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

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?”

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