Red Hat And the Five Forces Model:

Red Hat And the Five Forces Model:
An Analysis

Prepared by: Eric Zander
27Jan02
MGT-201B
This paper is available online at www.ericzander.com/Downloads/5Forces.pdf

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Introduction
Created by Linus Torvolds, a Finnish graduate student in 19911, Linux is a Unix-based
operating system (OS) for computers. Since 1991, Linux has grown to be the Unix
“flavor” with the largest market share. Despite this dramatic growth and associated
fanfare, Linux has yet to make significant inroads in the desktop market, holding only
about 2% of this market according to a recent survey2.
Founded in 1994 as a producer of a Linux distribution (distro), Red Hat is the largest and
most recognizable Linux- focused company. Due to the nature of the GNU Public
License3 (GPL), Red Hat is unable to make very much profit from selling their Linux
distro. Instead, they focus on value-added products such as support, consulting and
complementary products including proprietary software.
As the largest company in a nascent segment of the industry, Red Hat is poised for
growth. Herein is provided an analysis using the Five Forces Model to better explain
where Red Hat lies within its environment.

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Analysis
Threat of Entry
The operating system market is both monolithic and fragmented at the same time.
Monolithic due to the monopoly Microsoft holds on the desktop market which helps to
extend its power to other markets such as the server and handheld market. Fragmented
because, outside of the desktop market, Microsoft is often the largest or second largest
player but does not hold monopoly power4. As a result of these dynamics, there are very
high (some would say insurmountable) barriers to entry in the desktop OS market but
much lower barriers to entry in other markets and, for a Linux distribution, the barriers to
entry are very low.
Economies of scale
The economies of scale found in the software industry are very small. This is due to the
very low cost of production once the software has been developed. Cost per unit ranges
from virtually nothing (download) to a small amount for production of boxed CDs. Very
little advantage is seen in large scale production over small runs. This lack of economies
of scale presents a very small barrier to entry for competitors to Red Hat.
Product differentiation
Due to the GPL, there are few differences between Linux distros and new features rapidly
propagate between distros. Linux distributor’s methods of differentiation typically
include support, marketing and niche- market targeting.
Within the Linux community, there are about 13 major distros5. Due to their structure
(i.e. a for profit company6), size and marketing efforts7 and by offering the highest levels
of product support, Red Hat is the most recognizable distro of Linux around the world.
Cost disadvantages independent of scale
It has been estimated that the cost to develop the Windows 2000 operating system was
one billion dollars8 - a very high barrier to entry for a closed-source OS developer.
Microsoft, as any closed-source OS developer, must sell a large number of licenses to
recoup these costs. A benefit of the GPL is that a particular Linux distro has none of this
overhead and can charge much less for a copy of their OS.

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Even with this cost advantage, due to the portability of computer code and the GPL,
earning revenue from Linux is extremely difficult. Red Hat has not found a single “magic
bullet” to work around this. Rather, they have slowly evolved numerous solutions to
generate revenue. Most of these solutions are based around three major methods of
revenue generation: selling of services9 related to the OS, partnering with other
companies and, selling of proprietary software which runs best on Red Hat Linux.
Government policy
There is no direct government regulation of the software industry. Indirectly, numerous
government actions have had large impacts on the software industry over the years. Much
academic research into programming, out of which most OSes have developed, is funded
through government grants. Also, in recent and ongoing actions, the Department of
Justice (DOJ) has determined that Microsoft holds a monopoly in the desktop OS market.
Government actions related to the DOJ findings could potentially be a boon to Linux
distros with Red Hat leading the way.
Capital requirements
Traditional tangible assets such as plants and machinery comprise only a very small part
of the cost structure of Red Hat. Their capital resides in intangible assets such as patents,
computer code and the knowledge base of their employees. Similar to service industries,
the capital requirements to become a Linux distributor are very small. For the cost of a
few high quality programmers, an organization could easily begin a very similar venture
as Red Hat and the profusion of Linux distributions 10 is testament to the low capital
requirements.
Other sources
Due to the network effect (Metcalfe's Law)11, it is extremely difficult for a new operating
system to gain entry to any established market. This barrier is greatly reduced within the
Linux market due to the similarity of each distro. The larger barrier is not for any single
Linux distro but, rather, for Linux in general to gain access to the desktop market. Great
strides have been made in this area12 but have far to go.

