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ASHEVILLE, N.C.—Red Hat’s stock may have been troubled recently, but businesses still believe in the Linux distributor.

At a recent Blue Ridge Entrepreneurial Council meeting here of about 100 businesspeople, a trio of Red Hat Inc. executives didn’t find questions about law firms seeking to file class-action suits against the Linux company because of its recent financial restatement. Instead, they found an audience eager to know how Red Hat had turned “free software” into profitable business.

There was no simple answer. First, “Red Hat believes in entrepreneurs,” said Tom Rabon, executive vice president of corporate affairs. “We wouldn’t be here today if it we didn’t have that spirit in our own house.” However, he added, with open-source, “It’s not just all about making money; it’s about doing good.”

But that isn’t to say that open-source is just about sharing for sharing’s own sake. Michael Tiemann, the company’s vice president of open-source affairs, explained that open-source makes great business sense by leveraging the efforts of more than a million developers, according to a recent Evans Data research project. That being the case, it’s no wonder that “open-source software is developed faster and its bugs are fixed faster than those of proprietary software,” he said.

Read more here about Red Hat’s financial restatement.

But open source owes its success to more than simply a better way of developing software. Referring to former GE president Jack Welch’s groundbreaking work with GE plastics, Tiemann noted that because open source doesn’t put a barrier between end-users and the development community, developers quickly and transparently find out what users want. This results in software that meets customers’ needs as those needs evolve, he said.

In turn, Tiemann continued, businesses that adopt open-source programs will see constant incremental improvements to their programs. Thus, they avoid the kinds of problems that Nike, for example, faced when its legacy supply chain system broke and its next, massive supply-chain system couldn’t do the job.

Tiemann said this incremental improvement approach, which is part and parcel of open source, also means, “Gone are the days of the three-to-five-years value proposition for IT purchasing decisions. You can now see gains from a single quarter with less risk.”

Next Page: Making Linux predictable and providing solutions.

As to the specifics of why Red Hat is successful, Rabon said, “Red Hat makes Linux predictable.” He thinks of Red Hat as something like an assembly plant for software. “We take components from open source and put them together in packages, and we then certify, repair and maintain it for our customers.”

Tiemann added that while Red Hat had seen the enterprise opportunity for Linux by 1999, the company thought Linux wasn’t ready. “Red Hat was the last Linux distributor to announce an enterprise Linux, but we were the first to ship product.”

The company had to get it right the first time, he said. “You get one shot at the beginning. If you don’t, you may get a ‘We’ll call you back in six months,’ but sooner or later you’ll realize that you’re not going to get the business.”

Part of the reason for the delay, according to Tiemann, was that Red Hat was trying to avoid the frequent technology company mistake of “thinking companies want technology. They don’t. They want solutions. The technology can be a roadblock. You need to give the customer something they need.”

Click here to read about how Red Hat is aiming to do that with its Linux desktop.

And of course, you need to make money from it. “The retail model wasn’t working for us,” Tiemann said. “We couldn’t raise the price, but no matter what we tried to do with retail, it didn’t make that big a difference. [Red Hat CEO] Matthew Szulik kept saying get rid of the box product.” So, Red Hat started looking for a business model that would let it do so.

The first part of that was to create features—such as the RHN (Red Hat Network), the company’s managed service option—which would add value to the unadorned operating system. Then, Red Hat dropped its standalone Linux in favor of its RHEL (Red Hat Enterprise Linux), its enterprise offering, which comes with an RHN license for every copy of RHEL that a customer deploys.

Of course, some free-software fans took umbrage at the move and said it was against the GPL. But Tiemann said Red Hat checked with the Free Software Foundation and that the group didn’t see any GPL violation with Red Hat’s plans, so long as there were no restrictions on Red Hat’s source code.

Mark Webbink, Red Hat’s deputy general counsel and secretary, said the company has no problems with anyone using its source code. But Red Hat does have problems with anyone using its name or its trademark “shadowman.” That, Webbink said, Red Hat guards zealously. In the open-source economy, it’s the Red Hat brand, as well as its service, that carry value.

“The model has taken hold, and it’s working well for us, and it’s created a good cash flow for us, since all licenses are prepaid,” Tiemann said. “Of course, this kind of licensing plan isn’t new, but RHN is working, while Microsoft’s Software Assurance is having trouble.”

Read more here about users’ complaints about Software Assurance.

“We weren’t forcing people to make a change. Many vendors out there support earlier versions of Red Hat,” Tiemann said.

The result has been a big win for the company, according to Tiemann. “We went from almost no revenue from retail sales to over $33 million from subscriptions.”

This message of how “free” software could be turned profitable was well-received by the audience. One small ISV who wished to remain nameless said, “I couldn’t get my head around how you could make money by opening up your code, but I get it now.”

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