E-BUSINESS SPECIAL REPORT
Who's Making Money from Linux?

But what about pure-play Linux companies? Finding the right revenue model has been a challenge for Red Hat (NYSE: RHT) and SuSE , arguably the biggest players in the Linux market.

But It's Free!

Some people compare open source and free software to oxygen and water. These resources are all around us, and most of us are used to getting them for free. But there are still opportunities for people to make money by selling oxygen or water: Purify it, bottle it and deliver it, and it becomes a cash cow.

Similarly, there are ways to make money by selling Linux. Mark de Visser, vice president of marketing at Red Hat, told the E-Commerce Times that his company is confident it can turn a profit. "From all indications, we have come up with a business model that works and that companies appreciate," he said.

Is this profit motive at odds with open source objectives? Not at all, according to de Visser. "[It's] better for the open source movement if companies in that space make money," he said, so those companies can invest in and improve open source software.

In addition, he noted, companies like Red Hat are bringing enterprise vendors into the open source space. "Consider the work to bring Oracle (Nasdaq: ORCL) on board, and DB2 on board -- a lot of competent people are paid for those jobs."

Are They Making Money?

So, are pure-play Linux companies making money? It can be difficult to tell, since most Linux vendors are not public companies. SuSE's Joe Eckert told the E-Commerce Times that SuSE does not share earnings information publicly.

Red Hat recently stated its earnings for fiscal 2003. The company lost money last quarter, but just barely. It reported a 40 percent increase in revenue for its fiscal year ended in February, with a total of US$90.9 million in sales in fiscal 2003.

The company added 4,500 new subscribers to its Red Hat Enterprise Linux AS (Advanced Server) service in the fourth quarter, bringing the total to 16,500 subscriptions. But de Visser noted that much of the revenue generated by sales of subscriptions is deferred, so only a small portion of it is reported in any given quarter. For example, if a company buys a one-year subscription priced at $1,500 at the beginning of a quarter, only $375 of that total will be reported in first-quarter results -- not the entire $1,500. This may make Red Hat's earnings appear smaller than they actually are.

But despite accounting issues, subscriptions and services may be the wave of the future. According to LinuxWorld founding editor Nicholas Petreley, companies will have a hard time making a go of it through retail sales of boxed software alone. "I don't know if there is a future in selling boxes," he told the E-Commerce Times.

Focus on the Enterprise

Despite Red Hat's focus on profitability, de Visser noted that the company has no intention of moving away from the free software model. "We are very careful to strike the right balance there," he said. "We support the whole ecosystem."

That means you will not see Red Hat use proprietary software to drive customers to its enterprise offerings. "If we took it proprietary ... we would probably have to hire 5,000 to 10,000 developers ... and that would break our financial model," de Visser said.

Indeed, Linux companies pay for only a small fraction of work done on the software they sell. As SuSE's Eckert put it, "We consider ourselves a regular software company, except we get a fair amount done by thousands and thousands of people not to meet monetary [goals] ... [but] to fix problems or create solutions for those individuals." In contrast, Microsoft (Nasdaq: MSFT) bears the entire brunt of development costs itself.

Eckert did say it can be tough to strike the right balance while working with enterprise customers and the open source community. "The top customers ... need to see in you a professional way, while at the same time, if you lose roots in the open source community, that's not good either. You need to do both."

Where Should We Go Today?

In addition to subscriptions and service, Petreley said there are a few other avenues Linux vendors should be eyeing. For example, there is demand for "easy migration paths from Microsoft servers to a Linux-based or open source-based back-office server." He cited SuSE's OpenExchange Server as an example but said companies need similar solutions for Microsoft SQL Server and other software.

On the other end of the spectrum, Petreley added, there is an opportunity for Linux vendors to provide home entertainment products before Microsoft establishes itself as a strong player in the space.

"I can see why [Microsoft is] interested in that market. It's a potential market for lock-in," he said. "[It] could spell disaster for open source in that open source has a completely different philosophy and [is] not likely to get support in those areas [from entertainment companies]." Therefore, Petreley explained, it is important for open source players to get into the home entertainment market before proprietary formats for content become entrenched in this space.

Good Year for Linux

Most analysts are predicting 2003 will be a banner year for Linux. With sales and deployment of Linux servers slated for double-digit growth, there should be plenty of opportunities for Linux companies. "Based on everybody I talked to in late fall, this is one hell of a market," Eckert said. "There's a hell of a potential."

But in spite of increasing interest in Linux, Petreley said he doubts there will be room for all of the commercial Linux vendors. "Red Hat doesn't have much to worry about, it's the de facto standard." Other than that, he added, "[there is] a future for maybe one or two, and as many noncommercial [distributions] as people feel like working on."

Petreley also noted that if Linux truly goes mainstream, IT executives will be able to reduce the amount of money spent on servers. "I believe it was Bob Young who even said, 'One of the ideas behind Red Hat is to take a $10 billion market and turn it into a $10 million market.'"