Red Hat

= company relying almost exclusively on free software for its business models

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Description

by Benjamin J. Birkinbine:

"Red Hat, Inc., is similarly exemplary of this trend, as it is the largest and only publicly traded company whose business model relies entirely on free software. The company reported more than US$ 1.7 billion in revenue in 2015 (Red Hat, Inc., 2015: 43). These figures become even more striking when one considers that most of Red Hat’s software is covered by copyleft licenses, which means that Red Hat cannot rely on traditional copyright protections to prevent others from using its code. Rather, the broader free and open source community contributes code to Red Hat’s sponsored projects, including Fedora, RDO and JBossDeveloper. In this sense, Red Hat has found a way to incorporate commons-based peer production into its corporate structure." (http://peerproduction.net/issues/issue-10-peer-production-and-work/from-the-commons-to-capital/)

Case Study

Mike Chege:

"Red Hat is the proverbial garage startup. In 1994, Marc Ewing, who had recently graduated from Carnegie Mellon University, created his own version of Linux working out of his spare bedroom. He named his version Red Hat Linux. Marc’s release of his initial beta of Red Hat, the “Halloween” edition, earned him instant fame in Linux newsgroups. Shortly afterwards, Bob Young, owner of the ACC Corporation, a small catalog business that sold Linux and UNIX products, called Ewing up because he wanted to add Red Hat to his catalog of Linux products. A few months later, Young and Ewing agreed to merge Marc’s Linux business with Ewing’s ACC corporation, and Red Hat Software Ltd. was born.

Of course, Red Hat was not the only distribution available at the time. There were already other distributions such as SLS, Yggdrasil, and Slackware. But Red Hat’s selling point was that it developed a software program to aid in the complicated package installation and upgrade process. That program was the Red Hat Package Manager or RPM in short. Thanks to RPM, coupled with efforts to make the system easier to install and configure, Red Hat’s popularity soared.

From the outset, however, it must have been clear that selling software as a product was not going to be an easy way to build a sustainable business. This was because while the GNU General Public License or GPL — the copyright license that gives legal expression to the Four Freedoms and under which the Linux kernel and much of the software in the GNU/Linux system is licensed — has no requirements about how much you can charge for distributing a copy of free software, it also allows, even encourages, users to copy and distribute the software. People could thus redistribute copies of Red Hat without a penny coming to Red Hat. Furthermore, because competitors had access to the same freely available source code as Red Hat, there were limits to what Red Hat could charge for its product. As Bob Young (Martin, 2007) put it (brackets appear in original quote): “You couldn’t make any money selling [the Linux] operating system...because all this stuff was free, and if you started to charge money for it, someone else would come in and price it lower.”

Given the difficulty of surviving on software product sales alone, Red Hat had to search for a new business model. Despite the growing popularity of the GNU/Linux system, one of the biggest obstacles to GNU/Linux adoption in the corporate environment was a lack of support services. Seeing this as an opportunity, Red Hat begun to look into providing post–sales support to corporate clients. This marked the switch to what may be described as the “sell religion, not bibles” strategy with Red Hat moving up the software value chain from a business based largely on software sales (bibles) to one that was based largely on the sale of ancillary services related to its software (religion).

As shown in Figure 2, we have divided the software value chain into two sections: software packaging and software services. Software packaging refers to the traditional model of selling software as a product. Since we are talking about GNU/Linux distributions, software packaging would involve the aggregation, integration, and optimization of the Linux kernel and the numerous additional files that together form the GNU/Linux operating system, to create a distribution which may be accompanied by a manual and probably some post–sales support.

Software services, on the other hand, refer to the provision of support, maintenance, training, integration, customization, and consulting services. Since GNU/Linux distributors have already built up technical competence from packaging and optimising the GNU/Linux system, the presumption is that they can capitalise on this know–how to provide support, consulting, and other services.

In 2003, as part of its new business strategy, Red Hat discontinued its retail edition of Red Hat and introduced Red Hat Enterprise Linux. Red Hat Enterprise Linux was to be sold on a subscription basis. A subscription entitled the user to a copy or copies of Red Hat Enterprise Linux, support services including installation and other technical assistance, and access to patches and updates through the Red Hat Network service.

