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.”
When discussing open standards, one of IBMs leading strategists, Irving Wladawsky-Berger, said the IT business must follow the example set by the consumer electronics companies. A few years ago, the electronics industry came together to determine standards for CD players and, later, for DVD players. Today, those same companies that cooperated on standards “compete aggressively in content. The time for that to happen in the IT business is upon us,” he said.
Wladawsky-Berger, vice president of technology and strategy of IBMs server group, said that if major hardware and software companies want to see continued growth in business on the Web, then businesses must be able to talk to one another more easily over the network.
“Once you cast your lot with integrating computing and applications over the Net, a corollary of that decision is to embrace open standards and open source. The Internet requires a cultural shift that requires collaboration instead of competition,” he said.
So, IBM has been among a group of companies pushing the World Wide Web Consortium to adopt Simple Object Access Protocol, Universal Description Discovery and Integration, and Web Services Description Language. SOAP is a standard that provides the format for an electronic addressing system that lets applications communicate with each other. Another key standard, UDDI, could become the yellow pages for the Internet. Finally, WSDL is an XML-based standard that allows applications to exchange content.
The foundation of IBMs money-making strategy with open standards is its WebSphere line of middleware – also called application server software, e-business platform software or software infrastructure. IBM sells about two dozen titles under the WebSphere brand, including Java-based application software, XML translation software, management and development programs, and even a voice recognition program based on VoiceXML that allows users to access Web sites from telephones.
IBM also sells MQSeries integration software, which handles the exchange of information from one computer platform to another. Lotus Development Domino is IBMs primary e-mail platform. Its Tivoli products monitor Web sites for things such as excessive latency, security problems or performance lags. On the desktop, IBMs Lotus suite can handle everything from spreadsheets to e-mail. And IBM is making sure that all of those programs will be compatible with SOAP, UDDI and WSDL.
The goal, according to Steve Mills, senior vice president and head of IBMs software division, is to deliver “a coordinated transaction environment spanning multiple servers on multiple platforms.” That will be key in IBMs battle with Microsoft, Mills said, because Microsoft “doesnt have any product that looks like WebSphere. They cant do multiple transactions across multiple nonheterogeneous systems. They do Windows-only implementations. And in my view, customers dont want to move all their work to Windows.”
IBM appears to be gaining traction in the middleware business, a sector that IDC predicted could be worth $26 billion by 2005. IDC estimated that from 1999 to 2000, IBMs worldwide share of this market grew by 258 percent – faster than the 220 percent growth enjoyed by rival BEA Systems.
On the hardware side, IBMs sales are enormous, but flat. The companys hardware revenue actually declined from 1999 to 2000, when it sold equipment worth $37.7 billion. IBMs laptop and desktop computer business has struggled for years to achieve profitability, but the company appears to be gaining ground in the market for mainframes and Unix servers that cost $1 million or more. Last year, Sun had 61 percent of the market, while IBM held 24 percent. During the first six months of this year, IBMs share of the market jumped to 28 percent, while Suns share dropped to 54 percent. HP came in third, with 18 percent of the market. And IBM recently unveiled the Regatta, the p690 eServer, which appears to have a price and performance advantage over comparable Sun boxes.
Sun is clearly worried about IBMs strength. During a recent conference call, Sun executives said the company had formed a special cadre called the “IBM Blue Bombers.” The groups task is to focus solely on IBMs products and markets, and to “deal with the IBM threat head-on.”
But IBMs hardware surge may not last, said Bob Djurdjevic, president of Annex Research and a frequent IBM critic. “Their growth rate in hardware is going to continue dropping, and its going to be hard for them to make it up. So they have to really push on services,” Djurdjevic said.
EDS: Big Threat to Big Blue
IBM Global Services was never intended to be the companys growth engine. Launched just 12 years ago, the division has vaulted to the top of IBMs priority list, becoming what IBMs Gerstner recently called the companys “trump card.” Indeed, during the second quarter, the services division took in more revenue than the hardware division for the first time in IBMs history.
While much is riding on IBMs ability to grow the services division, challenges are omnipresent. More than a dozen other companies are competing for a share of a market that Gartner Dataquest estimated will be worth $1.1 trillion per year by 2004. Many companies – from HP to Computer Sciences Corp. and Fujitsu – pose a threat to IBMs services business. But EDS is Big Blues biggest worry. EDS is growing faster and its contract backlog is bigger, as a percentage of revenue, than IBMs.
