Wall Street

The folks over at RHAT haven’t wasted time putting me to work. I just spent two weeks working with investors, touring with Dion Cornett, the VP of Investors Relations. I don’t know how he does it. I used to see investors as a private company, mainly due to the impact we had on public companies at the time, but nothing like what I went through recently -- roughly 60 investors in three days.

Summarizing the state of the company in 40 minutes slots was a learning experience. The message needs to be fairly simple, which is probably why it works. Essentially RHAT/JBoss is a new company. The association of the RHAT brand is not to a given market, say Linux, but rather to the business model that backs it up. The business model of OSS has been proven by RHAT over the years. It is time to generalize it to other markets, be it Middleware or most of infrastructure, really. We will be successful if in two years people associate the RHAT brand with the business model and not just Linux.

So what is the business model? Very simply, we transform the way software is developed, distributed and supported. I have covered these topics many times here before. BTW in the good read category for recent writing on the subject, check out Matt Asay, Larry Augustin and the circle of colleagues debating the theoretical limits of the OSS model.

I think it is obvious to many people why the collaborative methodologies of OSS transform software development. While there is no free lunch and there is still an economic price to this development, the upside is a highly leveraged development model where quality software and limited resources can achieve large-scale success. JBoss reached 1 million downloads when we were just 2 guys and a dog.

One of the nuances becoming increasingly clear to many insiders is that the power of the model rests in the extremely low cost of distribution and sales. We reach millions of folks with free distribution and then monetize this base. It is a very efficient way to acquire customers. The result is that we spend 30 cents for every dollar of maintenance revenue, while the competition, on average, spends $3 for every dollar that ultimately comes in as maintenance. The downside, compared to proprietary software, is that on average we only monetize 3% of our user base for JBoss and roughly 10% for Linux. This low cost of sales we achieve through mass distribution is what makes the model tick. The customer gets to make up his own mind as to whether the software is any good as opposed to having to go through the vendor’s pricey and biased salesforce. This enables the OSS enterprise sales force to be very effective since they mostly are targeting highly pre-qualified potential customers.

The last statement is one many consider obvious. We transform the way the industry does support. Why? Well, that is the only place where we make ANY money at all, so we better be good at it. End of story. If we are not; well, very simply, we will die. It is not entirely surprising that RHAT and JBoss get rewards for “quality of support”, it is WHAT WE DO. RHAT got awarded, two years in a row, the “best value” award by ‘CIO Magazine.’ This resonates with the Street at many levels, including the purely financial. The renewal rate we achieve year after year is what makes our business growth so attractive.

It is up to us to execute on this vision. If we succeed, we truly will become the defining technology company of the 21st century.

But what about Oracle?

In my visit with investors on the street, a lot of people inevitably want to know about Oracle. In case you missed it in the press (how could you?), Larry Ellison has been talking, on and off, these past few months about putting out an Oracle/Linux distribution. Of course people want to know if such an attack is coming and whether we are defensible against it. Some people believe our business model would roll over and die. Nothing could be further from the truth.

Whether “Oracle/Linux” is coming is anyone’s guess. Common sense says “it is NOT coming” but then, there is common sense and there is what Larry Ellison wants. It would appear that what Larry Ellison wants, Larry Ellison usually gets. However, between Oracle wanting a Linux distribution, their being able to credibly put one together and the ultimate impact this would have on the Linux marketplace, there are a lot of things going on.

First of all, there is the fact that today Oracle benefits greatly from RHAT and Linux in general. The relationship, so far, has been very productive for both parties, and there are still a lot of efforts underway. There are so many things we can do together, from working on Fusion/JEMS (Fusion incorporates JEMS projects like JGroups) to us providing an OS appliance for them to run on, so many possible avenues of collaboration. However, collaboration is generally boring to the press, while “Linux war” makes for much catchier headlines. Meanwhile, the reality is that we are continuing to work with Oracle on a variety of projects. I am personally a bit of a fan of Larry’s and I suspect that as soon the current wave of news passes it will quickly be back to normal. If that weren’t the case, I’m not too concerned either.

Let’s assume Oracle wants to introduce a NEW distribution, what analysts call “Oracle/Linux.” It would take time to assemble: you need Linux engineers, you need OS experience. You also need to build a support structure and you need to make it not suck. None of this says “Larry can’t do it” it is just that it is all easier said than done. For more background reading on this, and why it’s an uphill battle, read Trip Chowdhry of FTN Midwest Research’s evaluation report on this scenario.

In fact, the recent rhetoric from the press has now been toned down to “Oracle wants to redistribute and support RHEL instead”. From a distance it sounds like this is feasible as RHEL is GPL. However it is a bit more complicated than that, read Baird’s Steve Ashley’s note for excellent background reading on the topic. See, nowhere in the GPL is it said that we must distribute the software to you in the first place. Dion Cornett likes saying GPL != Public Domain. In fact, in the case of RHEL, RedHat doesn’t distribute it to anybody, not for free that is.

