E-BUSINESS SPECIAL REPORT
The World According to IBM

After years of cost-cutting, reorganizations and investor discomfort, IBM (NYSE: IBM) is on top again. While rivals like Hewlett-Packard (NYSE: HPQ) and Sun Microsystems (Nasdaq: JAVA) struggle to survive the industry downturn, Big Blue has been humming along.

Financially, 2002 was not a gangbuster year for the company -- revenue from continuing operations declined 3 percent. But it still earned US$5.3 billion in a year when most firms struggled to stay out of the red zone.

How did IBM thrive in such a difficult environment -- and can the company extend its streak of success now that the era of Lou Gerstner, who taught the IBM elephant to dance, is over?

At Your Service

The recession played into IBM's hands to some extent. The company's broad industry and geography portfolio gave it a relatively smooth ride even when certain sectors got bumpy. But IBM also has been smart. It acquired PwC Consulting at a down-market price. "The fact that we were able to get [PWC] for the price we did was wonderful," Philip Oliver, vice president of worldwide strategy for IBM Global Services, told the E-Commerce Times. "It gave us a set of very strong client relationships with senior executives who were not CIOs."

Indeed, the Global Services juggernaut has been the prime driver of IBM's success. Even in the slumping market, Global Services revenue increased 4 percent to $36.4 billion in 2002. In the fourth quarter alone, IBM inked more than $18 billion in new services contracts.

Services is not the whole equation, of course. IBM still strives for product innovation. The company's new PowerPC 970 chip could put it front and center in the server processor arena. And IBM may start a minor revolution in the database world with Xperanto, a database initiative that represents a slap in the face to market leader Oracle (Nasdaq: ORCL). Based on the XML (extensible markup language) standard for data exchange, Xperanto will link data from its native location through a virtual database.

Pillar of Strength

But the services wrapped around IBM's products are often the difference between success and failure. WebSphere, IBM's market-leading Java application server, is a perfect example. Although other independent software vendors, such as BEA Systems (Nasdaq: BEAS), were in the market before IBM, they simply cannot compete with the entire IBM package.

"Technology superiority is not a decision factor. What IBM offers is a great sense of confidence and safety for customers looking to buy from a vendor that will stand behind the technology," said Mike Gilpin, research fellow at Giga Information Group. "It's also important to consider the impact of service capabilities and price." According to Gilpin, large customers may be getting as much as a 70 percent discount on WebSphere licensing.

Utility Player

But not everything is wine and roses at IBM. IBM Global Services was growing in double digits each year, Oliver said, but "it all came to a stop as the bubble burst. It put a big brake on the market." This year, Oliver sees industry services growth in the 4 percent to 7 percent range.

Where will future growth come from? IBM CEO Sam Palmisano and his lieutenants are betting $10 billion that corporate customers will buy into their new "on-demand computing" mantra. In this new paradigm, products and services delivery will be more fluid and flexible, and IBM will be more like an electricity or telephone company than a traditional IT vendor. Fixed IT costs will become variable, and IT infrastructure will be tied more closely to business needs and core competencies.

This all sounds good, but IBM faces significant roadblocks on the path to the vision's fulfillment. One of the biggest is that it will need to woo mid-market customers -- companies with roughly 100 to 1,000 employees -- to ensure a larger pool of buyers for what will be a cheaper product. The mid-market is not a customer set the company has been successful in reaching in the past, according to a report by IDC analyst David Tapper.

To achieve its goal, IBM recently announced it will hire about 500 software sales and support staff this year to target mid-market organizations. "We have to have services that are more product-like, and we're investing millions of dollars to get at that," Oliver said. "None of the very big players has really cracked the mid-market."

A Different Tune

As a utility, IBM also will have to become more "product-agnostic," according to Tapper. That means embracing a multivendor environment that uses best-of-breed technologies. "For IBM, swapping out from its own product may not be completely feasible," Tapper wrote. "The company depends on selling a large volume of devices to its own services division, and any substitution would leave the product division financially weakened."

The traditional caveats also apply: IBM could lose control of the customer relationship and cannibalize its own outsourcing revenue. It also will need to create an innovative channel strategy.

The irony of IBM's utility computing model is that to be successful, the company may have to throw out its high-touch, consulting services style. "A utility service, by definition, creates a more 'arm's reach' type of relationship with the customer," Tapper wrote.

Can the elephant learn some new steps? Stay tuned.