Marketing Memos

Is Linux making Sun see Red?

Stock prices reflect mass consensus of where the economy – macro or micro – is heading.  Silicon Valley watchers woke to discover that the market capitalization of Sun and Linux vendor Red Hat were about equal.  Though matched market caps are not meaningful in and of themselves, the trend lines that have brought parties to parity caused more than a few folks to portend the a new dawn (and no, I refuse to make the obligatory ‘Setting Sun’ joke).

People invest in businesses from which they expect a return, and when the mass consensus – the wisdom of the crowd if you will – drops your share price to liquidation-level expectations, you may indeed be facing a corporate dirt nap.

The market is largely on fat software/support margins.  I bet the same way.  Software it wonderfully portable (any Internet connection), well differentiated (even among Linux distributions) and has fat margins.  Hardware is not as portable (though stock in UPS is a good play), increasingly commoditized (x86/64 servers abound) and thus has crumbling margins.  To make real money in hardware these days, you have to ship a lot of iron.

But investors also buy and sell faith in execution.  Businesses with clear, narrow and well executed market focus tend to do well.  Diversification is OK, but within the context of serving one or two markets.  Red Hat is very focused on enterprise Linux, almost to the extent of ignoring embedded and desktop Linux.  Sun is all over the place, trying in one breath to be server company, and Open Source software company, a storage company, and a chip company.

They are actually a schizophrenic company with a 77.4% share price drop in the last 12 months.  They are doing worse than most banks and brokerages.

The real measure of what the market thinks about Sun and Red Hat can be found in one pair of numbers – their cash/share and price/share.  A price per share well above horded cash shows how much wealth investors believe the company will generate.  If the price per share equals the cash per share, then investors see zero value in the company’s operations.

Red Hat’s stock is trading for 3.6 times cash.  Sun is selling for cash plus spare change.

	Sun	Red Hat
Market Cap	$2.80B	$2.78B
Trailing P/E	N/A	35.7
Price/sales	0.2	4.32
Profit margin	-9.9%	13.5%
Revenue growth	-7.1%	22.1%
Cash per share	$3.56	$3.99
Price per share	$3.79	$14.64

What is Red Hat doing well?  Turn to the checklist presented in the book In Search of Excellence and you’ll see that Red Hat has covered most, if not all, of the eight items that define and excellent company.  Sun has not, but most seriously has forsaken the principle of “sticking to the knitting – staying with the business that you know.”  They have moved in too many directions too quickly without any unifying theme based on their expertise.  They appear to chase market tangents (storage one day, Open Source databases the next) without creating a singular compelling reason for customers to buy and investors to invest.

For Sun to survive they will need to solidify their holdings into meaningful solution sets that drive some form of unique value which they can monetize (giving away software is not a viable monetization scheme).  They need to quit chasing icons and fads and start delivering a real value proposition.  They need a brand.  Something on which buyers and investors can anchor their hopes and trust.  They need a leader who can marshal Sun’s strengths and has the guts to trash its weaknesses.  Sun needs a maniac warrior with a Napoleon complex and market blood lust.

Larry Ellison has $10 billion in cash lying around and has occasionally talked about getting into the hardware business.  The difference between Sun’s cash- and price-per-share totals $170 million.  Larry could snatch up Sun without wincing and get his chief database competitor MySQL as part of the deal.  With Sun’s massive multi-threading monster chip, Oracle would have a database server combo that might be unbeatable.

Come-on Larry.  The time is right.  Get ‘em while they’re down.

We are about eight years behind schedule.

Around the millennial epoch I helped SuSE whelp the SuSE Linux Enterprise Desktop (SLED), a product that is till on the Novell price list. Growing frustration with Microsoft viruses, continued vendor lock-in and the inherent lower cost of an Open Source desktop were hailed as the beginning of the end of Microsoft’s dominance.

Yeah. I didn’t believe it either.

SuSE arguably had and still has the best alternative to a Microsoft desktop, and considering that it is not Vista, perhaps the best desktop available. But like many good technology solutions it never took the market by storm despite continued frustration with Vista, continued vendor lock-in and the inherent lower cost of an Open Source. Market dynamics and realities stopped SLED’s march.

