When Red Hat kicks off its annual customer conference May 8 in San Diego, The VAR Guy will be watching closely. The company faces at least seven key challenges–and opportunities–as it tries to remain the open source industry’s most successful company. Here’s the rundown.

7. Don’t Underestimate Oracle Linux: At first, The VAR Guy dismissed Oracle Linux as a yet another pretender in the market. But during a meeting with The VAR Guy last week, SugarCRM CEO John Roberts said he’s taking Oracle Linux very seriously. And he believes customers will, too. Hmmm. It’s difficult to argue with the CEO of one of the fastest-growing open source application providers. Red Hat will need to continue working closely with Oracle’s database and application teams, even as the company competes head-on against Oracle Linux.

6. Rally IT Consulting Partners: This week’s Red Hat Summit focuses mainly on customers and software developers. Red Hat says it may launch targeted regional events for resellers, integrators and IT consultants. The sooner the better, The VAR Guy thinks. Red Hat will need thousands of partners if the company intends to compete against Microsoft for small and midsize business customers… the focus of challenge #5…

5. Embrace Small and Midsize Business: Microsoft remains the SMB king. Many small business owners and entrepreneurs have never heard of Linux. But that could change as Red Hat and its partners continue to fine-tune their software for SMBs. Red Hat’s best chance for SMB success is likely through hosting companies, which use Linux to run email and other applications for their SMB customers.

4. Figure Out Desktop Linux: How did Red Hat overlook this market opportunity? Here’s the simple explanation: When Linux didn’t gain share on the desktop earlier this decade, Red Hat retreated to the server. But Ubuntu and Novell quietly continued their respective desktop Linux efforts. And those initiatives are now paying dividends. Dell plans to offer Ubuntu on some desktops. And Novell has won several big desktop contracts. Naturally, Red Hat now wants a piece of the action and is — once again — ramping up its desktop initiatives.

3. Keep Microsoft-Novell at Bay: Admittedly, The VAR Guy initially dismissed the Microsoft-Novell alliance as little more than marketing hype. But despite some protests from the open source industry, the Microsoft-Novell deal appears to be gaining momentum. Plus, Dell has now announced plans to support the Microsoft-Novell alliance. Sure, Dell continues to support Red Hat servers in a big way. And Dell is sponsoring the welcome reception at this week’s Red Hat Summit. But the Dell-Microsoft-Novell trio has to be unsettling.

2. Adjust to Open Source Applications: In recent weeks, application providers like MySQL and SugarCRM have held major customer and developer conferences. Clearly, the center of the open source universe is shifting from Linux to applications. Red Hat will need to make a big move to ensure it doesn’t get eclipsed by these and other fast-growing application providers.

1. Drive Online Software Sales: This is the big wild card. The billion-dollar question. The make-or-break move. If Red Hat builds its online store correctly, the company could become the Amazon.com of online software sales. Partners and customers will be able to purchase third-party open source applications from a single location, managed by Red Hat. The company’s so-called online exchange should be operational this summer. Expect an update from Red Hat later this week.

Despite these challenges, The VAR Guy remains bullish on Red Hat’s long-term prospects. The company continues to gain momentum with VARs and integrators. And Novell’s own challenges should allow Red Hat to remain king of the Linux market … at least in North America … for the foreseeable future. But that doesn’t mean Red Hat can afford to rest on its laurels.