The leading Linux seller drives customers to its more expensive "advanced" line with support contracts, pricing changes and certification restrictions.
Red Hat is newly profitable, but the Raleigh, N.C.-based company is betting that its Advanced Server and Advanced Workstation products will dramatically boost its finances. To shift customers away from the lower-priced Professional and Personal versions, the company is taking the carrot-and-stick approach and will release at least two new Advanced versions by the end of March, company executives say.
In addition, Chief Financial Officer Kevin Thompson hinted during a Thomas Weisel Partners investment conference Wednesday that a coming lower-priced version of Advanced Server will mean Red Hat can start expanding its current competition against Unix companies to include Microsoft as well.
The moves with the premium products and the Red Hat Network services Red Hat sells to manage premium systems show the company's strategy for profiting from open-source software that may be obtained for free. Although customers can "cobble together" products to create something very similar to Red Hat, they'll be on their own when it comes to supporting the system, Thompson said.
"It's impossible to replicate a certified version of Red Hat Advanced Server. That only comes from us," Thompson said. "Yes, our model is open-source, but it doesn't mean it's free."
Red Hat's moves are smart, said Giga Information Group analyst Stacey Quandt.
"The more they can drive customers to adopt Advanced Server, the more they further their annuity model with a higher (profit) margin," Quandt said. "They definitely want to drive people to buy Advanced Server."
Among the moves Red Hat is making to push the premium product line:
• Several new premium products are coming to expand the number of computers Red Hat can include in its plan.
Red Hat released its first Advanced Server product last May and an Itanium version of Advanced Server last fall in cooperation with Hewlett-Packard. Thompson said Red Hat will release a mainstream version of Advanced Server for more widespread Pentium and Xeon machines "in the March time frame."
A new version of Advanced Server, 3.0, will arrive this fall, including support for IBM's zSeries mainframes, Thompson said.
• Red Hat's plan to release a new, lower-priced version of Advanced Server will come to fruition by the end of March, said Erik Troan, Red Hat's director of product marketing, in an interview. The new products, which Red Hat said in December likely would cost between $600 and $800, will have a smaller profit margin but will let Red Hat expand to run on almost three times the number of servers, Thompson said.
The current Advanced Server was "priced to be competitive with Unix," Thompson said, but the new product "will be very competitive with Windows...We're getting huge demand from customers."
• Red Hat has set up agreements with IBM, HP, Dell Computer, Oracle, Fujitsu and several other companies that require them to support only the premium products, Thompson said.
"The enterprise product family is the only Red Hat product that ISVs (independent software companies) and IHVs (independent hardware companies) will be certified to," Thompson said. "If their customers are not running a version of Advanced Server, they cannot guarantee a level of service and support."
• The company has reduced the time it will support the nonpremium products, most notably for version 7.3, which Red Hat will stop supporting Dec. 31 instead of mid-2004. That means updates for bug fixes and security vulnerabilities will be phased out sooner for the low-end products.
In contrast, the premium products will be supported for five years, Red Hat said. "We encourage customers who want long-term support for products to use our enterprise product line," Troan said.
In 2002, Red Hat initially was choosing between a three-year and five-year support lifespan for the enterprise products, settling on the longer term, though the company's Web site for a time listed the three-year period.
It can be difficult to phase out products and support for them, especially when it comes to server products that often are used for years. Microsoft recently extended the support plans for its aged Windows NT operating system.
In October, Microsoft announced that its operating systems--and not just its enterprise products--will be supported for a minimum of five years.
Red Hat gets $2,500 per year for a copy of Red Hat Advanced Server, a price that includes a subscription to Red Hat Network services. The company books revenue from a sale over the entire 365-day span of the agreement, not just in the quarter the deal was signed.
A crucial moment will come in June, when the first customers who bought Advanced Server product subscriptions have the opportunity to renew their contracts, Thompson said. Red Hat eagerly awaits the day.
"We expect our renewal rates to be very high," likely more than 80 percent, Thompson said.
Red Hat sold 8,000 subscriptions to Advanced Server in the quarter ended in August, 12,000 in the quarter ended November, and expects to sell more than that for the current quarter, which ends this month, Thompson said.
By comparison, Hewlett-Packard sells about 15,000 copies of its HP-UX operating system per quarter, he said. "We're already the same size as HP in two quarters of Advanced Server," Thompson said.