Novell bets its future on Linux: CEO Jack Messman hopes open source software will take a bite out of Microsoft.

In the early 1980s, a Utah-based start-up called Novell Data Systems announced a new line of personal computer hardware--but it came just one month before IBM released competing products at a quarter of the price. Novell's offering obviously wasn't going to work.

So lead investor Safeguard Scientifics sent Jack Messman, its executive vice president, to examine the situation and see if there was any hope to recoup their money. Late one night in Provo, Messman happened upon three of the company's consultants who had connected PCs made by three different companies and were sharing data--networking at its most nascent--as part of an arcade-style game. At the time, no one else had figured out how to do that. "I called Safeguard, and said, 'I think we should put more money into this because I think it has some potential,'" Messman recalls.

Novell went on to invent PC networking with its NetWare product and became a hero in the technology world. Eventually, Messman hired Ray Noorda as the permanent chief executive and left Novell, spending time at Warner-Amex Cable Communications, and eventually landing as CEO of Cambridge Technology Partners. Yet all through this time, he remained on Novell's board.

Today, Messman is back at Novell as CEO--once again making a big bet on a new technology and going up against another giant, this time Microsoft. He's betting that the open source software Linux can be built into a competitive weapon. Ironically, he's doing it partly with cash from Microsoft's antitrust settlements.

The reason Novell needs a bold strategy is that NetWare has lost much of its viability because Microsoft has gradually absorbed basic network functions into Windows. Messman is betting on Linux, which he combines with Novell's software and services, to attack Microsoft's monopoly on desktop software. While many analysts believe that he has sound strategy, the question is whether he can change Novell's culture and improve execution quickly enough to make the company relevant again. When he returned to Novell in 2001 following its acquisition of Cambridge, "we found a company that had been attacked by Microsoft for a 15-year period, and the company was in a hunkered-down mode," Messman says. The company has suffered through a decade of flat revenues and an aggregate net profit margin of roughly 0.8 percent.

The burning question is whether Messman can obtain enough traction with the Linux strategy fast enough to offset declines in the NetWare cash cow, a classic technology paradox. "Since 2000, Novell has consistently been losing NetWare [user licenses] to the tune of 12 to 14 percent every quarter," says John Enck, vice president at the technology research firm Gartner Group.

This is due in part to an engineering-oriented culture with too little regard for marketing. The company developed directory services (tracking and controlling the confusing tangles of networks in an enterprise) and network identity management (single-point control of user privileges), both well regarded by experts. But Novell missed other emerging uses of networks: client server, email and the Internet. "Over the years, Novell created a lot of great products that had no markets, or they were far ahead of their customers," Messman says. "We were playing good defense. We were still alive, we had a good cash balance, people liked us--that was key. But the thing you have to realize is that you can only play defense for so long."

As CEO of the company, Messman's task now is to find ways to take the services that NetWare delivered, such as file and print sharing, messaging and collaboration, and expand them beyond the sinking legacy product by embracing Linux. The open source operating system had been rapidly gaining popularity among companies looking to reduce the licensing fees they paid for server-level products like Microsoft's Windows or any of a number of versions of Unix, which was the inspiration for Linux.

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Although Novell literally owned the code to Unix, it was in a long-standing legal dispute with a company called The SCO Group, which claimed that it had the rights. So Novell hopes a new "clean-room" version of Linux with no use of the existing Unix code will catch the market trend while avoiding legal entanglements. "We're focused on Linux and making that into an operating system that will ultimately be on a par with Windows," says Messman, now 65.

The way Messman sees the world, it's everybody against Microsoft. "We think in the future there will only be two major operating systems. There will be Linux and Windows." As to how one makes money by offering free software, he says, "You can make money on the service business itself, but you really make money by putting proprietary components on top of the operating system itself," because eventually everything in open source becomes a free commodity.

But it's been expensive and slow. In 2004, according to public filings, out of $1.2 billion in revenues, Novell earned only $238 million from new software licenses. Yet development costs were $198 million. "They're basically spending almost as much on R & D as they are on the licenses they're generating from it," says software industry analyst Jeffrey Tarter.

