By Timothy Prickett Morgan
With PC, server and maintenance revenues skidding, software revenues increasing only modestly and services revenues growing but not terribly profitable, it isn’t even ironic that IBM would sign a $3bn, five-year technology cross-licensing and hard disk supply deal with EMC Corp, its staunchest rival in the mainframe and open systems disk array market. Long-time IBM watchers who still remember how Big Blue crushed opponents and would never dream of cooperating with them, are bound to be disappointed by this deal as well as the one IBM signed in early March with Dell. But this is the new co-opetition era of the computer business. Co-opetition is probably best described as a situation where vendors cooperate as much as they compete, and end up confusing themselves as much as their customers about what their real business is aside from making money.
The simple fact is that IBM needs to show revenue and profit growth because these are what drive stock prices, which in turn drive Chairman Gerstner’s compensation package. The fact that IBM is willing, even eager, to sacrifice the long-term strategic benefits of having exclusive as well as superior technology for its own products in exchange for short-term money on the barrelhead is apparently not a cause for concern for industry analysts or Wall Street. It’s a cause for celebration, because now they can say that IBM, having faltered in its bid to drive up server sales in 1998, and likely to do even worse in 1999, is now firmly focused on a strategy that will deliver growth. (Have you heard this one before?) For you old timers who remember when IBM sold off the mainframe lease base, saw huge increases in mainframe sales and then built factories and marketing plans that the mainframe base would continue growing at this rapid pace, the aggressive moves by IBM’s Technology Group may have a familiar ring. Everyone with the possible exception of former IBM chairman John Akers — who made that mainframe bet when he was in command at Big Blue and lost his job when that horse didn’t come in — is hoping that IBM’s strategy of selling patents, software and components to other equipment makers revitalizes IBM. Whether or not it ends up turning IBM into a giant component supplier with a dwindling legacy server business depends on how many of these deals IBM signs.
IBM’s Technology Group, which was set up last September, is responsible for selling IBM microprocessors, custom ASICs, embedded processors and related software, disk drives and arrays, removable media drives and libraries and advanced display technology. With continuing difficulties in PCs and servers, IBM has rejiggered its corporate organization and its financial books to reflect its new emphasis on three areas — technology sales, services sales and software sales. The latter two are still to a very large degree based on drag-along revenues from its AS/400 and mainframe businesses, so cashing in on its vast research and development and excellent component technology is the only pure play with profit potential that IBM has.
The EMC deal inked yesterday follows fast on the heels of a similar, more extensive deal IBM cut with Dell Computer on March 4. Under the Dell deal, IBM and Dell cross-licensed each other’s intellectual property relating to PC desktop and server technology and Dell agreed to buy IBM’s disk drives, some semiconductor components, networking peripherals and display technology over the next seven years for a whopping $16bn. With the EMC deal, IBM and EMC have agreed to exchange intellectual property in the storage arena and EMC has agreed to buy IBM’s hard disks as core components in its Symmetrix disk arrays. Over time, EMC expects to use other IBM components, such as PowerPC and Power microprocessors or custom chips, in its products. The two companies also agreed to collaborate on future developments in storage area networks and on developing open standards, especially as they relate to storage for IBM’s S/390 line of mainframe servers.
Last year, the Technology Group brought in $6.8bn in OEM revenues, derived mostly from the sale of microprocessors, custom chips, hard disk drives and disk components. IBM’s microprocessor, disk and display technologies — including copper CMOS-7S and silicon-on insulator chip fabrication, magneto-resistive (MR) disk heads and small form factor disk drives and high-resolution flat panel monitors — are way out in front of the competition, so it comes as no surprise that companies are willing to pay for them directly or indirectly by purchasing products that use them from IBM. The Technology Group is headed up by James Vanderslice, a 32-year IBM veteran who is not young enough to replace Chairman Gerstner when he retires but who is nonetheless eager to build an empire of his own within IBM’s corporate walls as well as to steer IBM in strategic directions that will deliver financial results. Whether or not Vanderslice and the IBM executive committee and board members who support the aggressive sale of IBM technology are correct is unknown. Vanderslice’s history suggests that he had been dealt some pretty tough cards at IBM and has had mixed results. Vanderslice ran the IBM Printing Systems division, then called Pennant Systems, when Chairman Akers was still at the IBM helm back in the early 1990s, and expressed a desire to take Pennant public as IBM was contemplating breaking itself up into Baby Blues. (This IBM printing business is now for sale with no apparent buyers.) Vanderslice has subsequently moved on to head up the Storage Systems Division, and was in charge IBM’s mainframe disk business when EMC wrested control of that market from Big Blue. He was also behind IBM’s signing an OEM disk array deal with competitor StorageTek in the mainframe area that was supposed to put IBM back in the driver’s seat but never did.
The EMC deal makes as much sense, and nonsense, as the Dell deal from earlier in the month. A more sensible IBM would have signed a rebranding and co-marketing agreement with Dell to sell Dell’s PC line and completely exit the PC manufacturing game, which has been a boat anchor around IBM’s neck since the late 1980s. IBM could have had Dell sell its Netfinity server line in exchange, and probably could have then finagled a giant PC services contract out of Dell, which used to use Digital service before Compaq bought it. That would have been a staggering deal, and for all we know Chairmen Gerstner and Dell discussed just this. But it didn’t happen. IBM should have similarly just given up and sold its storage patents and software to EMC in exchange for a commitment from EMC to use IBM processor and disk components and adhere to jointly developed standards to interface EMC disk arrays with IBM’s OS/390, OS/400, AIX and NT servers and their respective system management programs. IBM says that it is firmly committed to the PC and storage businesses and that it has every intent of competing head-to-head with both Dell and EMC, but this will become increasingly hard to believe as IBM signs similar deals with other competitors in the months to come. And even if IBM believes it, it doesn’t mean a demoralized sales force will be able to sell IBM products against competitor’s products that can now also boast that they are IBM Inside.
If IBM really wanted to maximize shareholder value, it would spin out the Technology Group just like AT&T stupidly let go of Lucent Technologies and Bell Labs, the only real valuable parts of Ma Bell. The IBM Technology Group has 2,500 research scientists, 15,000 development engineers and 45,000 manufacturing employees plus a dedicated staff of sales and support people. The Technology Group is apparently IBM’s fastest growing segment (once you get rid of printers and DRAM memory) and would have IBM, the server and PC vendor, as its biggest customer. Of course, this kind of thing will never happen so long as Wall Street is happy with IBM. But it would make for a great IPO, at least for those shareholders that didn’t mind the real IBM stock dropping as Technology Group’s soared.