Microsoft and Red Hat Linux: Two Contrasting Business Models

The strategies of rival companies are often predicated on strikingly different

business models. Consider for example the business models for Microsoft
and Red Hat Linux in operating system software for PC’s.

Microsoft’s business model for making money from its operating system
products is based on the following revenue-cost-profit economics:

• Employ a cadre of highly skilled programmers to develop proprietary

code; keep then source code hidden from users and lock them in to
using Microsoft’s proprietary software.

• Sell then resulting operating system and software package to personal

computer (PC) makers and to Pc users at relatively attractive prices
(around $75 to pc makers and about $100 at retail to pc users) and
achieve large unit sales.

• Most of Microsoft’s costs arise on the front end in developing the

software and are thus “fixed”, the variable costs of producing and
packaging the CD’s provided to users are only a couple of dollars per
copy-once the break-even volume is reached, Microsoft’s revenues
from additional sales are almost pure profit.

• Provide technical support to users at no cost. Red Hat Linux, a

company formed to market its own version of the open- source Linux
operating system, employs a business model based on sharply
different revenue-cost-profit economics:

• Rely on the collaborative efforts of volunteer programmers from all

over the world who contribute bits and pieces of code to improve and
polish the Linux system. The global community of thousands of
programmers who work on Linux in their spare time do what they do
because they love it, because they fervent believers that all software
should be free (as in free speech), and in some cases, because they
are anti- Microsoft and want to have a part in undoing what they see as
a Microsoft monopoly.

• Collect and test enhancements and new applications submitted by the

open-source community of volunteer programmers Linux’s originator,
Linus Torvalds ,and a team of 300-plus Red Hat engineers and
software developers evaluate which incoming submissions merit
inclusion in new releases of Red Hat Linux – the evaluation and
 integration of new submissions are Red Hat’s only up –front product
development costs.

• Charge a modest fee to those who prefer to subscribe to the upgraded

and tested family of Red Hat Linux products. Subscription fees include
a limited number of days of service, support, patches, and updates.

• Release updated versions of Red Hat Linux every 4-6 months to small
users and every 12-18 months to corporate users.

• Make the source code open and available to all users, allowing them
to create a customized version of Linux.

• Capitalize on the specialized expertise required to use Linux in multi-

server, multiprocessor applications by providing fees-based training,
consulting, support, engineering, and content management services to
Red Hat Linux users. Red Hat offers Linux certification training
programs at all skill levels at more than 60 global locations- Red Hat
certification in the use of Linux is considered the best in the world.

Microsoft’s business model – sell proprietary code software and give service
away free – is a proven money maker that generates billions in profits
annually. On the other hand, the jury is still out on Red Hat’s business model
of marketing open-source software developed mainly by volunteers and
depending heavily on sales of technical support services, training, and
consulting to generate revenues sufficient to cover costs and yield a profit;
Red Hat posted losses of $140 million on revenues of $79 million in fiscal
year 2002 and losses of $6.6 million on revenues of $91 million in fiscal year
2003. But in the first 9 months of fiscal 2004, Red Hat earned a $9 million
profit on revenues of $89 million. And the profits came from a shift in Red
Hat’s business model that involved putting more emphasis on selling
subscriptions to the latest Red Hat Linux updates to corporate users.

1. How does Red Hat’s strategy fit the company’s situation?

2. Can Red Hat achieve sustainable competitive advantage?

3. Do you think Red Hat’s performance is getting better? What are the
challenges?