Today, EDS has more than $80 billion – EDS representatives would not give an exact figure – in backlogged contracts. Thats more than four times IBMs 2000 revenue of $19.7 billion. IBM has a bigger backlog, with $95 billion in contracts, but thats less than three times the $33.1 billion in services revenue that IBM took in last year. In addition, Djurdjevic said, in two of the last seven quarters, EDS new contract sales have exceeded those of IBM Global Services. And every time IBMs services representatives sit down with potential clients, “they have to convince customers that they are hardware- and software-agnostic. EDS, Accenture and CSC dont have to do that,” Djurdjevic said.
IBM executives are quick to admit that virtually everything the company now does – from its dozens of partnerships to open standards to hardware design and implementation – is designed to grow the services business. An integral part of that strategy is Web hosting, a business that Dataquest expects will be worth $9.3 billion per year by 2004.
IBM is one of many companies, including HP, that have targeted hosting as a way to assure future revenue. During the first six months of this year, IBM signed more than $1 billion in new hosting contracts. Those deals could grow in value over time, as IBM adds functionality and services to its data center offerings. Chief among those services will be security. In July, IBM began offering 30 new services, including virus detection, intrusion monitoring, firewall maintenance and ethical hacking. Last week, it also unveiled a wireless security initiative.
But as Firemans Funds McCarter has found, plenty of other companies, such as CSC, CGI and EDS, offer hosting and other services that IBM offers. And by pushing open standards, IBM may be opening the door for all of its competitors to vie for the same markets it covets. “As other outsourcing businesses have grown, they can now deliver the same economies of scale that IBM is achieving,” said McCarter, who added, “and all of them are cutting margins on services to win as much business as possible.”
Innovation Is the Future
IBM has the best research labs in the world. Last year, the company spent $5.5 billion on research and development and was awarded 2,922 patents in the U.S., making it the eighth straight year the company led its peers in that category.
All that money, patents and research horsepower is giving IBM products that few companies will be able to match over the short term. For instance, Big Blue will spend $2.5 billion over the next five years on Project eLiza, which aims to make computing infrastructure far easier to manage. IBM said it will introduce products that automatically install and configure OSes, perform load balancing and clustering to alleviate traffic bottlenecks, and switch automatically to redundant assets if the server senses impending failure. Some of these capabilities are already available. Dell licenses IBMs technology for some of its PowerEdge servers, and Compaq and HP have put failover capabilities in some of their hardware. But IBM aims to make this self-managing technology ubiquitous, and it could make the work of I-managers much easier.
IBM is also developing several new, more powerful chips that could dramatically increase the amount of computing power available to I-managers. Earlier this year, IBM, Sony and Toshiba announced a project, called Cell, that they promise will deliver a “supercomputer-on-a-chip.” The companies have said the new device, due sometime in 2004, will be used for broadband connectivity and could be capable of 1 teraflop – 1 trillion calculations per second – of processing power. That would mean that in the span of seven years, IBM will have condensed the power of Deep Blue – the 2,800-pound computer that beat chess grandmaster Garry Kasparov in 1997 – into a single chip.
Then, theres grid computing. IBM is among several entities that are developing ways to use high-speed data networks to link thousands of computers around the globe. Within a few years, I-managers may be able to routinely use the grid for a variety of tasks, such as extra storage. Or, if a Webmaster needs extra server capacity during a high-traffic time, such as Christmas, he or she could lease bandwidth and server space from IBM, or another vendor, for as long as needed.
All of these technologies – from open standards and self-managing servers to faster chips and grid computing – are part of IBMs belief that computing and Internet usage will be akin to utilities, like electricity or water. “You dont care where the water or power comes from,” Wladawsky-Berger said. “You just get it over the infrastructure. More and more people want to get these resources over the Internet.”
All of those technologies will also make computing cheaper, and therefore available to more people. And as it becomes cheaper, it will become more pervasive – which, in turn, will give IBM more opportunities to manage a burgeoning network of computers running on IBM hardware and software. “The more pervasive computing becomes in society, the more people and businesses will say, I like what I get out of it, but Id rather not have to know anything about this damn technology,” Wladawsky-Berger said.
That may be true. And IBM is clearly betting that I-managers will want someone else to handle any “damn technology” problems that might arise. Its a big bet – a multibillion-dollar bet – that could make Big Blue even bigger.