November 12, 1998

STREET WISE by Sam Jaffe


On Oct. 31, an independent software designer named Eric Raymond posted on his Web site an internal Microsoft memo. The paper, which was quickly distributed throughout the Internet and became known as the Halloween Document, identified a goblin that supposedly was spooking the software king -- a computer operating system called Linux.

The memo implied that Linux just might be a chink in the armor of seemingly invincible Microsoft. But on further examination, that doesn't seem likely. Instead, it seems possible that Linux could even help Microsoft by putting some of its competitors on the defensive. In short, analysts say, you might want to wait if you're thinking of selling your Microsoft shares because of Linux.

It's true that Linux has made a splash in the press, which has characterized it as the next great contender to dethrone Microsoft's mighty Windows NT operating system software. Unlike previous contenders (Apple, OS2, Java), Linux, a derivative of the popular but fragmented UNIX operating system, is an open-source operating system. That means its core kernel is free and available to anyone.

Prior to the Halloween document, Microsoft didn't seem concerned about Linux and its presumed threat to Windows NT in the market for powerful machines called servers. But afterward, Linux got respect. Though it has less than 5% of the server market, it has won rave reviews as more compact, more stable, and less prone to errors than other Unix operating systems. Or for that matter than Windows NT which, in its fifth year, seems poised to make the same leap to dominance in servers that Windows 95 enjoys on desktop PCs.

The spark that set off the Linux firestorm was a mundane memo from Microsoft software enginner Vinod Valloppillil, who wrote in part that "OSS poses a direct, short-term revenue and platform threat to Microsoft, particularly in the server space." He further described Linux as a technical and price-point value leader over other Unix systems and NT. Advocates of Linux and other open-source software programs cited the memo as proof that even Microsoft now sees them as a threat. There has even been speculation that Microsoft planted the document to give it a better chance of turning back the Justice Dept. in its current antitrust case.

For now, Microsoft is downplaying just about everything. "The document in question was a white paper written by a staff engineer. It was his own opinion," says Ed Muth, group manager of enterprise marketing, the Microsoft division that would be most affected by the growth of Linux. "It's not a blueprint or a road map." For the most part, though Muth labels Linux a competitor, he also downplays its potential. He questions how much market share it will gain outside of the low-end commodity server market, where it's quite popular. In other words, he sees Linux as just another niche competitor. "I can understand a small independent Internet service provider deploying Linux to operate a server, but I would be surprised to see a money center bank use it to run its trust department," Muth says. For the most part, he's right: The death announcements for NT are way premature.

For one thing, small independent networks are the primary customers for Linux. Even if Linux were to push out all the other Unix systems available, such as those sold by Sun Microsystems or IBM, it would still have to compete against Microsoft's NT, which is gaining ground rapidly against all Unix systems.

Then there's the issue of price. One of Linux' key attributes is that it's free and cheaper to run than most commercial operating systems. But network administrators worry about more than money. "If you have to keep a server running for your multibillion dollar company to stay healthy, does it really matter if you pay $800 for it or if you pay zero dollars for it?" asks Fritz Reynolds, a fund manager who runs the Reynolds Opportunity fund and who has owned Microsoft stock since it went public.

"The free part is not the important part of Linux. It's the open-source part," adds Ransom Love, the CEO of Caldera Systems, which provides technical support and educational material for users of Linux. He argues that because they have Linux' source code, programmers have more leeway to tailor the operating system to their needs than they do with Windows NT.

Microsoft's Muth disagrees on that point. "The number of customers who need access to the source code in our experience is less than 1 in 300," he says. He adds that programmers value the purity of the code -- that there are not dozens of versions floating around -- more than their ability to fiddle with the software.

Just because Microsoft isn't immediately threatened by Linux doesn't mean there are no losers, however. The server market is divided into high-end and low-end. The low end is dominated by Unix machines, most of them supported by major manufacturers such as Compaq and IBM. If Valloppillil's Halloween memo turns out to be prescient and Linux takes all of the low-end Unix market, Compaq and IBM will suffer accordingly.

It is in the high-end market that the fiercest battle will play out, however. There, the two biggies are Microsoft's NT and Sun Microsystem's Solaris7 version of Unix. If Linux can grab a foothold in the high-end, it will probably be at the expense of Solaris, a Unix system. If anything, Microsoft might benefit from victories by Linux, which would allow it to bull rush the server market with NT while Sun and IBM cut back to lick their Linux wounds.

A winner from the Linux onslaught could be Dell. It stands alone as the only major computer maker in the server market that doesn't have its own version of Unix. If Linux were able to consolidate that market, then Dell could easily sell Linux-compatible servers while its rivals would hesitate so as not to cannibalize their own Unix products. "Step one in Linux emergence is consolidating Unix," says Credit Suisse First Boston computer analyst Michael Kwatinetz. "If this occurs, PC players like Dell would be able to offer industry-standard Linux servers and desktops, and the Unix market would much more closely resemble the PC market -- except that the operating system would be free."

The finale of the Linux story has yet to be written, and there are sure to be several more plot twists. But for now, it appears that manufacturers who rely on Unix -- not Microsoft and NT -- are the most vulnerable. So Microsoft may be in the clear -- at least, this week.

Sam Jaffe writes about the markets for Business Week Online

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