compete with Windows] in any significant way.”

He contrasted that to Ballmer successor’s Satya Nadella’s professed love of Linux. To be fair, Azure was well down the road to embracing open source late in Ballmer’s reign but Microsoft’s transition from open-source basher to open-source lover is still noteworthy — and indicative of open-source software’s wide spread adoption. If you can’t beat ’em, join ’em.

Open source is great, but profitable?

Red Hat CEO Jim Whitehurst
Red Hat CEO Jim Whitehurst

So everyone agrees that open source is goodness. But not everyone is sure that many companies will be able to replicate Red Hat’s success profiting from it.

Sure, [company]Microsoft[/company] wants people to run Linux and Java and whatever on Azure because that gives Azure a critical mass of new-age users who are not necessarily enamored of .NET and Windows. And, Microsoft has lots of revenue opportunities once those developers and companies are on Azure. (The fact that Microsoft is open-sourcing .NET is icing on the open-source cake.)

But how does a company that is 100 percent focused on say, selling support and services and enhancements to Apache Hadoop, make money?  A couple of these companies are extremely well-funded and it’s unclear where the cash burn ends and the profits can begin.

Replicating Red Hat — no easy task

Gigaom Research Analyst Andrew Brust has a good take on Hortonworks as a potential tracking stock for those who want to see if the open-source-plus-IPO-model will pay off. As he states:

“Hadoop is becoming a universal data layer, increasingly embedded in other software. Open source may not be the fastest road to monetizing software, but it is a super highway for establishing standards that gain rapid industry-wide support.”

In an interesting blog post coming about a month before the Hortonworks IPO, Host Analytics CEO Dave Kellogg said Red Hat’s model may be hard for Hortonworks and others to replicate. In his view, Red Hat’s model of selling professional services, support and maintenance for Red Hat Enterprise Linux (RHEL) operating system and JBoss middleware works because these products are relatively low-level infrastructure. In his words:

  • The lower-level the category the more customers want support on it.
  • The more you can commoditize the layers below you, the more the market likes it. Red Hat does this for servers.
  • The lower-level the category the more the market actually “wants” it standardized in order to minimize entropy. This is why low-level infrastructure categories become natural monopolies or oligopolies.

And even given Red Hat’s success, it is still a small company compared to commercial software giants like [company]Oracle[/company], Microsoft, IBM etc., as Kellogg also pointed out.

RHT Market Cap Chart

RHT Market Cap data by YCharts

So, the big question is whether a new generation of open-source-rooted companies — in big data, in analytics, in middleware — can wring profits out of what is essentially free stuff. I’m not convinced.

That is not to say there can’t be a highly profitable exit. Something along the lines of Oracle’s $7.4 billion pick-up of Java and MySQL via Sun Microsystems. As one wag said at the time: “Doesn’t [Oracle Chairman] Larry Ellison know he could have just downloaded MySQL for free?”

5 Responses to “Red Hat’s success aside, it’s hard to profit from free”

  1. Constantino

    I can’t understand why you started the article with “…… make money off of free, well, open-source, software.”. You are using the wrong ‘free’ in that comparison.

  2. Don’t forget that there are quite a few “new” companies that have yet to be proven in the public markets, but are showing amazing progress privately. The “oldest” of these “new” companies is probably MongoDB. They took the classic open source model and did some amazing community/developer marketing to build up the ecosystem, then transitioned into enterprise selling. They’re now trying to set themselves up for the future with a range of cloud products. Note the similarities with how Amazon started and built their enterprise business around developers.

    More recent examples are Nginx (as a company, the project itself is quite mature), Docker and Hashicorp (Vagrant) and CoreOS. Again, all developer focused and building companies around the open source product.

    It’ll be a while before we know the success of the latter examples, but MongoDB are an interesting candidate for a future IPO.

  3. Data Juggler

    I have been developing open source for over 5 years now, I think most consumers of open source software are not very appreciative of how much work goes into creating the products.

    For the comment that I just read about ‘Imagine creating that base yourself, I did all the work myself for everyone for all 12 of my projects.

    I suck at marketing, so I don’t get the mass appeal that many developers do, but out of tens of thousands of downloads I can’t get any get a review or a rating.

    I get emails ‘Been using it for over a year, and they write when they have a problem but I rarely get a ‘Thank You’ and the $3 per month I make off Ad Sharing from Code Plex really doesn’t encourage open source development.

    1 Rating or a few kind words and that is enough to keep creating multiple projects.

    I wish open source consumers were more appreciative of the software they are using for free. A comment should be required or a link advertising the project to use something if you like it.

  4. pr.ranjan

    You miss the point about the whole economics of Open Source. You get the base for free, imagine pumping money in R&D and building that base yourself. The core gets better and robust over time and companies can add value added extensions such as security, support and features on top of it.

    You as a customer get longevity in the product because it’s open source, many people contribute and care about it, and security of not being abandoned by the whims of a proprietary companies managers.

    So RedHat, HortonWorks does not have to bootstrap Linux and Hadoop from scratch, they get that for free. The money they make will always be icing on the cake. But their expenses will be less.

    These things takes a lot of time, how long did Microsoft take to reach here, how long did Linux took, it’s already in NYSE and UK Stock Exchange. How long did Hadoop took it’s everywhere now small and big companies.

    Where is Novell, Sun Microsystems, they were proprietary ( SUN tried otherwise but bit too late ). Do not measure value with just IPO money raised, and quarterly earnings.
    You know how short sighted investors are..

    • “Open source economics” is a new phrase to me. It’s also stating that this somehow different from any other business who has to take in more than goes out the door. RHT shouldn’t be considered on par with MSFT, etc – it’s two different market segments. But for right now, Red Hat’s done well (I remember the fun of the IPO 15 years ago) and is going to always stick around in business. Open source in technology is fine in smaller shops but for larger ones, you want that comfort of being able to pick up the phone and get support from someone and that’s part of what Red Hat sells.

      And investors are perhaps short sighted. I mean, it’s my money going into a product and I expect that I get a return on my investment. I want more money sooner than later. And RHT is making money with a good stock performance.