"I Think We're Up to the Challenge"

Red Hat CEO Matthew Szulik talks about his strategy for turning free software into a profitable business

"First they ignore you. Then they laugh at you. Then they fight you. Then you win." Those words are printed on the wall at the Raleigh (N.C.) headquarters of Linux software company Red Hat (RHAT ). The quote is from Mohandas K. Gandhi, and Red Hat CEO Matthew Szulik likes to draw parallels between Gandhi's insights and the trajectory of the open-source software movement, which encourages any programmer who has the urge to improve upon software that's essentially free -- and thus challenges the software establishment.

Szulik believes the world has moved from laughing at Linux to fighting it. At least, the part of the world that Microsoft rules, one of the few places in the information-technology universe where Linux has remained systema non grata.

Now, it's up to Szulik to do something about winning. Red Hat has struggled to make a buck, turning operating profits but fighting a tide of net losses resulting from slumping sales and write-downs of assets purchased during the dot-com boom. Still, he remains upbeat. With more than $280 million in cash and liquid assets, Red Hat has a good cushion to lean on.

Szulik's latest product, the high-priced Advanced Server software system, could buoy sales. A victory for Red Hat in selling it would mean a big boost for open-source, a movement Szulik believes in passionately. BusinessWeek Online Technology Editor Alex Salkever spoke to the CEO on these and other matters on May 8. Here are edited excerpts of that conversation:

Q: What's the current status of Red Hat?


We began a transition 14 months ago from what was largely a retail business to becoming a provider of enterprise software and consulting. We're well on our way through that transition. Large companies such as Morgan Stanley, Cisco, and CSFB are now deploying Red Hat Linux in mission-critical environments.

Q: Why are they deciding to use Red Hat?


It's a couple of things. One is the competency we have as a company. On the product-development and engineering side, we have built in a lot of service capabilities. Our economic viability is important. Our cash position and our third-party relationships give customers a lot of confidence.

Q: Are you concerned down the road about having to go up against folks like IBM Global Services, HP, and Sun, which is slowly migrating in an open-source direction?


There is an inevitability of competition in an open market. We have chosen two very difficult competitors since the company was founded -- Microsoft and Sun. I think we're up to the challenge. The company is well capitalized and has strong management. And keep in mind, our rivals mainly have experience supporting a proprietary technology. Supporting Linux and building a proven relationship with the open-source community is a different matter.

Q: How well do you think the profit margins of open-source will hold up over time as more companies get into the game?


I'm often asked that question. Our gross margins last quarter were 65%. I hope that dispels the questions we get about Red Hat being a services company, because historically service-company margins are in the 30s. We're a technology company first. We recognize that our opportunity to deliver technology as a managed service began in 1998 when we went to a subscription model. If we were simply selling open-source software in boxes at retail, we wouldn't be able to deliver that kind of performance.

Q: How far out do you think the open-source model extends? It works for servers and operating systems. But how about for niche products, such as Photoshop?


As the CEO of an open-source company, I think it's no longer a question of if but when. It will take a proven methodology and proven distribution and service channels to refine the approach. It's a very difficult and expensive process to build. But I'm starting to see open-source solutions being developed around PostGres (an open-source database). If you look at OpenOffice, which ships with Red Hat 7.3, that's a competitive productivity suite.

Q: Market researchers such as Gartner think that Microsoft's Window's XP is going to outpace Linux because of its connection to Windows.


Proving that would be a challenging debate. How do you track the free distributions [of open-source software] that are downloaded? It's an inexact science.

Q: You're the biggest open-source player, pulling in $80 million to $100 million per year in sales. If you were to guess what the size of the market is right now, what would you say?


You have to look across the industry, at servers shipped, consulting services, everything that goes into Linux and other open-source products. It's probably close to a multibillion dollar business.

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