In what is a surprisingly rare event, I’m seeing some of the commentary I expected to see around an entry here. As Tim Bray says, this is uncommon because “what I think about what I write has no relation to what others think about what I write.” In commenting on this phenomenon before, Christopher Baus captured it perfectly and I’ve come to believe quite strongly in what I now call Baus’ law. The impacts are probably familiar to most of you: off the cuff comments generate a horde of links and comments, while honed, tight essays go virtually unnoticed.
But in this particular case, I knew that I was likely to provoke a response from at least one smart individual out there – Mr. Matt Asay. And so it did. As an added bonus, Brandon Whichard and Glyn Moody chimed in on the topic.
Each piece is interesting, and I recommend you read them – if only because they’re much shorter than my overlong note. As expected, however, it was Matt who took the most umbrage at my comments, saying “Stephen is a smart guy. But he’s wrong on this one.” Matt too is a smart guy, so I both appreciate the embedded compliment and respect the dissent. If he thinks I got it wrong, it’s worth looking into. But let’s review a few of his objections, because I think the exercise might plow some new ground:
- “What’s interesting to me is that the very same numbers – at least, I assume we have access to the same data – tell me a very different story. Red Hat will hit the $1B mark in 3-5 years, and will likely do so without seriously tapping into the gold mine that is Windows territory.”
When I wrote yesterday’s piece I did nothing more than glance in cursory fashion at the basic financials of the major players, extrapolated from what I know of their businesses and the opportunities and challenges in front of them, and reached a general conclusion. So in reading Matt’s piece today, I was interested enough to revisit those numbers, and what I found was interesting. Before I proceed, you should be aware that financial metrics are absolutely not my field, and my hedge fund working brother was unavailable to assist, so take it all with a grain of salt.
But according to Google Finance, RHAT’s 06 revenues were 278.33M. My math is not so strong, but I believe they’d need to pick up an additional 721.67M in revenue to be able to stick a B next to their revenue. I also could quibble with Matt’s characterization of 3-5 years as a timeframe fitting the definition of “soon” , but let’s accept it for the sake of argument. According to Matt, then, somewhere between 2007 and 2011 Red Hat would need to hit the billion dollar mark. What I did then was relatively simple: I clicked through Google Finance to get the sales ratios from Reuters, and got their 5 year annual growth sales rate, which was 28.05% (compared to the industry which is apparently 13.95%, so Matt’s right – it’s business model is fairly remarkable).
Firing up a spreadsheet, I did a basic calculation that essentially looked like (PREV YR REV * .2805) + PREV YR REV, and projected it out five years. My totals look like this: 356.4 (2007), 456.37 (2008), 584.38 (2009), 748.3 (2010), 958.2 (2011). You’ll note, I trust, that the year 5 number does not qualify for the B title. Close, but still a bit short of what Novell makes today. For more context that would also be a thirteenth of what Sun makes today, a 44th of what Microsoft makes, and a 91st of what IBM makes (yes, the Sun and IBM examples are apples to oranges, in that both derive more money from other areas of their businesses than they do from software, but I think it’s useful to establish what a billion actually means).
Now in Matt’s defense, I’ve taken the five year average, and it should be noted that Red Hat’s sales rate increase of late has been up considerably. The sales versus a year ago are up 39.94%. If you recompute the above calculation, factoring in a sales growth rate of just shy of 40% for the next five years, the numbers look like this: 389.5 (2007), 545.06 (2008), 762.76 (2009), 1067.4 (2010), 1493.72 (2011). So not only does Red Hat hit a billion dollars, they do so in 4 years not 5.
Assuming you think 4 or 5 years qualifies as soon, the question then becomes whether you think Red Hat will grow close to 40%, buoyed by the acquisition of JBoss, further consolidation and entrenchment of the Linux server market, and potential future acquisitions, or shy of 30%, weighed down by increasing competition from Solaris/OpenSolaris, a newly relevant Ubuntu, the fact that growth is more difficult the bigger you get, and a damaged relationship with IBM. I’m currently in the latter camp, and would assume Matt counts himself as a member of the former.
Given Red Hat’s success, it’s certainly a defensible position. But I do think that there are question marks.
- “Other companies – JBoss ($60M this year) and MySQL ($80M) – are also on track. Heck, I’d even put SugarCRM and Alfresco up there as being on rocket ship trajectories to the $1B mark, though we’re a few years behind.”
Let me state up front that there are few open source companies that I respect as much as MySQL. I’ve said positively glowing things not just about their community and technology in the past, but I think they have one of the best executive teams in the open source software business. Marten, Zack and co not only get open source, they get technology, they get community, they get the model. And no, before you ask, they are not a RedMonk customer (though they should be ;).
With all that said, however, do I see MySQL becoming a billion dollar revenue machine in the kind of timeframe that I would term as “soon?” No. MySQL, and most other open source software players, simply do not command the margins that their closed source predecessors did which more or less mandates a volume play. Volume, as I’ve said, is the surest path to success but nobody said anything about it being the quickest. Will they get to a billion dollars in revenue? Well, it’s no secret that they have big ambitions; in turning down an Oracle buyout, Marten said “”We will be part of a larger company, but it will be called MySQL.” I’m in agreement that they’ll be part of a larger company; they’re adding a fair number of people, from what I hear.
As for the other players mentioned, I’d just say this: if the history of closed source software businesses is any guide, MySQL is likely to hit a billion before they are.
- “He’s wrong on this one. He’s right on the customer benefits of open source (“[I]t does benefit customers by lowering pricing and increasing choice”), but I think he’s wrong about focusing on volume over conversion rates”
I believe Matt has concluded that I’m for volume over conversion rates because I argued for volume over the billion mark, but that’s actually not what I believe. I think conversion rates are actually quite important, and that open source vendors absolutely should focus on trying to reduce customer barriers to entry via precisely the methods that Matt outlines so as to increase the number of customers they convert. What I am arguing against, rather, is the measurement of open source firms by a closed source yardstick; the economics, IMO, are simply different. Take Sleepycat’s Berkeley DB; it’s a piece of technology that has been deployed tens of millions of times if not hundreds of millions. Closed source vendors would kill for that kind of reach. Was it a billion dollar company? Not even close. Was it a successful company? I think so. Even if they were able to increase their conversion rate by the kind of percentages that Matt’s talking about, they’re still not a billion dollar firm because the economics are fundamentally different.
There’s one big caveat to my argument that should have been mentioned in the original piece, which is that the assumption that open source is fundamentally a low margin business stays true. There are many variables that affect software margins, and it’s not impossible that some of the existing players could shift the market so significantly that they’re able to dramatically improve margins (Red Hat’s already done this to some extent), or that newer entrants to what have been higher margin businesses (such as Greenplum) will be able to get away with substantially higher margins than the open source businesses that preceded them. So watch for that.
Apart from that, let me simply state that I’d prefer that Matt be
wrong right here. Higher margin software businesses mean more revenue for value added services such as industry analysis, so it’s in my best interests that he be right. So Matt, I look forward to you, Red Hat and all the other open source businesses proving me wrong.
Disclaimer: Greenplum, IBM, Sleepycat (Oracle), and Sun are RedMonk customers, Alresco, JBoss/Red Hat, MySQL, SugarCRM, and Ubuntu are not.
Update: I’ve been terrible at forgetting my disclaimers lately, so that was added, and I also corrected a few typos.
 My original statement, the one he quoted, read “At this point, however, I do not expect any of the major pure open source firms to challenge the billion dollar threshold any time soon.” My definition of soon was more in the 1-3 year timeframe than 5.