Bigger Blue

IBM stakes its future dominance on a strategy built on Linux, services and the Internet.

It should have been an easy contract for IBM to win. And in years past, it probably would have won the deal.

But in late August, Firemans Fund Insurance Co. awarded a 10-year, $350 million outsourcing contract to Canadian integrator CGI Group, not IBM Global Services. CGI won even though Firemans Funds data center in Phoenix, which CGI will now take over, is true Big Blue: It contains several IBM mainframes, including an OS/390 and some RS/6000 servers running AIX, IBMs proprietary version of Unix.

"At the end of the day, CGI had a better financial proposal and a better people and technology fit than IBM," said Billy McCarter, chief information officer of Firemans Fund.

One lost services deal does not a trend make. But losing the business of the Firemans Fund had to be painful for Big Blue, which is increasingly staking its future on its ability to garner major outsourcing contracts. And while IBM has weathered the ongoing tech downturn better than many of its competitors, the technology giant faces challenges on almost every front. In servers, IBM is facing off against new, more powerful machines from Sun Microsystems, as well as Dell Computer and Hewlett-Packard/Compaq Computer. In services, Electronic Data Systems, IBMs chief rival, is quickly gaining ground.

Meanwhile, IBMs stock is stuck in neutral, hovering near the $100-per-share mark for about two years. And its unclear if or how IBM will be able to accelerate its growth beyond the 1 percent revenue gain the company recorded last year. Last week, several Wall Street analysts lowered their projections for IBM, saying its third-quarter earnings - to be announced this week - could fall 17 percent from the second quarter.

Growing such an enormous company - IBM is the eighth largest corporation in America and employs 316,000 people - would be difficult in the best of times. And these are certainly not the best of times. The Sept. 11 terrorist attacks have shaken the world economy and reduced projected technology spending. Although the attacks may allow IBM to garner new government security contracts, "its not going to be enough to offset the slowdown in corporate demand," said David Bailey, a Gerard Klauer Mattison & Co. research analyst.

There are leadership questions, too. Early next year, IBM is expected to go through its first leadership transition in nearly a decade as Lou Gerstner, the companys much-lauded chairman and CEO, heads for the exit and hands the reins to Sam Palmisano, IBMs president and chief operating officer.

Despite the challenges, few people are betting against IBM. Big Blue will prosper "because its the casino. Its the house. It has such size and scale that if customers are concerned about the HP/ Compaq merger or other tech companies surviving the downturn, theyll go to IBM. They become the default choice, and that benefits the company enormously," said Jonathan Eunice, Illuminatas principal analyst.

Big Blue holds either the No. 1 or No. 2 position in practically every category in which it competes. Its research labs are the envy of the Fortune 1,000. Its microchip fabs are busy and profitable. And it has married more often than Elizabeth Taylor. Over the past two years, Big Blue has inked more than 100 separate deals with software vendors around the world that give it leverage in new markets and the ability to sell more hardware and services.

To maintain that dominance, IBM is betting its future on a strategy that mixes innovation and services with a hard push for Linux and open standards. In short, Big Blue will produce new products in every business segment and hope that open standards - combined with its embrace of Linux and the overall use of the Internet - will accelerate demand for IBMs hardware, software and, in particular, its services.

"Its a bet-the-company kind of move," said Susan Eustis, president of WinterGreen Research in Lexington, Mass. "Theyve been known as a proprietary provider for so long that they risk their position by moving to open standards." Eustis said IBM risks losing market share because every vendor will be able to provide hardware and software that interconnects with other systems.

The Big Blue Picture

"Our strategy is to integrate with anything," said Stefan Van Overtveldt, IBMs program director for WebSphere technical marketing. IBM sees a business model in which "a company is able to focus solely on its core services, and can outsource all the surrounding activity over the Net by integrating applications that are running internally with services running on the Web," Overtveldt said.

More than any major IT company, IBM is wagering that Linux will be an omnipresent operating system. All of IBMs server lines can now run Linux. Its a tectonic shift for a company that has spent millions - if not billions - of dollars, developing and marketing proprietary systems such as AIX. Despite that history, IBM will spend $1 billion this year promoting and developing Linux, the open source OS that just a few years ago was part of the lunatic fringe. Its a fringe no more. Today, IBM is selling an increasing number of Linux-based mainframes to major corporate users, including recent deals with Korean Airlines and Securities Industry Automation, which operates the computers and communications networks for the New York Stock Exchange and The American Stock Exchange.

IBM is embracing Linux for a number of reasons. Chief among them: By using Linux, IBM undermines Microsoft and Sun, both of which sell proprietary OSes. If IBM sells a server loaded with Windows NT for $1,000, Microsoft gets a licensing fee that comes out of IBMs profit margin. If that same server ships with Linux, IBMs profits are higher and Microsoft gets nothing.

Linux also fits with IBMs belief that computing will be a utility. In the near future, in an open standards world, pervasive computing and interconnectivity will be important. OSes will not. And by using Linux, IBM raises its stature in the open source world, giving the company battalions of allies that can help it develop better software - quite a change for a company that just 19 years ago was facing Department of Justice antitrust litigation.

"Theres still some skepticism in the open source community about IBMs involvement with Linux," said Michele Rosen, an IDC research manager. "But theres also no question that they have rehabilitated their image in the industry and they are now in an enviable position. They were trusted when they were proprietary, and they are trusted now as theyre embracing open standards and open source." The trust factor will be important as open standards and open source progress, Rosen said, because "any vendor thats perceived as being closed or untrustworthy from the privacy or security standpoint will have a challenge addressing those issues."

Finally, Linux gives Big Blue robust software at little or no cost. In IBMs view, the cost factor is critical because the company foresees a world of pervasive computing in which almost every electronic device - cell phones, personal digital assistants, cars, refrigerators, microwave ovens and game devices - will be continually slinging code back and forth.

"If you are going to make a lot of embedded devices, and all of them are talking to each other, you have to keep costs down," said Dan Powers, IBMs director of Internet technology. In IBMs future world, Linux will be everywhere - and invisible. "We call it the amazing disappearing penguin," Powers said, referring to the aquatic bird that is Linuxs logo. "The penguin will be everywhere, but you wont see it."