Can open source still save Novell?

When Novell releases its fourth-quarter financial results next week, industry observers will be looking for signs of whether the company’s big bet on Linux is starting to pay off.

So far Novell has had little to show even though the Linux market is booming. Industry watchers say Novell needs to more forcefully pull away from its proprietary software roots to win over open source supporters.

“I can’t find any other companies that have . . . leveraged an open source and proprietary model and been successful at making money at it,” says John Enck, a vice president and research director at Gartner. “We remain skeptical on how a company can make money on open source other than services and maintenance.”

At the start of last year, CEO Jack Messman said the company’s acquisition of SuSE Linux would help turn Novell around within two years. But with those two years almost up, the company continues to struggle. In the third quarter, Novell reported revenue of $290 million, down 5% from the $304 million it posted in the year-earlier quarter. Earnings plummeted 90% over that period. And earlier this month, Novell said it was slashing its 5,800-person workforce by 10%.

Novell declined requests for interviews, but in published reports Messman has dismissed the flagging third-quarter numbers as a “one-time glitch” and has said the company’s Linux strategy is on track.

Still, the company has struggled when it could be cashing in on an exploding Linux market. Linux servers posted their 12th consecutive quarter of double-digit growth in the second quarter of this year, with revenue growing 45% compared with the same period a year ago, according to IDC. By contrast, Microsoft Windows Server revenue grew 14%.

Maybe more troubling for Novell is that Red Hat, about a tenth of its size, is thriving. Credit Suisse First Boston says Red Hat holds nearly two-thirds of the Linux market, while SuSE’s share is hovering around 20%.

Not that Novell’s financial picture is completely bleak: the company has $1.6 billion in the bank. But financial and industry analysts were unsettled enough by the third-quarter results to call for management changes as a way to right Novell’s course.

The issue is that Novell is having a tough time articulating a strategy that involves a tricky balancing act of selling both proprietary and open source software, analysts say.

Next week’s financial results will shed more light on how Novell’s transition is going, but regardless of those results, analysts and users say the company needs to more fully embrace the idea of open source. The software maker bundled its classic NetWare services with SuSE Linux earlier this year, but hasn’t fully made the open source leap.

Novell executives say they’re bringing value to Linux “up the stack from the kernel” with services such as identity management, security and systems management. Red Hat is taking the same path, but submitting those add-ons – such as the directory services it acquired from Netscape – into the open source community under the General Public License.

“After spending a significant amount of money to acquire [Linux desktop and server company] Ximian and SuSE, it chose to bury the technologies and the opportunity it acquired under a flood of its traditional products,” says Michael Goulde, an analyst at Forrester Research. “Certainly, a new strategy is required focusing on the complete application platform.”

Novell’s approach to open source hasn’t gone unnoticed by customers. Jim Klein, director of information services and technology at the Saugus Union School District in California, for example, is a longtime NetWare user and was co-owner of a Novell reseller before taking his current position 10 years ago. But when he decided to migrate his 52 NetWare servers to Linux early last year, he opted for Red Hat.

“Ironically, when Novell bought SuSE and committed to Linux, it legitimized the platform for us and caused us to look at it more seriously,” Klein says. But after reviewing both Red Hat and Novell, “ultimately it came down to who was a true open source company.”

“Novell was, and is still, layering their proprietary software on top of Linux, which was – and appears to still be – their primary focus,” Klein says. “Once someone becomes committed to the modularity of the open source model, the Novell way of doing things doesn’t match up.”

The problem is that while the primary tenet of the open source community is to build applications on open standards to allow interoperability, Novell closely links its open source offerings to its proprietary software, he says.

“Novell solutions, while they support open standard connections to a certain extent, rely on each other to function, rather than operating independently. GroupWise won’t work without [Novell Directory Services], which [management software] ZENworks also requires,” he says.

What Novell needs to do is “become more a pure-play open source company,” Klein says. “All of their products should operate independently of each other but complement each other, and drop easily into an enterprise environment, with full support for open standards and integration with non-Novell solutions.”

It’s that kind of corporate reinvention that seems to be driving Novell’s latest restructuring efforts, analysts say. “Novell is trying to reshape the company in a big way,” Enck says. “They are . . . doing this with a real goal of moving forward and making some money on Linux, identity and resource management.”