So, to put Red Hat’s experience within the framework of the software dialectic, the exclusion principle did not work well with software sales because free and open source licenses in general circumscribe the opportunities for earning money through license fees, the source code is freely available to competitors, and people are allowed to share and redistribute the software virtually as a right. With the services approach on the other hand, only those who buy a subscription are eligible to receive support from Red Hat, and even though adaptations of Red Hat Enterprise Linux such as CentOS can be downloaded for free off the Internet, access to support and maintenance services as well as updates to official Red Hat packages via the Red Hat Network are only available to subscribers.

The evidence suggests that this approach has paid off handsomely for Red Hat. In the fiscal year 2007–2008, Red Hat achieved revenues of US$523 million and a net income of US$76.7 million (Red Hat, 2008). Total cash, cash equivalents, and investments as of 29 February 2008 were US$1.3 billion, and at the time of writing, the company had a market capitalization hovering around US$4 billion.

At the same time, Red Hat has always made an effort to remain on good terms with the free software community by making all of its source code available to the community and by supporting various free software projects. Red Hat is also a founding member of the Open Invention Network which is a company that acts as a “patent pool” whose members have agreed not to assert their patents against GNU/Linux or GNU/Linux–related applications.

Though Red Hat’s behaviour may ultimately be guided by the less noble need of turning a profit and keeping its shareholders happy, it has attempted to do so while remaining scrupulously faithful to the letter, if not the spirit, of the GPL." (http://www.uic.edu/htbin/cgiwrap/bin/ojs/index.php/fm/article/view/2186/2062)

Red Hat Linux

by Benjamin J. Birkinbine:

"In order to understand the types of products and services that underlie Red Hat’s market position, we need to examine exactly how Red Hat has been able to profit from free software. I begin with a discussion of Red Hat Linux, which was the original operating system sold to customers from 1994-2004.

...

When Red Hat first began offering products and services in the early 1990s, it sold a compact disc (for approximately US$ 50) that contained a Linux distribution called Red Hat Linux, some additional applications and documentation. Red Hat Linux was based purely on computer code that was protected by the GPL and other FLOSS licenses—that is, code that must remain freely available for distribution, modification, adaptation, etc. Red Hat Linux provided the principal source of revenue for Red Hat during its early years. Revenue came primarily from sales of Red Hat Linux to distributors and original equipment manufacturers (OEMs) for inclusion on their hardware. These companies are some of those which invested directly in Red Hat during its early years: Dell, Cisco, Hewlett-Packard, IBM and Intel. Because Red Hat had a potentially very large and distributed labour force to draw on—namely, the FLOSS community—its business model was highly scalable. That is, Red Hat had the ability to quickly expand its market share to provision a large number of customers without incurring increased investment costs. This was precisely Red Hat’s strategy: To rapidly increase the market, deriving a small amount of revenue from a large number of transactions, while reinvesting part of its earnings back into the FLOSS community. While Red Hat Linux constituted the primary commodity for Red Hat during its early years, the bulk of its work was coming from the support it provided for this software. Red Hat’s employees provided customer support, education, training and technical support to its clients. This strategy, along with Red Hat’s strategic partnerships, allowed the company to begin picking up market share during its early years. While the company’s revenues were still growing up until 2004, it still had not become a profitable business. This was in part due to a spate of acquisitions of other software firms before the dot-com bubble crash, but also because the company had not yet found a way to substantially increase subscription sales at the enterprise level. This is precisely the change that occurred when the company shifted its focus to Red Hat Enterprise Linux, which became its core commodity and continues to be today. The final stable version of Red Hat Linux was released in 2003, which was the same year that Red Hat Enterprise Linux was released." (http://peerproduction.net/issues/issue-10-peer-production-and-work/from-the-commons-to-capital/)

Red Hat Enterprise Linux

by Benjamin J. Birkinbine:

"In 2003, Red Hat split its Red Hat Linux project into two separate projects: Red Hat Enterprise Linux and the Fedora Project. Red Hat Enterprise Linux continued as a core commodity for Red Hat in the same way that Red Hat Linux had been before. The Fedora project, however, became a community-based FLOSS project. Red Hat Enterprise Linux relied on the same model as Red Hat Linux in terms of providing packaged distributions of a free operating system but, rather than selling individual compact discs containing the software, Red Hat Enterprise Linux was made available solely through a subscription model.