“The reality is that (the Linux desktop) is a slow, gradual, unstoppable growth,” said my buddy Jeremy White at CodeWeavers, a crew that knows more about Linux desktops than Torvalds. “Emphasis on ‘slow’. Growth is steady, but measured in a fraction of a percent and mainly overseas.”

The reason Linux desktops have never been a big hit with businesses is because no segment of the market sees enough advantage. Technically challenged small businesses have enough to deal with, and can’t even migrate away from Windows 98.

Midsized firms have the technical skills required, but the cost savings do not justify it. With discounts, the combined Microsoft operating system and common office applications cost about $200 a seat. If we assume a business with 500 employees and a four year hard/software life cycle, that is an annual expense of $25,000. This savings would be entirely wiped out by the switch costs and requisite hair plugs for the IT staffers who ripped out their own follicles during the migration effort.

Enterprises simply have too much inertia. They have invested heavily over the years in management infrastructure and IT expertise with Windows. Conversion to a Linux desktop might be profitable, but the scope of the project (not to mention technology territoriality) scares away IT staffs with urgent issues, like installing more network bandwidth so play Gears of War on company time is more enjoyable.

Whatever promise Linux desktops had in the early days were hampered by a premature rush to deploy. One former Novell product manager told me “There were a million dirty little secrets of failure.” Many of the big deployments heralded in the trade press never happened. He noted that lawyers panned early editions of Open Office for the simple lack of strike-through fonts. Forget retraining users when the basic tools were unusable.

But the Linux desktop market is growing, and will (eventually) create a significant dent in Microsoft’s territory … someday. In Asia and in developing countries, Linux is becoming the de facto OS for all computers including desktops. This includes foreign enterprises. Assume that their desktop administrators make $15,000 a year. It is cheaper to have their administrators and support staffs learn GIMP and train all employees than it is to buy copies of Photoshop. Disparity in economics drive differential rates of adoption.

This regionalized momentum will not directly affect industrialized countries, though over time we will have to deal with incoming documents in native Open Office formats. In industrialized countries Linux desktops will be found in the enterprise, but only on techie desks (but then again it was the techies who brought Linux servers into the enterprise, and we see where that led). There will be niche uses, including virtualization controllers and some thin clients.

Yet Linux adoption will grow mainly from consumers. And, yes, I did take my medication this morning.

The tech industry inverted in the new millennia. It used to be that computer technology was designed for business first, and that technology later filtered down to consumers. Now consumers are leading in many fields (laptops, cell phones, etc.) and innovations for consumers later reach the enterprise. How many enterprises are providing Phones or their equivalents to employees? How many will five years from now?

This is where netbooks and cell phones come into play. Devices people use the most set their expectations for usability. Though in their nascent stage, netbooks (which are primarily Linux based) are becoming the tool of choice for many households who now do everything on the web. They use Google Docs, Quicken Online and keep family photos on Flickr. The old concept of a laptop, much less a desktop, is gone. And Linux/Firefox has become the OS/UI with which they are most accustomed.

Then there are cell phones. Android is easing past its growing pains and ready for broader adoption. Palm is resurrecting itself with the Linux-based Pre. Motorola, HTC, Samsung all build Linux handsets. Android and the Pre show Linux can be cooler than Apple. People use their smart phones more than their netbooks. Thus usability levels of expectations are being set by smaller devices that are used more frequently, and over which Microsoft does not have the same leverage as with desktops.

I won’t predict that Linux will rule the end user space (and if I knew this for sure, I would keep it between me and my stock broker). But like life, Linux finds a way. It is the original computer virus, able to infiltrate every hardware platform. It’s only limitations appear to be the imagination of developers … who are smart enough not to tie ribbons around applications.

If there is a single word to describe today’s worldwide business environment it is “directionless.”  Business and consumer spending are slowing to a crawl until some economic direction (even downward) is identified.  People and corporations alike are simply holding cash until they see clear and safe places to spend and invest.

Global indecision.

This state of economic ambiguity will hit many parts of the technology business hard.  In the B2B space, customers are spending only on things that are essential, such as replacing broken servers and PCs.  Even then they are restraining spending and eking the last I/O out of those aging boxes (not me – I’m buying a new laptop this month to do my part in reviving the Chinese economy).  B2C sales are slowing even in the hotter-than-Hades mobile market.  With unemployment rising and a looming federal deficit – currently standing at 8% of GDP and with new spending proposed – ready to push inflation to 1970’s highs, the state of the technology business may be depressed for years.

