Michael Tiemann, chief technical officer of Red Hat, used the 2003 Wharton Technology Conference as a chance to crow. In his keynote speech, he boasted that Red Hat is the “first successful, publicly traded open-source company.
“Last quarter, we reported our first full [Generally Accepted Accounting Principle] profit,” he said at last month’s conference, whose theme was “Expanding Business Horizons.” “We are very proud of our financial performance. Where this performance comes from is our ability to deliver an incredible amount of value.” What he neglected to mention was how small that profit was. Red Hat earned $214,000 on sales of $24.3 million in the quarter that ended Nov. 30, 2002. And the modest profit – the company’s profit margin was less than 1% – came from investments, not sales of software and support service; $3.1 million in investment income offset a $2.9 million loss from operations. For its 2002 fiscal year, Red Hat reported a net loss of $140.2 million, or 83 cents a share, on sales of $78.9 million.
The company, based in Raleigh, N.C., distributes an open-source computer operating system called Linux, which is available for free on the Internet. It also sells support services. Open-source computing lets programmers tinker with the source code – the brains – of an operating system. It’s as much a philosophical movement as a business model. Open-source programmers believe that letting people freely tweak and expand software leads to better products with fewer bugs. This “ragtag band of geeks,” as BusinessWeek recently referred to them, sees Microsoft, which zealously guards its proprietary software, as its nemesis.
If Tiemann was jubilant, the dominant mood at the conference was subdued. The technology sector still feels battered by the bursting of the late 1990s stock-market bubble; dozens of dot-coms have shuttered their operations; the telecommunications industry is in the throes of a restructuring; and even giants such as Cisco Systems in San Jose, Calif., which makes and sells Internet routers, are retrenching. A sense of hopes dashed pervaded a conference panel on web services that had occurred earlier in the day.
But Tiemann, a 1986 University of Pennsylvania graduate, came to his alma mater to celebrate; he even wore a Penn tie. And he positioned Red Hat as the anti-Microsoft, taking veiled stabs at the software giant throughout his talk. “What the analysts are saying – and we’ve now won the analysts at Merrill Lynch, Goldman Sachs and Credit Suisse First Boston – is, ‘Technically, these guys are winning,’” he noted. “And it’s not because of just Red Hat vs. the monopolist. It’s because the whole world is on our side.
“People who have product-centric views of [computer] architecture are doomed to fail,” Tiemann added. “The only way to succeed is to look at what your goal is and then go hunting for products.” His implication: Successful companies don’t just depend on Microsoft and its Windows operating systems.
Tiemann pointed to Morgan Stanley, a New York investment bank and Red Hat customer. “In the year 2000, Morgan Stanley began to believe that Linux was getting pretty good.” The company announced that it would begin a switch to a Linux-based computer system in 2004 and have the transfer four-fifths done by 2007. Then Morgan Stanley teamed up with Red Hat, which is helping it install servers using Red Hat’s version of Linux. “We’re about 50% through the entire migration – a year before they expected to start – and we expect to be done in 2004.”
One of Morgan Stanley’s Wall Street competitors, Lehman Brothers Holdings, is also switching to Linux, though, to some extent, the change was forced upon it. “On Sept. 11, 2001, Lehman Brothers lost both of their data centers in Manhattan,” Tiemann said. “When the dust settled, they received an insurance check for about $40 million to replace their servers. Their IT director called us and said, ‘What would it take for me to migrate all my stuff to your platform? I bet we can run 80% of our workload on it.’ In fact, we concluded that 80% was about the correct number. It looks like they’re going to spend $10 million replacing their hardware and end up putting $30 million in the bank.”
Red Hat will need a lot more stories such as these if it aims to impress investors. On March 18, its stock closed at $5.95. Its shares have traded at under $10 since the beginning of 2001. At the height of the stock market’s tech bubble, they had traded at more than $100.
During the question-and-answer portion of his talk, one questioner challenged Tiemann to defend his company’s reliance on, in essence, a band of volunteers it can’t control – the worldwide community of open-source programmers.
In response, Tiemann argued that the relationship between Red Hat and open-source programmers is like that between church and state. They are separate but equal, he said, cohabitating peaceably. “The community of open source – the inspiration, the freedom, the energy to create – is something fully sustainable without corporate handouts and subjugation. And we, Red Hat, have figured out that we can happily profit by not trying to control that community.” Another questioner tweaked him for using slides for his presentation created by Microsoft’s PowerPoint program. His riposte: “These slides were actually made in Open Office [an open-source software program] and, out of convenience for the people here who run an inferior operating system, converted.”
He also appealed to skeptics, asking them to take a fair-minded look at the open-source movement. “If you poke on this [way of doing business and making software] anywhere near as hard as you poke on businesses that claim web services, that claim wireless … you will find a fundamental improvement that open-source has made to software development.”
If Tiemann is skeptical about web services, the participants on the conference’s panel on the topic weren’t. They believe web services are reshaping computing. “Web services” refers to high-level computer applications that work together seamlessly via the web thanks to a computer language called XML. “Think of it as an economic lubricant for systems integration,” said Cliff Reeves, Microsoft’s general manager for the .NET strategy group.
Web services, for example, might entail one company’s purchasing system speaking directly to its supplier’s inventory management system and – this is key – doing it across the web. “Although there’s a technical definition of web services, in the market, it’s a very nebulous term,” said Simeon Simeonov, a principal in the Boston office of Polaris Ventures, an investment company. “Is it hardware or software? Networking? Is it just an extension of distributed computing or a new way to build applications? No company has shipped anything amazing in this space but many of them are working on things.”
One is Microsoft. Another is IBM, which is focusing on ways to use web services to help customers become on-demand e-businesses, said Bob Sutor, director of web services technology. The computer giant pitches the flexibility and responsiveness of Web-services applications – business virtues, not their gee-whiz appeal, he said. “As a software developer, I can tell you that web services is cool. And that’s why it was so hot over the last three years. But it’s much harder to sell up the chain. Today, you’ve got to sell it to the [chief information officer].” That means making a business case, especially in a tough economy.
One place where that kind of case has been easy to make is Amazon.com. “One out of four products we sell is fulfilled by a third-party supplier,” said Colin Bryar, Amazon’s director for web services. The suppliers communicate with Amazon via a web-services computer interface.
“They can list an item for sale on our site or change a price. That might not sound like a big deal for three or four products. But as you manage hundreds of thousands of products, you need computer communication between the companies.”