If you want to have the software, you must subscribe to RedHat Network (RHN) and if you redistribute the patches or RHEL (which you can) you must pay us for every instance, if you don’t, well, we are under no obligation to give you the future patches and upgrades, in other words, we cancel the RHN distribution to you and you are technically /forking/ RHEL.

Ok so let’s assume Oracle forks RHEL instead of assembling a new distribution, which would bypass the cost and time described in the above paragraph. IT IS STILL A NEW DISTRIBUTION, technically it is not RHEL and the second he does this, it is not the same product. In fact, the applications that are certified on RHEL will not be certified on the fork.

There are many factors working to our advantage in this particular scenario. First RHAT has an enormous ecosystem of certified applications. In the Operating System world, the leading “standard” has a practically insurmountable advantage due to positive feedback loops. Think Microsoft vs Apple: more users = more apps and more apps = more users, and so on in a virtuous feedback loop. By the same token, Sun won the Unix wars back in the early 90’s by developing the “catalyst,” an extensive catalog of partner ISVss that gave them the advantage. The same dynamic is at play in the Linux market, the certification programs are key. I believe that feedback loop represent a virtual game-over; it is too advanced and too stable a mechanism by now. Sun couldn’t get it going with Sun/Linux and IBM couldn’t get it going with OS/2 and IBM/Novell couldn’t get it going with Suse. In fact IBM just released a version of Lotus Notes for Linux and made it available on RHEL first with “support for Suse to come in 90 days.” The ISVs and IHVs are supporting RHEL because that is where the largest portion of the paying Linux market is. ISVs go where the customer is and vice versa. It would take a whole lot of time and money for ORCL to duplicate this momentum and they don’t know whether the customer wants or will take it.

And that is really what counts at the end of the day. Does anyone REALLY want this? Does ANYONE REALLY WANT ANOTHER LINUX DISTRIBUTION IN THE ENTERPRISE MARKET? Please raise your hands. It turns out in a recent study, that 2% of ORCL’s installed base would want ORCL/LINUX from ORCL… Interesting, no? If Oracle’s existing customers don’t really need a Linux distro from them can you imagine what that picture looks like for those that are not already in the Oracle customer fold? It is not clear that ANYONE really wants this third distribution in the enterprise market.

Since RHAT has no partner that represents more than 10% of its business and only 2% of Oracle’s own customers say they would buy this, would RHAT really feel the impact? Did someone mention OS/2? I believe our business model is defensible.

Ironically, knowing how smart Larry and his organization all are, it’s a safe guess they know all of this. For the record, sitting down with one of the 10 richest men on the planet to discuss “meta-data” structures was an enjoyable experience I am grateful to have had. Larry probably knows we wouldn’t hurt at a business level, and that he cannot take on RHEL in a frontal product war. Or, maybe he doesn’t care. He’s also right about the software industry being in a phase of consolidation. For all of you conspiracy theorists out there, the most entertaining scenario is that all this talk about an Oracle Linux distribution in the press is just a FUD campaign to scare RHAT investors and customers and impact our valuation, a la the Siebel/PeopleSoft playbook. The possibility of acquiring RHAT at a discount (and JBoss for nothing ☺ ) would be tempting indeed, if it did not entail the risk of forcing the hand of the other big players at the table.

Game Theory: a Nash Equilibrium of the enterprise software industry

So, today, we are in an interesting situation. RHAT is being perceived as the new kid on the block in the big leagues. Some label us a new “Microsoft”— conveniently forgetting how, in open source as opposed to proprietary software, the inherent checks and balances limit the establishment of anything resembling a conventional monopoly. I, for one, believe that no one has an interest in moving against us here. The ecosystem of open source is a stable environment because of something akin to a Nash Equilibrium. If Oracle moves, what do you think IBM, HP or Microsoft would do? Short of a software industry equivalent of the Hitler/Stalin pact (and we all know how short a honeymoon that ultimately would be), it would really be unwise for Oracle to take that risk as it would only set up a replay of the Unix wars, but this time with Linux.

I believe the future of professional open source probably will be this large INDEPENDENT open source vendor. We are in the top 5 among the large infrastructure vendors, after IBM, Oracle, SUN and Microsoft. They may not like it, but if they move, the ensuing Linux wars will ultimately only benefit Microsoft and RHAT, just as, outside of Microsoft, Sun was the only beneficiary of the Unix Wars, which they used to consolidate their position. Why upset a situation that currently works to everyone’s advantage?

I believe we are seeing a Nash Equilibrium in action. If there is a set of strategies with the property that no player can benefit by changing his or her strategy while the other players keep their strategies unchanged, then that set of strategies and the corresponding payoffs constitute the Nash Equilibrium. A simple way to describe this is the popular saying “nobody move and nobody gets hurt”. Some companies may not like the fact that RedHat declared independence by buying JBoss. But it was bound to happen and everybody is going to have to live with it. We have created the largest, independent OSS company and the business model of OSS is growing. A bright future awaits us and our partners, and there is enough open source goodness to go around for everybody.

marcf