How Red Hat Scaled From an Unlikely Startup to a Major Global Enterprise
Throughout its history, it’s been able to continually adapt and scale its business model to a changing market
PHOTO CREDIT: Getty Images
By the mid 90s, Microsoft ruled over the technology world. Through its Windows operating system, which ran roughly 95% of the world's computers, it was able to leverage control over much of what other companies did and built commanding positions in productivity software and other facets of the industry.
Yet even as the tech giant was at its peak, a danger loomed. Like barbarians at the gate, hordes of developers banded together in online communities to collaborate on their own software. Unlike Microsoft's proprietary products, nobody owned these and anybody was able to alter or customized them as they pleased.
Steve Ballmer would come to regard open source software as a cancer. Yet where the Microsoft CEO saw danger, two entrepreneurs saw an opportunity. They created a company called Red Hat that was focused wholly on the Linux open source software, a seemingly crazy idea at the time. Today, however, it has grown into a major global enterprise. Here's how they did it.
A Wild Idea
When Bob Young and Marc Ewing combined their efforts to create Red Hat in 1995, it seemed like an unlikely idea. Microsoft launched Windows 95 that same year and had begun its rise to dominance. It had invested billions to develop its technology and was determined to protect that investment. How could a fledgling firm with no products of its own compete?
Yet as Paul Cormier, President of Products and Technologies at Red Hat explained in a blog post, "open source is a development model, not a business model." An open source community can develop technology, but it can't deliver customer service, help fix the inevitable day-to-day problems that crop up or train staff. What Red Hat did was essentially transform Linux from a technology project to a technology product that customers could use with confidence.
It was also to find an unlikely ally. IBM, which had fallen from grace in part because of Microsoft's rise, saw open source software as an opportunity to take control of its own destiny once again. It began shipping its mainframes with Linux and eventually would donate hundreds of its own patents to protect the community.
Perhaps the most important factor to the rise of open source was the Internet and the freewheeling culture it brought with it. The LAMP stack (Linux, Apache, MySQL and PHP) became standard for many developers building websites. Red Hat went public in 1999 and achieved the eighth-biggest first-day gain in the history of Wall Street. It was on its way.
Scaling Up To The Enterprise
By 2000, Red Hat, when Matthew Szulik took over as CEO, Red Hat was a public company and, with the Internet already becoming a powerful force, the idea of open source software was becoming more accepted. Yet the company was still distributing its product in shrink-wrapped boxes. Clearly, it needed a new business model.
So in 2001, Szulik took a leap of faith and launched an enterprise version of Linux on a subscription basis, and "Red Hat Linux Enterprise" became its flagship product. The move proved to be enormously successful. Large businesses could now both get the benefit of using open source software, while at the same time gaining a reliable partner that could help them run it.
Yet it also meant that the company had to evolve. It was no longer a scrappy startup, but increasingly a key partner to many of the world's most trusted brands, That meant it had to build more than technical excellence, but also to deliver great customer service and build industry expertise so that it could provide more full-scale solutions.
"As we've moved up the stack and closer to the application layer, we've become much more of a strategic partner to our customers, which has resulted in an increase in our average deal sizes," Eric Shander, Red Hat's CFO told me. "That also means a much more involved sales cycle, where we need more specific technical and industry expertise, which has required us to become more planning intensive around where and how we deploy our critical resources."
"For example," he continued, "when we're talking to retail customers, these customers are having to actively innovate their business models and that eventually leads to IT implications. They don't need just a stable IT environment, they need the kind of flexibility that enables agility and the ability to perform system changes rapidly to respond
to changes in the industry."
Servicing The Cloud
By 2012, Red Hat's customers faced a new challenge. Cloud technologies were becoming increasingly important, but as with operating systems, they didn't want to get locked in to a single vendor. Unlike operating systems, applications delivered through the cloud are not one-size-fits-all, but need to be specifically designed for a specific business function.
"The buyer's journey over the last five years has been for large enterprises to increasingly adopt the hybrid cloud, to match the the infrastructure to the particular needs of each application and use case," says Mike Kelly, Red Hat's CIO. "That means we've had to invest is tools to help our customers do that."
Today, the company offers a suite of products that help manage the cloud for over 90% of Fortune 500 companies, including its OpenStack Platform, which acts as an operating system for the cloud, OpenShift, which helps manage container technologies like Docker and Kubernetes and Ansible, which helps automate basic repetitive tasks.
Still, Red Hat has stayed true to its open source roots. All of its software is available for free to anyone who wants to use it, even previously proprietary software from companies it acquires. Still the it has been able to build a fantastic business, earning almost $3 billion in revenue during the 2018 fiscal year at better than 20% margins. IBM acquired Red Hat in October for $34 billion.
The Next Phase
The IBM deal opens up new possibilities for Red Hat. "Joining forces with IBM will provide us with a greater level of scale, resources and capabilities to accelerate the impact of open source as the basis for digital transformation and bring Red Hat to an even wider audience," said Jim Whitehurst, CEO of the company.
In a way, the acquisition is a replay of Lou Gerstner's early support of Linux at IBM back in the 1990's. Much like 20 years ago, the century-old tech giant is today being threatened by powerful competitors, Amazon and Microsoft, who are dominating the cloud market. Red Hat gives it the ability to not only compete, but to preserve independence and flexibility for its enterprise clients.
Customers also seem to be excited by the possibilities. "What I'm looking for is for IBM to use Red Hat's tools to speed up development of hybrid cloud integration which would reduce the amount of work we need to do on the back end and enable us to better serve our customers," Tim Beerman, CTO at Ensono, a company that provides hybrid cloud services, told me.
Yet the potential may be even greater than that. With Moore's law ending, we will need new computing architectures, such as quantum computing and neuromorphic chips, to advance the field. IBM has made long-term investments in both technologies and both will need new software to run them. Red Hat gives them a unique vehicle with which they can build an open source ecosystem to do that.
What few people realized back in the 90s was that open source software doesn't mean the end of proprietary technologies. Rather, it provides a stable environment upon which proprietary technologies can be built. That's the opportunity that Red Hat siezed more than two decades ago, with a new era of computing dawning, that is what lays before it today.