Depending on the level of subscription, customers could get access to customised versions of the Red Hat Enterprise Linux operating system, plus the different levels of support services for the operating system. In effect, Red Hat Enterprise Linux was a similar product to Red Hat Linux with a different customer distribution model. Red Hat then used the revenues from sales of Red Hat Enterprise Linux to support the Fedora Project. The relationship between these two projects provides perhaps the most interesting insight into how Red Hat incorporates the commons.

The split into Red Hat Enterprise Linux and the Fedora Project in 2003 was made with the intention of finding a mutually beneficial way for the FLOSS community and Red Hat to collaborate on developing software. Red Hat Enterprise Linux continues to serve as one of Red Hat’s core commodities, and the company profits from subscription sales to its customers. The Fedora Project was meant to be a community-sponsored project that would provide an incubator for innovation. In return, the innovation that occurred within the Fedora Project could then be implemented into Red Hat’s commercial offerings. This was possible because of the ownership and governance structure of the Fedora Project, as well as the worker contracts established with contributors to the project." (http://peerproduction.net/issues/issue-10-peer-production-and-work/from-the-commons-to-capital/)

History

by Benjamin J. Birkinbine:

"To illustrate the specifics of how this process takes place, I begin by providing a brief historical overview of Red Hat, which specifically focuses on the company’s two core commodities, Red Hat Linux and Red Hat Enterprise Linux.

...

Red Hat Software, Inc. was founded in 1995 when open source software was still an emerging but rapidly growing phenomenon. In 1991, Linus Torvalds released the code for his Linux kernel project. While those who supported the open-source project were extremely dedicated to its cause, the market for software and, more specifically, the market for operating systems was still dominated by large firms, most notably Microsoft and its Windows operating system. In 1993, Bob Young formed a company, the ACC Corporation, which primarily sold Unix- and Linux-related accessories and books, and Mark Ewing created his own distribution of Linux, Red Hat Linux in 1994. One year later, Red Hat Software, Inc. (simply referred to as “Red Hat” from here onwards) was founded after Bob Young’s ACC Corporation merged with Mark Ewing’s company. Red Hat was founded with the purpose of making open source a commercially-viable business model by lending credibility to the emerging open-source phenomenon. In effect, Red Hat was intended to bring the power of open source to businesses by providing packaged solutions to customers, while funnelling their earnings back into the open-source community by supporting free software projects.

As Bob Young declared in 1999,

We recognised the value of giving customers control of their software, and sought to bring brand reliability to the Linux product. We would offer support to customers and accelerate development of the operating system by investing our own R&D [research and development] dollars in new Linux technology that would then be given back for free to the community, for any Linux programmer or distributor to use. We had no intention of ever “owning” the intellectual property we created. Instead, our business model was based on quickly expanding the market, and earning a small amount of revenue from a large number of customers who would buy a product that was better quality than that being offered by the industry leader, Microsoft. (Young and Rohm, 1999: 10)

The “better quality” that Young is referring to is the Linux-based operating system, which is created by collaborative development, as opposed to closed proprietary development. The open and collaborative model of development, exemplified by Linux, is notable for its efficiency, innovativeness and security. Red Hat found a way to offer an operating system that could be easily adapted to the unique needs of different customers. This was particularly important in a time when hardware vendors were reliant on large, proprietary firms such as Microsoft to develop operating systems that could run on their hardware. The speed at which new versions of proprietary operating systems could be developed was much slower compared to the open-source options. Consequently, Red Hat negotiated—and continues to rely on—strategic partnerships with hardware manufacturing companies, such as Intel, IBM, Dell, CISCO, Hewlett-Packard, Sony and others.

Such partnerships are beneficial to Red Hat and its partners for several reasons. First, Red Hat pursues its original goal of endowing to free and open source software with commercial credibility because of its support from major information technology firms. Second, Red Hat positions itself as a leading company dealing solely in free software. Third, Red Hat continues to funnel funding back into free software projects as a way to support the developer communities that work on these projects. In this sense, Red Hat serves as an intermediary between large information technology firms and the FLOSS community.