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Threat of Substitution
With 13 major distros and over 305 distros total, there is a large threat of substitution to
Red Hat’s distro. What is much more difficult to substitute are the services Red Hat
offers. There are many very small organizations which provide Linux- focused services
but few large ones and, none as successful as Red Hat.
Bargaining Power of Buyers
By differentiating themselves through marketing, quality and service, Red Hat has
successfully differentiated themselves from competitors. The perception that they offer a
superior product gains them power when bargaining with buyers of their product. But,
due to the nature of open source, Red Hat must maintain this image to retain their price
premiums in this competitive market.
Bargaining Power of Suppliers
Red Hat has essentially no suppliers. They take (and develop) a raw material (Linux) and
package it with various other services and software to add value.
Rivalry Among Current Competitors
There are two classes of competitors to Red Hat. First is the monolithic Microsoft which
controls or is a leader in most OS markets. Second are the numerous other Linux
distribution organizations. Although competitors, a Davids-vs-Goliath mentality is shared
by many Linux organizations ; there is a general environment of cooperative competition
among Linux distributors. Linux distributors recognize that the ir biggest challenge is not
each other but the total Linux market size – which, outside of the server niche, is very
small and ripe for growth.

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Conclusion
Red Hat, one of the first commercial Linux distributors, has grown to become the largest
and most recognizable distributor. Due to the GPL, no Linux distributor can prevent other
entrants to the market through manipulation of the OS – a tactic long favored by
Microsoft in their dominance of the desktop segment. This forces Linux distributors to
compete on features other than the OS. Support and services, two of the features
commercial Linux distributors compete on, are intangibles. They are not as easily
compared to one another as the speed of a CPU or the horsepower of a car engine. Also,
due to the youth and small size of the Linux segment in the overall OS market,
competition between Linux distributors is best characterized as friendly competitiveness:
we do not see advertisements of one Linux distributor claiming their distro is better than
another; what we do see are Linux distributors extolling the virtues of Linux over other
OSes including proprietary Unix variants and all Microsoft OSes.
As the largest, one of the oldest, and having a very well recognized brand, Red Hat is
very well positioned to benefit greatly as Linux continues to develop and grow in the
numerous OS market segments.

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Notes

1 For a good history of Linux written by Linus himself, see
http://www.li.org/linuxhistory.php
2 For many dated (1999) but interesting statistics, see
http://www.mc.edu/campus/users/bennet/dontfear/index.html
3 The GPL allows anyone to modify the source code in any way they wish as long as they
contribute their modifications back to the community.
4 See http://www.netcraft.com/survey/ for recent statistics on server OS market share,
http://www.allnetdevices.com/wireless/news/2001/10/12/palm_os.html for recent
handheld OS market share figures,
http://www.asisinc.com/embeddedosmarketshare.jpg for the embedded OS market
share as of 2000 and http://slashdot.org/article.pl?sid=01/12/20/0514203&mode=thread
for an interesting discussion on desktop market share.
5 See http://www.linuxplanet.com/linuxplanet/reports/1266/1/
6 There are non-profit organizations who also make Linux distros, the Debian distro being
the best known.
7 Red Hat enhances their image and actively “gives back” to the Linux community by
employing numerous Linux developers including Alan Cox, one of the lead kernel
developers. Also, by doing the development, they are often able to stay a half step
ahead of their competition.
8 See http://www.zdnet.com/windows/stories/main/0,4728,2595272,00.html for the
development cost of Windows 2000.
9 Several companies have taken this route including Zope Corporation which makes
Zope, an open source content management and layout tool which competes directly
with Cold Fusion, a proprietary product by Macromedia.
10 “It appears that there are about 350 distributions available online” see
http://www.elinux.com/articles/distros/index.jsp
11 See http://www.killer-apps.com/contents/booktour/metcalfes_useful_equation.htm
12 There are several software solutions available to allow Windows and Linux to coexist
on the same computer. Examples include Win4Lin, Lindows, and WINE.

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