Earnings Show We Need Revolution Conservation!

We had some important tech earnings reports yesterday, and so we need to review them in a systematic way.  IBM and Intel are perhaps the two prototypical tech giants, and what they do in concert is a measure of the health of the industry.

Let’s start with IBM, who was a poster child for the view that software is where it’s at.  Their software revenue was up by about 4% y/y, which doesn’t sound great but is good in comparison with hardware numbers, which were off 17% by the same measure.  Mainframes were again the only systems bright spot for IBM, which is bad because clearly new customers are unlikely to come into the IBM fold by jumping into a mainframe.

In our spring survey, published in July’s Netwatcher, we noted that IBM has been on a two-or-more-year slide in strategic influence, and that the slide was almost certainly attributable to a lack of effective marketing/positioning.  IBM remains strong where its account teams are almost employees for all the time they spend on customer premises (read, mainframes).  They’re weak where channels sales diminishes the ability of the sales process to overcome what are obviously major marketing weaknesses.

Intel had a similar quarter—disappointing revenue but better profits.  In Intel’s case it’s pretty obvious what the problem is, and in fact IBM’s problems in hardware also impact Intel.  Hardware price/performance has steadily increased over time, and while that’s been great for things like server consolidation via virtualization, it eventually becomes difficult to justify more muscle per system, which slows refresh.  In the PC space, people can stay with their old PC and buy a new tablet instead.  I think tablet sales are only part of the system problem; the other part is slower upgrades because we’re hitting the plateau in terms of how additional power can be usefully applied.

Revenue shortfalls are nothing unusual this quarter.  SAP also missed on revenues, as did Nokia and Ericsson.  What’s happening here in my view is that both Street analysts and the companies themselves have been relying on that mystical “refresh” driver or presuming (as Cisco has always done) that the demands of Internet users for bandwidth to watch pet videos will be met regardless of profits.  Clearly what’s happening is that the business buyer and the carriers are both demanding better return in incremental investment than current technology is offering, so they’re not refreshing things.

Verizon, who also reported, seems to validate some of this theme.  While the company is expected to boost capex modestly, it’s clear that the expansion is going to wireless and likely that wireline will actually take a hit, meaning that wireless spending will grow more than capex will.  Investment follows return, just like in your 401K.

On the network side, which is of course my focus, I think this demonstrates two key points.  First, there is going to have to be some creative cost management in network infrastructure for both enterprises and network operators.  The kind of revenue trend we’ve seen isn’t going to reverse itself in a year, so cost savings will be demanded to help sustain profits while revenues continue to tail off.  Second, eventually you have to raise the benefit side—revenue for operators, and productivity gains for enterprises.  This isn’t easy, and it’s a culture shift for vendors to support.  They don’t want to make that shift, but there is absolutely no choice in the long run.

Applying this to our current technology revolution trio of cloud, SDN, and NFV, I think there are also two key points.  First, we are not going to fund three technology revolutions independently.  Somehow all this stuff has to be combined into one revolution, a revolution that can manage the costs of the trio by combinatory benefits, and one that can also aggregate the benefits into one use case.  We’re anemic in this unanimity of revolutions department.  Second, the unified revolution has to be aimed at revenue in the long run and cost control as a short-term benefit.  That’s the polar opposite of how all three of our revolutions are seen today.  In my surveys, users were unable to articulate strategic benefits to any of the three technologies, only cost-reduction benefits.  Reduce costs, reduce TAM, and does this quarter show that we should be seeking lower revenue over time?  Vendors are crazy here, and they will have to get smart very quickly.

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