However, Red Hat also benefited from venture capital investment after it was established, particularly at a time when the “dot-com” investment bubble was on the rise. Frank Batten, Jr., through Landmark Communication, was an early investor in Red Hat and committed US$ 2 million to the company in 1997 (Young and Rohm, 1999). Landmark Communication was famous for investing in the Weather Channel, and the company remains a privately-held investment firm that now operates under the name Landmark Media Enterprises. Red Hat also received investment capital from Greylock Limited Partnership and Benchmark Capital, a company based in Menlo Park, CA, and known for its investment in, and support of, the open-source community. All three of these entities—Landmark Communication, Greylock and Benchmark Capital—became major shareholders in Red Hat after its initial public offering (IPO).

Red Hat held its IPO in August 1999. The investment from venture capital firms, as well as the company’s partnerships with major information technology companies, led to rapid growth of the firm’s value. In September 1999, Red Hat’s stock price rose to more than US$ 122 per share, up from its original price of US$ 14 per share. At the time, Frank Batten, Jr., owned 15 million shares of the company, while Greylock Limited Partnership owned 8.7 million shares, and Benchmark Capital owned 5.8 million shares (Kanellos, 2002). However, in the interest of giving back to the FLOSS community, the company tried to compile a list of all FLOSS developers who contributed to Linux and other FLOSS projects. While arriving at a fully comprehensive list was not possible, the company managed to develop a list of approximately 5,000 developers. The intention was to make these developers stockholders in the company so they could benefit from the company’s growth. While Securities and Exchange Commission regulations prevented a large portion of these developers from becoming investors, more than 1,000 of the eligible 1,300 developers became early shareholders in the company (Young and Rohm, 1999). Making the effort to include members of the FLOSS community as early shareholders in the company signalled Red Hat’s commitment to the community.

In the years following the IPO, Red Hat continued to enjoy growth in revenue. What is particularly striking about Red Hat’s growth was that the company was not significantly affected by the dot-com bubble crash between 1999-2001. Rather, Red Hat emerged from this period and continued to grow. One reason for the company’s steady growth during this period may be the strategic partnerships that Red Hat negotiated with large information technology firms in the lead up to the dot-com crash. Those firms—Intel, Cisco, IBM, Dell, etc.—also survived the crash and many have solidified their position as leaders in the market for information and communication technologies. Even though Red Hat was a start-up company, the partnerships that the company formed with these larger firms ensured that Red Hat would be supported by these businesses into the future.

While the company continued to enjoy growing revenues, its net profits exhibited a noticeable decrease during the dot-com bubble crash. Red Hat’s profits dipped from 1998 until 2002, but rose again in 2003. This performance almost perfectly coincides with changes in management, and can also be explained by a shift in Red Hat’s business strategy. In 1999, the original co-founders, Bob Young and Mark Ewing, left the company. In 2001, Paul Cormier joined Red Hat and began to lobby in favour of shifting the company’s business model. Specifically, Cormier wanted to provide FLOSS solutions at the enterprise level rather than in the consumer market. To more fully explain the nuances of this shift, the following section contains an in-depth discussion of Red Hat’s core products, how those commodities shifted focus over time, and how Red Hat was able to centralise intellectual property within its corporate structure." (http://peerproduction.net/issues/issue-10-peer-production-and-work/from-the-commons-to-capital/)

Discussion

Ruth Suehle:

"Q.What is the secret of Red Hat's success?

A. In 1993, Red Hat Linux was one of the first Linux distributions, along with Debian and Slackware. That was still five years before the term "open source" was coined. Linux and open source software were not widely known for many more years, much less trusted by large companies or recognized by future competitors. As late as 1999, while promoting his book, Bill Gates remarked about Linux, “Certainly we think of it as a competitor in the student and hobbyist market. But I really don't think in the commercial market, we'll see it in any significant way." He criticized open source for its lack of central control. Fast-forward to 2011, when the Microsoft Openness blog quoted CEO Steve Ballmer: “Our goal is to promote greater interoperability, opportunity and choice for customers and developers throughout the industry by making our products more open and by sharing even more information about our technologies”. The world is changing.

Today open source software is not a hobby or a threat, it is simply reality for the technology industry. It is also no longer just about developing code. The Red Hat company used open source to create a business model that brings the company nearly a billion dollars in annual revenue. CEO Jim Whitehurst has called that model "the most powerful thing about what we've accomplished." The company is listed on the New York Stock Exchange and the S&P 500 and has grown a long list of offerings beyond Linux, from middleware to virtualization, training, and consulting.

