IBM: Deep Trouble Beneath Tactical Success

IBM’s earnings are always interesting, and right now they’re downright critical.  First, obviously, IBM needs to show it’s getting back on track or it risks a loss of customer credibility that would quickly become impossible to stem.  But second, IBM is likely a barometer for the pace of change in the IT market.  Big guys always suffer during fast shuffles.

At a high level, IBM was a tactical plus and at least a mild strategic minus.  The company beat slightly on EPS but missed on revenues, which I think is the most critical number.  The Street response was generally favorable given that they pick up on EPS, but most financial analysts noted the hole in the boat as well.  IBM can succeed by cost management alone for a while, but unless it wants to be bought part and parcel by Lenovo it needs to do more than just stabilize sales, it needs to increase them.

Part of the revenue problem isn’t IBM’s to solve.  The company lost in Europe and Asia and in emerging market where economic conditions were challenging, but they only managed to be flat in major markets.  But broadly their results were troubling because their big gains were in hardware; IBM lost ground in revenues in other segments of their business.  Nobody, even IBM, could possibly see that picture as positive.

What should worry IBM most is their dip in revenues for global business services and technology services; the former off most sharply.  IBM has kept its place on top of the IT heap largely because they exercised more strategic influence on buyers.  Business services trends are a decent reflection of their ability to sustain that influence, and those trends are off.

Software was also weak, and here the concern is WebSphere, which had in the past shown double-digit gains.  All it could deliver for IBM was 1% growth, and branded software was off overall.  IBM’s development tools (Rational) were off sharply, which suggests IBM is losing the edge in controlling new software creation and enhancement.

What was the hardware gain?  Well, there’s not a lot left but System Z was delivering.  Mainframes are not a growth market, folks.  Buyers who suppressed investment there in doubtful economic conditions were loosening their purse strings but that wasn’t unexpected.  Power systems managed only a small gain even with x86 servers out of the product line.

In their prepared remarks, IBM set what should have been its own tone.  “Our strategy is focused on leading in the areas where we see the most value in enterprise IT.”  Well, is that mainframes?  IBM needed to drive the cloud, SaaS in particular, and carrier cloud most of all.  They did generate 60% growth in cloud revenue (to $7 billion).  They’re pushing Bluemix and Watson successfully in the Enterprise, but from what I can see from my own surveys their success is within the IBM base.  You can’t increase milk production by re-milking the same cow.

Mining the customer base has been a pattern with IBM, and even in the enterprise space their lack of forthright positioning has weakened their ability to influence buyers.  That’s particularly true given that the cloud engages broader constituencies within the enterprise, constituencies that IBM sales doesn’t influence much.  What IBM lost half a decade ago was evangelism.  They need to be able to drive new market opportunities.  In the SMB space that meant x86, which IBM sold, and more application software.  In the cloud space, the opportunity lies with cloud providers in general and with the network operators in particular.

The as-a-service trends that are behind both cloud-SaaS and NFV have enormous potential.  NFV alone, according to my most recent modeling, could produce over 100,000 new data centers (albeit many smaller ones, in central offices) worldwide.  SaaS could generate thousands of additional and larger ones.  These opportunities emerge from a fundamental shift, the kind of shift IBM has in the past embraced when necessary.  The kind they don’t seem to be willing to embrace now.

IBM’s cloud ambitions appear to be taking the form of cloud services to current customers, back to mining the old base.  Not only does that cement them further into their tunnel-vision problem of positioning to the broad market, it directs their cloud initiatives purely at cost savings.  Even the Street admits that if IBM were to transition buyers to the cloud the result would likely be dilutive.

You can’t succeed in IT if you can’t succeed in the biggest incremental data center opportunity in the world, perhaps the largest ever.  That’s NFV, and IBM has consistently underplayed its (actually considerable) assets there.  You could argue that IBM has failed to learn a lesson that HP is rumored to be learning, which is that they will lose more competing with cloud providers than they’ll gain in direct cloud revenue.  IBM may be so enthralled by their 60% growth in enterprise cloud services that they’re losing sight of the enormous pie of hardware/software sales that will accrue in the space.  IaaS is not ever going to be a revenue bonanza for IBM and they have undermined their marketing position to the SMB space most likely to drive SaaS.

In IBM’s prepared remarks, the phrase “service provider” never appears.  Neither does “SDN”, “NFV”, or even “network”.  That suggests that IBM doesn’t appreciate the magnitude of the changes virtualization is driving, or the fact that you can’t lead a buyer to the future by addressing just the steps you find convenient.  Rival Cisco is doing the right thing in the cloud space, engaging with network operators rather than competing with them.  Cisco is also viewing cloud data centers as an ecosystem, including switches and the x86 servers that people want.

It’s possible that IBM sees its own cloud efforts as a means of displacing the commodity x86 stuff that it’s now exited in hardware sales terms.  But even if that’s true, IBM still has to recognize that without software value-add as a revenue kicker, all it would be doing if its cloud plans succeeded would be entering a business with declining margins and selling to a small and static portion of the total opportunity space.  That’s an uncharacteristically short-sighted move.

I have a long history with IBM; I learned programming on an IBM computer 50 years ago and I cherished a notepad with their tagline of the time, “Think.”  I’ve seen them weather more storms than any other tech vendor, seen them prosper when virtually every other computer vendor flagged.  I have to confess confusion here.  IBM has seen the writing on the wall for at least three years and probably for more than five.  Once virtualization raised its head, commodity hardware was the platform, middleware the differentiator, and applications the revenue driver.  With all that time to invest, to develop, to position, what the heck was IBM thinking?

What IBM is going to have to do at this point is buy somebody, perhaps multiple somebodies.  They need core technology in the network, cloud, SDN, and NFV spaces to augment their current capabilities.  More than that, they need somebody who can take fresh and exciting stories to the broad market.  They need to make buyers do what that old notebook of mine challenged us all to fifty years ago—think.