However, whiskey sales are growing steadily.

Tech companies are faced with the ultimate agility question.  When the economic essence of the world is fundamentally changed, when mid-future economic trends bode ill, and when the combination may drive a new “child of the depression” frugality, how does a technology company respond?  The market for tech will be as fundamentally different as the economic landscape.

Personally I like recessions -business at Silicon Strategies Marketing typically rises when old marketing strategies are no longer viable and tech companies start dialing us up.

Tech’s problems are multiplicative.  First is the problem of trying to determine how the market for technology has changed.  The second is the realization that making such predictions is premature given the directionlessness of the global economy.  In short it is too early to predict what the new market realities are and it is too late to avoid making changes.

John Yossarian had it easy.

Throughout the end of 2008 I have been repeating a speech titled “Marketing Technology in Tough Times.” Originally written in the dot-bomb era, the talk recaps a single salient aspect of corporate psychology that is amplified during economic downturns.  Matching your outreach efforts to the core market disciplines of your customers is critical given that the top management of buyer companies reinforced those disciplines during a recession.

Yet, this recession is different.  Normally a recession lasts about 18 months, unemployment raises a couple of percentage points, and despite localized suffering, most people skate through unscathed.  This recession has already broken the averages for unemployment and duration given current projections.  And unlike typical recessions, there has been massive, global, debt-financed economic interventions that threaten to spike inflation. These longer and more onerous economic realities will fundamentally change the buying behavior of industry and individuals, likely making them more cautious, fiscally conservative and frugal.

How does a tech company deal with this?  Naturally it depends on your specific market, product and competitive position.  However, there are some rather universal realities you will face.

Pricing: Expect downward pressure on prices and thus margins.

Longer sales cycles: Purchase decisions move up the management food chain (even in families) when times are tough, delaying decisions and killing some deals.

Alternative hunting: Last year it was a no brainer for the average buyer to acquire the hot new cell phone.  This year they will select cheaper models.  In corporate software, alternatives like Open Source will receive more attention.

Just saying no: Some sales will simply vanish as executives (including heads of households) will decline to purchase anything that isn’t essential to survival.

Let us assume that these fundamental changes in buyer attitudes are long-term or even permanent.  Technology vendors will need to make fundamental changes as well.  Realizing your specific market has its peculiarities, there are some basic realignments you will likely face for the next few years.

Recast as essential: As buyers restrict purchases to only those things that are essential, recast your products as being essential.  They may not actually be essential, but neither are color televisions and they continue to sell.  Items that appear to be luxuries or that offer marginal added value will go unsold.

Create new essential value: Look long and hard at your product roadmap and move to the top features that create value that can be sold as being essential.  This is tricky as the definition of essential may be narrow.  Yet the theme remains – new revisions of your product in the short- to mid-term should focus on elements customer cannot do without (this may take some education on your part).

Articulate value and survival improvement: When buyers are focused on survival, helping them survive is a key way to win business.  Review your marketing messages and recast your value propositions (where possible) to provide buyers ways to get them through the recession.

Trim the channel: You channel is hungry, but so are you.  When times are good and your goal is to take as much market share as possible, a large and motivated channel helps.  When times are bad and many of your channel partners will wither anyway, cut back and bring as much new business in-house, keeping those margins to yourself.

Wring costs internally: Silicon Valley largess is legendary, so knock it off.  Friday beer blasts and free coffee may be a thing of the past.  When your top-line revenues are restrained, keeping the bottom-line up requires reducing expenses.  Your employees already get it – times are tough.  They won’t resent (very much) corporate frugality when it means keeping their jobs and their stock options above water.

Sell value: Much Silicon Strategies Marketing’s corporate coaching focuses on articulating value.  Value and ROI are different things, and wise marketing pros know how to sell value and not products.  Understand that what your market values today is different than what they valued last year, then sell to their new values.

Most of all, stay optimistic.  This may sound funny given that I just spilled 900 words of gloom.  But the essence of mankind has been invention and change.  As a species, and especially the Silicon Valley tribe, change the world by inventing.  We solve slightly more problems than we create.  If you plan for survival and continue to explore and innovate, you’ll see the sun rise again.