Part 2: When the tech bubble burst, Red Hat went big to ride out the storm

“First they ignore you, then they laugh at you, then they fight you, then you win.”

Entering the 2000s, Red Hat was a darling among computer programmers and Wall Street traders. But marketing CDs to tech enthusiasts in bookshops and electronic stores wasn’t going to make the company profitable. It needed to convince institutional clients to trust open source.

And it would have to do so with new leaders.

In November 1999, Bob Young stepped down as CEO, replaced by software executive Matthew Szulik. Marc Ewing left two months later, cashing out a portion of company stock worth $31.5 million. He was replaced as chief technology officer by Michael Tiemann, a pioneering software engineer from California who had formed the world’s first commercial open-source company, Cygnus Solutions, which Red Hat acquired.

Donnie Barnes, one of Red Hat’s first four employees, exited soon after Ewing.

For the new leaders, 2000 provided a rude awaking. Red Hat was on a hiring tear — it ended the year with 550 employees — when the dot-come bubble burst, nosediving the company’s value. Shares that had reached a high of $148 in January plummeted to $5.13 by year’s end.

“Luster off Red Hat,” read a headline in The News & Observer that spring.

As the economy worsened, the viability of Red Hat was called into question. Tech startups, every week, were folding. On Feb. 3, 2000, Red Hat sold 4 million additional shares during a secondary public offering at a price of $95 each. The next month, tech stocks eroded. Selling the shares when it did (and not a month later) gave Red Hat “a floor” on how far it could sink, Tiemann said.

“We put a big, big buffer against any kind of short-term cash crunch,” he said. “It took us out of the realm of ‘Can the company survive?’”

While it was able to continue operating, Red Hat was also taking arrows from its rivals. In 2001, then-Microsoft CEO Steve Ballmer labeled Linux “a cancer” and Microsoft’s operating systems chief Jim Allchin called open source “an intellectual-property destroyer.”

“We were changing the industry and a lot of companies were mad at us,” said Michael Ferris, Red Hat’s vice president of corporate development and strategy who started at the company in 2000.

Among their staff, Red Hat leaders spread a quote, often wrongly attributed to Mahatma Gandhi, which addressed their critics: “First they ignore you, then they laugh at you, then they fight you, then you win.”

“We felt we were on the right side of history,” Young said.

In June 2001, Red Hat eked out its first profitable quarter. Then a tragedy accelerated its growth.

Sept. 11 destroyed servers housed in World Trade Center

The Sept. 11 terrorist attack killed more than 2,750 people at the World Trade Center in New York.

It also destroyed the principal data centers of many Wall Street investment banks, which were housed in the twin towers. With their computers wiped out, financial institutions had to choose whether to rebuild with standard proprietary software or the emergent open source. Many picked the latter.

“(9/11) unbound what had been a barrier to entry,” Tiemann said. “It wasn’t as if (the banks) just overnight made this transition, but it absolutely opened up the opportunity (for them) to make a completely different set of business decisions than they would have had to make if they were carrying however many hundreds of millions of dollars of existing inventory.”

In the following years, Red Hat’s client list grew to include Morgan Stanley, AOL Time Warner, General Electric, UBS, Amazon, Dell, Deutsche Bank and Cisco, among many others. Red Hat had won over Wall Street.

Persuading corporate executives to trust Red Hat Enterprise Linux could be a challenge, however, said Joanne Rohde, who became Red Hat’s chief operating officer in 2004.

“It was very hard and we had to explain it,” she said. “In general, the technicians would get it but the security people would not get it. The people that would rather trust the brand name would not get it.”

Red Hat fends off Oracle and wins over an old rival

Rohde arrived at Red Hat at the tail end of what she called the company’s “Wild West era” — a moment when the last vestiges of the startup era (a relaxed if disorganized culture) was giving way to a more corporate climate. By then, Red Hat had left Durham for good, relocating to a 120,000-square-foot office complex on North Carolina State University’s Centennial Campus in West Raleigh.

A native of Durham, Rohde felt she had to leave the Triangle after college to start her career in the early 1980s.

“There weren’t sufficient job markets for the kinds of things I did in tech and finance back in the Dark Ages,” she said. “But Red Hat gave me an opportunity to come back.”

At Red Hat, Rohde led the company’s transition to subscription models, which she said were key to making free software services profitable.

“We kind of flipped the model on its head,” she said. “The software is free. The value add is all those things you wrap around it: the service, the testing, the version control, the knowledge. That’s where the real value is.”

By the mid-2000s, Red Hat was the world’s largest provider of Linux.

Customers proved loyal. In 2006, Oracle CEO Larry Ellison unveiled plans to erode Red Hat’s open-source service market share by replicating its Linux package at a reduced price.

“This is easily the biggest challenge Red Hat has ever faced,” a technology analyst said at the time.

That was the downside to building a business around open source; any competitor could see the formula and copy it. But Red Hat endured. Young would often compare his company’s success to that of Heinz Tomato Ketchup: Everyone can read the ingredients and make their own, but people trust the brand.

Soon, Red Hat was servicing more than 90% of Fortune 500 companies.

By then, even the most vehement former critics were amenable to Red Hat’s kind of software. Microsoft had begun to integrate open source into its core operations.

“Microsoft was on the wrong side of history when open source exploded at the beginning of the century, and I can say that about me personally,” Microsoft President Brad Smith later said.

In the 2010s, “open source has won” became a popular tagline among programmers. After years of fighting for legitimacy, former Red Hat executives said victory felt good.

“There was never gloating,” Tiemann said. “But there was always pride.”

In Part 3: Would Red Hat take its fedora to Texas or Georgia?