Analysis: Linux marches on

Linux's bark is turning into a bite for Microsoft. As a result, the software giant is stepping up to protect itself and keep corporate customers from turning to the open-source operating system to satisfy server and desktop needs.

The company says Linux, which gained double-digit market share in the past 12 months, is its No. 2 challenge behind the slumping economy. That assessment - together with Microsoft's efforts to smooth customer discontent over its costly and complex annuity licensing program and the impending expiration of nearly one-third of its customer licensing contracts - means the company could suffer customer defections and lost revenue.

One of the vendor's next high-profile battles, according to sources, is DaimlerChrysler AG. The automaker is said to be squirming under Microsoft's annuity licensing plan and contemplating replacing some of its Windows server infrastructure with Linux. DaimlerChrysler officials would neither confirm nor deny the possibility of such a move.

Two years ago, DaimlerChrysler made a highly publicized commitment to Linux by replacing a Unix cluster with an IBM Corp.-built cluster of 108 Linux workstations. The goal was to reduce the cost of running crash-test simulations, the company said.

"We continue to work with DaimlerChrysler," says Scott Handy, director of Linux software solutions for IBM, although he would not provide specifics.

Microsoft is said to be in talks with DaimlerChrysler to stem any defection to Linux by negotiating licensing terms under Microsoft's Licensing 6.0 and Software Assurance program, the annuity licensing program that has caused a backlash since its introduction in May 2001.

Microsoft said it does not comment on specific customer deals.

"Licensing 6.0 is the best thing to ever happen to Linux," Handy says.

It's a beast Microsoft created and is trying to tame.

Ballmer sounds alarm

Microsoft CEO Steve Ballmer said in a memo to employees in June that the company would need to fix mistakes it made in implementing the annuity licensing program. He added that Linux requires Microsoft's "concentrated focus and attention."

As a result, Microsoft has become more flexible in contract negotiations, willing to offer discounts that sometimes reach 45 percent and other unusual concessions, especially when battling against Linux, according to analysts and customers.

The most striking example of change is a high-profile flop by Microsoft that might have set a tone in Germany, where DaimlerChrysler has its headquarters in Stuttgart.

In June, the Munich city government said it will migrate 14,000 Windows desktops to Linux beginning in early 2004. The city decided Linux would be less expensive over time, even though Microsoft's bid was nearly $12 million less than those from IBM and SuSE Linux, which is based in Germany.

Microsoft's bid, which Ballmer delivered personally, started at $36.6 million and was slashed to $23.7 million at the 11th-hour, including an unusual offer to unbundle Word from Microsoft Office.

The loss in Munich overshadowed Microsoft victories in other European cities, including in Frankfurt, according to Ballmer's remarks at the company's July 24 financial analysts meeting. But Microsoft won't provide specifics on that deal.

The tit-for-tat lends credence to Linux's climb up Microsoft's challenge meter, as does an open source test lab that Microsoft opened in May and an attack on Linux that Ballmer delivered at the analysts meeting. Ballmer said there were misconceptions about Linux's overall value, citing research from Gartner and IDC that said Windows was up to 30 percent less expensive on the desktop and up to 22 percent less expensive on the server than Linux.

"What's going on with Linux and some of the big Linux distributions, and open source, is that the rate of deployment, the rate of creation, [and] of releases of Linux that address security problems also has, perhaps, even bigger problems than we have," Ballmer said.

Growth seen in surveys

Despite those claims, the most recent research by IDC shows that Linux had a 26 percent share of the server operating system market in 2001, up from 22 percent in 1999. The uptake is in line with IDC projections that Linux will have 30 percent of the server market by 2007 (compared with just more than 50 percent for Microsoft) and will be commonplace on corporate evaluation lists by 2005.

Overall, however, Microsoft says it has a 53.1 percent to 16.7 percent advantage over Linux on the server. On the desktop, Microsoft continues to dominate, although the deal in Munich could ignite corporate interest.

"I'm not happy that we grew share and Linux grew their share a little bit more at the server level last year," Ballmer said.

The rush to stem the rising tide of Linux intersects with Microsoft's effort to correct problems with its Licensing 6.0 program, which has attracted only 30 percent of current customers, according to a March survey by The Yankee Group.

Of the 70 percent not in the program, 42 percent said they are not participating because they signed Licensing 5.0 contracts as a way to delay a decision on the 6.0 program. But most of those 5.0 contracts will expire between September 2003 and July 2004.

"The point is, will Microsoft be able to talk those people into signing up for 6.0 and Software Assurance?" says Alvin Park, an analyst with Gartner Inc. "If they don't sign them, it will be a significant revenue problem for Microsoft."

The company says it also must get new contracts for both Licensing 6.0 Enterprise Agreements and Software Assurance from midsize to large accounts and get customers to cover more products under those contracts.

That uncertainty has led Microsoft to acknowledge that it can't predict unearned revenue growth for fiscal year 2004. The revenue is derived mostly from licensing commitments that are paid in installments over three years. Over the past two years the company has had growth of 38 percent and 16 percent in unearned revenue, mostly fueled by two-year Licensing 5.0 contracts.

But while Microsoft scrambles, Linux hasn't taken advantage with a slam dunk.

The recent lawsuit brought by The SCO Group Inc. against IBM over intellectual property rights surrounding Unix and Linux is catching attention. Microsoft recently licensed the SCO Unix code, which many saw as a move to fan the flames.

Linux still must prove itself in key areas, including integration, interoperability, scalability and reliability. And the portfolio of corporate applications for the platform must grow.

"Linux says it is free and it is open, but it has not stepped up to the plate and said how much it costs," says Laura DiDio, an analyst with The Yankee Group.

She says her research shows that one-tenth of one percent in difference on reliability from one operating system platform to another can result in an additional 63 hours of downtime and generate US$700,000 to $3.5 million in additional support and administration costs depending on the size of an organization.

And another thing is that many Windows users are dug into the platform in certain areas of their organization.

Paul Mercurio, senior vice president and CIO of Mobile Travel Guide, which runs a travel Web site, recently outsourced the site to IBM. IBM hosts the site on a mainframe running Linux. "Open source and innovation can happen without the control of one company that may have an agenda," he says.

However, internally, the company has a Windows infrastructure because programs such as Word and PowerPoint have become essential for sharing files with outside partners.

"The Microsoft stuff works, and there is not a lot of reason to change," he says. "Whether we like it or not, some of these applications are de facto standards."

Microsoft CFO John Connors boiled it all down in a recent conference call for financial analysts.

"If Linux gains more share, that's an impact to us," he said. "If Linux gains share on the desktop, that's an impact to us. If we execute well, we mitigate the risk."

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