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?”

The OpenStack opportunity: so how big is it?

Calculating how much revenue — or profit — commercial vendors wring out of open-source software is a tough nut to crack.

One reason is that the vendors themselves muddy the waters. There’s lots of handwaving on areas of investment when it suits their purposes but as to revenue? Well, um, never mind. (Even the cloud revenue numbers these companies put out are obfuscated, but that’s another story.)

It’s also hard because the revenue models for open-source software vary widely. Some companies charge for support; others offer both an open-source (i.e. “free”) version of the software under an open-source license and sell a commercially licensed version; some offer professional services; some combine one or more of these models. It’s complicated.

Seismic shift in sales model

One thing is clear; enterprise IT vendors accustomed to reaping fat margins on up-front sales of software licenses and then healthy margins on yearly support and maintenance re-ups, will have a very hard time replicating that profitability in the open-source world. For one thing, big customers moving to open-source are doing so at least in part to get away from that old model, which they deem as onerous, if not downright punitive. They don’t mind paying for stuff necessarily — in fact, they like the idea of an accountable vendor — but they don’t like being strong-armed into paying for stuff they don’t need or use.

On the other hand, it’s very hard for vendors to profit off of free software. For more on this check out a really interesting blog post by Dave Kellogg, CEO of Host Analytics, based on his analysis of the Hortonworks S-1 filing last month. In his view, the only company in the open-source realm to build a significant business on open-source software is [company]Red Hat[/company], and even Red Hat is itty-bitty compared to [company]IBM[/company], [company]Oracle[/company], et al.

But back to OpenStack specifically. How much money are the dozens (and dozens) of self-proclaimed OpenStack companies making? As a gage of participation, the OpenStack Foundation has 8 Platinum members; 16 Golds and 87 Corporate Sponsors for a total of 111 official stakeholders. But getting real numbers out of any of them on their revenue is a tough task.

Parsing out OpenStack revenue

Luckily, for this Week in Cloud report, 451 Research took a stab at it and last week issued estimates on the revenue picture for OpenStack. It’s call? OpenStack revenue will hit $3.3 billion in 2018, up from about $883 million this year — a 40 percent compound annual growth rate over those four years. It surveyed 60 OpenStack players and its figures include both public and private cloud. It said current revenue comes mostly from 30 of those 60 comapnies. Opinion differs but I would bet [company]Mirantis[/company] and [company]Rackspace[/company] are the two companies now making some dough off of OpenStack. The rest? Well, it’s still early days.
OpenStack Revenue Predition

Whatever you think of OpenStack, it does seem to have won the branding and marketing war when it comes to open-source cloud frameworks. That’s so although even some OpenStack proponents concede that CloudStack is a more mature solution.

“If you want cloud now, you could go with CloudStack, but these vendors are buying into the future, which appears to be OpenStack,” said Jay Lyman, research manager for cloud platforms at 451 Research.

If you take the $3.3 billion as gospel, and divide that by the 60 companies surveyed, that’s $55 million per company in 2018. Not chicken feed but not a blockbuster either. But most onlookers agree that the number of OpenStack vendors is in flux and that the consolidation we’ve already seen — Cisco buying Metacloud, EMC buying CloudScaling, etc. will continue. It just does not seem feasible that there is room for a hundred or more vendors to profit from this technology.

And, to be fair, skeptics find both the current and future revenue totals for OpenStack to be wildly optimistic. We’ll have to check back in a few years to see what happens and hope that by then the vendors will be more forthcoming about real numbers. One can hope, right?

Structure Show: Handicapping the clouds

Other than the OpenStack melee, most cloud watchers keep their eyes on [company]Amazon[/company] Web Services, [company]Microsoft[/company] Azure and [company]Google[/company] Cloud Platform.

If you want an informed opinion about the relative merits of all these players, who better to ask than the CEO of a multi-cloud management company? So we did. This week’s Structure Show guest was Sebastian Stadil, founder and CEO of [company]Scalr[/company] and he has some interesting thoughts not only on the big three but on other clouds from Oracle, [company]Joyent[/company] etc. Don’t miss it.

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Red Hat and Mirantis: The gloves are off

They may still be nominal partners, but the bad blood is now on show for all to see. Red Hat claims Mirantis reneged on their deal by releasing its own product, but Mirantis responded by accusing Red Hat of an OpenStack lock-in ploy.