All of this has been built on the belief that open source is more than a way to develop software. It is a way to run a business and the best way to participate as a part of the global community. Red Hat has grown through the power of collaboration, not just on source code, but on everything it does.

Red Hat sees the opportunity for the principles that have made open source successful as a business model to change the world, and the company intends to help make it happen through promoting principles like transparency, collaboration, diversity, and rapid prototyping, collectively something it calls “the open source way.” These characteristics can – and will – change everything about our world in the same way the open source model has changed how software is created, based on a few key openness concepts:

1. An open exchange. A free exchange of ideas is critical to creating an environment where people are allowed to learn and use existing information toward creating new ideas.

2. The power of participation. When we are free to collaborate, we create more. We can solve problems that no one person may be able to solve on their own, and we can create solutions that will be applied in ways we did not imagine.

3. Rapid prototyping. Rapid prototypes can lead to rapid failures, but that leads to better solutions found faster. When you are free to experiment, you can look at problems in new ways and look for answers in new places. You can learn by doing.

4. Meritocracy. In a meritocracy, the best ideas win, and the best features make it into the end product. In a meritocracy, everyone has access to the same information. Successful work determines which projects rise and gather effort from the community.

5. Community. Communities are formed around a common purpose. Together, a global, open community can create beyond the capabilities of any one individual. It multiplies effort and shares the work.

But how does all that apply to Red Hat’s success? It starts with the subscription." (http://timreview.ca/article/513)

The Red Hat Subscription Model

"Although "open source" is now clearly about more than the code, to understand how it created Red Hat’s success, we have to start where it began: with the code.

All software has source code. As we know, not all software creators choose to share that code. But when they do, it means freedom and choice for the user. Industries can no longer operate in silos – neither the companies within a single industry, nor industries apart from one another. The world is becoming only more connected. What one company needs today, another company needs tomorrow. And what that company needs tomorrow might change the world in an entirely unrelated field. We have seen it over and over again when one person or organization creates a piece of code for its own needs, shares it, and another organization is able to reuse it in unforeseeable ways. That is the value of open source, and it happens every day.

Red Hat believes that because of that value, open source is inevitable, because it puts the choice and control in the hands of the customer, and Red Hat accomplishes the combination of open source value with business profit through its subscription model – the enterprise complement to the rapid innovation of open source development.

Open source empowers impressive innovation and rapid change. But if you are running a production environment, innovation and rapid change are frightening words. So Red Hat takes thousands of packages, freezes the code, and creates an enterprise-ready edition of that software, working with chip designers, hardware vendors, and independent software vendors to certify and tune the hardware and software that Red Hat products will work with. Then we back it with a promise of support for seven years, bringing the strength of open source to a level of security that is right for the stability production environments need – enough stability for many of the world's stock exchanges to run on Red Hat Enterprise Linux. So while traditionally licensed software loses its value as it ages, subscription software continues to support an infrastructure with updated features, security enhancements, and increased hardware and software support, not to mention predictable costs." (http://timreview.ca/article/513)

More Information

See also: Fedora Project

1. Case Study: Giving It Away: How Red Hat Software Stumbled Across a New Economic Model and Helped Improve an Industry. By Robert Young, 1999. From the book Open Sources
2. Another Linux Distro: Debian

• Q&A. What Is the Secret of Red Hat's Success? Ruth Suehle. TIM Review, January 2012 [1]

Case study by Mike Chege:

1. Red Hat, 2008. “Red Hat reports fiscal fourth quarter and fiscal year 2008 results” (27 March), at http://www.redhat.com/about/news/prarchive/2008/fourthquarter.html, attached 13 December 2008.
2. Red Hat, 2007a. “Form 10K Red Hat Inc.,” at http://media.corporate-ir.net/media_files/IROL/67/67156/REDHAT10K07.pdf, attached 13 December 2008.
3. Red Hat, 2007b. “Red Hat Summit 2007,” at http://www.redhat.com/videos/summit2007/, minute 00:27, attached 13 December 2008.
4. Red Hat–a, “Open source development list,” at http://www.redhat.com/truthhappens/leadership/osdevelopment/, attached 13 December 2008.
5. Red Hat–b, “Investor relations,” at http://investors.redhat.com/, attached 13 December 2008.
6. Red Hat–c, “Red Hat videos,” at http://www.redhat.com/videos/ourfilms.html, attached 13 December 2008.