Nevertheless, Novell still enjoys technical expertise, a sizable support and consulting staff it acquired with Cambridge, and an existing strong network of business partners that sold to end user companies. "When people looked at buying Linux, they didn't know who they were going to turn to for support," Messman says. Maybe now they could. Inside contacts said that SUSE, widely known for a technically high quality Linux, was available for acquisition. Novell spent $210 million in 2004 on SUSE and "got into the Linux business in a big, big way."

The acquisition of SUSE was probably among the smartest that Novell had done--certainly more effective than Noorda's purchase of WordPerfect--to challenge Microsoft in the office suite category when it lacked the "marketing muscle," according to Messman.

However, Novell still needed to shift its focus from products and engineering to solutions and marketing. Part of the solution has been to bring in outside talent that was not bound to the NetWare legacy, after which management defined how it wanted the culture to behave and then documented those decisions to provide a touchstone. Practically speaking, making the shift meant instituting 360-degree performance appraisals and adopting new rewards systems. "We put six or seven teams together; they worked and came up with recommendations, all of which were accepted," he says. Top officers then went out and scheduled meetings with 10 to 20 employees at a time.

Although that change alone was enormous, there was a second problem: a strongly hierarchical and authoritarian mind-set in which employees refrained from taking initiative. That would never do, so Messman implemented a matrix management system where people work across organizational divisions and product lines. A matrix can be inefficient, he says, "[but] it was the only way we could break out of a parent-child culture."

Novell's cultural reformation has been underway for three years, and Messman thinks it will take another 18 to 24 months to complete. The company may find itself in a strong position at the end of that process, with a new management team in place, a source of technology products not tied to NetWare, and $1.6 billion in the bank (largely because of the Microsoft antitrust lawsuits) and with more from Redmond potentially on the way.

Skeptics Aplenty 

For all the positive-sounding news, many who watch the company remain skeptical about execution. Can Messman take not one but two engineering-oriented organizations--Novell's traditional core as well as SUSE's--and make them customer-oriented? "It's always been a company driven by the sandbox mentality of their founders," says Tarter. "They would never think to go out and ask customers what they want or what they need. That's why they've missed everything. You can hire competent marketing people, and you can hire competent sales people, but if they have products that are boring and low in value, there's nothing you can do." And building proprietary components keeps the company in the product development business, which has not been a rousing success for a long time.

Changing managers also doesn't guarantee results. "The senior staffing changes in Novell at least haven't appeared to be that dramatic," says industry analyst Rob Enderle, who sees some of the replacements as being of questionable success. One new head of marketing was "a complete waste of money," he says, noting that she changed a corporate logo that enjoyed high recognition among customers.

Then there's the question of whether Messman's strategy can work quickly enough. While Linux has seen significant growth, investment bank SG Cowen has warned that the Linux market has slowed with license sales lagging, and that it could be a long time before the operating system becomes an established choice at all levels of a company.

Despite the problems, it's not clear how many options Messman and Novell have. "If they were going to have a future, they had to jump into Linux," says Al Gillen, research director at IDC.

And if Novell has to carve an unfamiliar path, so eventually will virtually all software companies. "Ultimately, the effects of open source software are going to have a similar long-term impact on all software companies," Gillen says. "People tend to look at it and say, gee, the proprietary technologies tend to be too difficult to maintain." Those early to arrive might actually have the opportunity to create more dominant positions, so Novell might gain an advantage.

Can Messman pull it off? With a competitor like Microsoft, most experts are skeptics, with opinions ranging from "tough" to "a snowball's chance." As Enderle says, "If he had a cape and wore an 'S' on his chest, he'd still have a problem." But if Messman can navigate the hazards, Novell's competitors might find it a hot competitor--once again.

RELATED ARTICLE: Novell's Wild Ride

* 1980

Safeguard Scientifics buys a controlling stake in Novell Data Systems; company introduces NetWare in 1983

* Early 1990s

Novell has nearly 70 percent of the networking market

* 1992

Company buys rights to AT & T's Unix

* 1994

Company buys WordPerfect and Borland's spreadsheet Quattro Pro 

* 1997

Eric Schmidt becomes CEO

* 2001

Novell completes acquisition of Cambridge Technology Partners; Jack Messman becomes CEO

* Jan. 2004

Novell finishes acquisition of SUSE Linux 

* Nov. 2004

Novell settles one antitrust claim with Microsoft for $536 million

Source: Chief Executive