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Research Duquesne Advisory delivers in-depth analyses of Information and Communications Technologies, their implementations and their markets. Research is based on critical observation of the market by the analysts and their on-going contacts with the vendor community, together with hands-on, practical experience in consulting engagements.

Big Blue 3.0: Software-defined IBM

by Daniel LeBourhis



Big Blue 3.0: Software-defined IBM
2013 has been a difficult year for IBM. Revenues shrunk by 5%, profitability by 1%. Market share in the once essential server market has plummeted. As a result, short-term focused Wall Street analysts have been broadly negative on the stock despite massive buy-backs.

IBM has appeared as a declining, old-fashioned company, whose future relevance in the new era of cloud could be questioned. Losing the CIA private cloud contract to Amazon Web Services was widely interpreted as proof of this decline.


The challenge of sustainable growth

It is clear that IBM has had, for the last several years, a serious growth problem. While new entrants in ICT were posting impressive results (e.g. AWS, Google), opening new markets and attracting media and market attention, established large ICT players were hit hard by the economic crisis and have experienced revenue decline, stagnation, or at best limited growth in 2013. This was particularly true of hardware vendors. For example, HP’s revenue decline of-6.7% in 2013 was sharper than IBM’s, despite market share gains in the server business.

In these difficult conditions, IBM has nevertheless made several bold moves in 2013 to reposition itself for growth and better leverage its core capabilities. Among these initiatives, the most noticed have been the acquisition of SoftLayer and its establishment as IBM’s public cloud foundation, and the divestiture of the x86 server business to Lenovo.

In the first quarter of 2014, further moves and initiatives indicate that IBM is implementing true, deep strategic evolution, rather than simply addressing an adverse short-term context with a tactical response. Assuming successful execution –which remains to be seen - this evolution will profoundly change IBM’s positioning and relationship with its markets. It is therefore important for IBM’s existing and prospective customers to properly assess these changes.

A quick review of IBM’s evolutionary path

IBM’s already long history has already seen many different periods, but two major “eras” can be identified. The first era can be described as the “hardware-defined IBM” era – from the company’s inception to a time when it ruled IT markets with ultra-dominant market shares, and up to the eighties/nineties when it ignited the PC revolution.

IBM then engaged in a major shift which led to the “services-defined IBM” era that lasted until beyond 2010 as the company became a global leader in IT services, including professional services.
This shift was triggered by technology evolution that brought new, lower-margin competition against IBM in hardware and system software, while growing information systems complexity was fueling strong demand for high value services. Indeed, this largely successful conversion was not an easy one, and most of IBM’s hardware competitors have not achieved much success in the services market. Even HP’s acquisition of EDS has only yielded mixed results at best.

Historically, IBM has always relied on two major levers to sustain profitability and growth: technology innovation and control, and customer intimacy and control. While continued technology leadership was essential in the hardware-defined IBM era, IBM’s sales and customer focus were also critical ingredients of its success. In the services-defined IBM era, customer intimacy was essential to establish a leading position, but IBM almost never cut back on R&D and continued to secure technology control with fundamental research. The balance between the two levers could vary but both have remained critical.

Over both eras, IBM regularly divested mature, low margin businesses – from electric typewriters to PCs – to maintain its margins. However, as the ICT services market matured, pressure on margins increased. In addition, services can only be industrialized to an extent, and like any personnel intensive activity, they carry highly proportional variable costs. In a context of globalization, the only way to cope with price pressures and lower margins was to relocate resources to lower cost geographies (most notably India) and reduce personnel in high cost geographies. IBM moved from being a “multinational” company (with resources to service its customers in each country) to a “global” company with global work sharing, with the implication that a given local IBM geography was far less self-sufficient than in the past.

This had two consequences: a somewhat reduced degree of customer intimacy, particularly in the midsized enterprise markets, and an increased reliance on channel and services partners to compensate for more limited in-house resources.

Reigniting growth in the world of cloud

It is the services-defined IBM model that has now reached its limits, and IBM clearly needs a new, major “growth relay”. While IBM’s communication focuses on cloud, mobility, big data, analytics, and business transformation, the company’s recent moves strongly suggest that its third major era can actually be characterized as the “software-defined IBM” era.

Of course, hardware will remain important for IBM despite divestitures. The z Series mainframes continue to drive a large chunk of IBM’s profits, and the Power platforms remain an important part of the company’s offering. And of course, services will not be abandoned because they remain a key revenue generator and are essential to IBM’s understanding of its customers’ business issues.

Nonetheless, IBM clearly will rely on software as the main vehicle to productize and monetize intellectual property (IP) and deliver value to customers and partners in a highly automated, industrialized fashion that enables higher margins and substantial growth. IBM’s cloud initiatives, despite their importance and the attention that they have attracted, will simply be the primary vehicle for this software-centric approach, rather than its core.

IBM’s investments, as well as recent announcements, all point in that direction.Commenting on their cloud strategy in February 2014, IBM executives cited the following numbers:
  • SoftLayer acquisition: $ 2 billion
  • Cloud Data Center expansion: $ 1.2 billion
  • Acquisition investments: $ 7 billion (essentially software firms, from Middleware to SaaS applications)
  • Software Cloud Development: $ 1 billion

SaaS as a key business and a preferred delivery model

The emphasis is now clearly on software. For example, IBM currently boasts more than 100 SaaS offerings. IBM’s focus includes middleware and PaaS (see below a short discussion of the important BlueMix announcement), where it has a strong historic portfolio but the company can also make acquisitions to enter emerging domains, as recently exemplified by the Cloudant NoSQL, Database as a service (DBaaS) acquisition. Business applications are also of great importance, as IBM continues to promote a business transformation message to its customers and prospects.

In terms of delivery model, the pay-as-you-go model (“Whatever-as-a-Service” in cloud parlance) is clearly preferred by IBM (even outside the cloud, as indicated by the recent announcement of such a billing model for IBM’s XIV storage solutions). This is no surprise, since IBM has had, from its beginning, a long-standing predilection for recurring revenues models…

Watson: turning a “solution looking for a problem” into a potential IP-generating service

Outside the strict cloud space, investments around Watson – primarily also a software application, despite its hunger for processing power – indicate that IBM has finally a clear strategy for turning this technology into actual business. Watson is primarily an artificial intelligence system that interacts with users in natural language and has huge information analysis capabilities, both in terms of volume and analytic techniques. Cleverly, IBM’s Watson division positions the product as an “assistant” to various human users, from operational personnel to subject matter experts, rather than a substitute (as did the initial Artificial Intelligence (AI) promoters).

Interestingly, Watson has a potential business model that resembles Google’s approach: Watson can be made available for a variety of activities to provide assistance services of various kinds, in an “as a service” mode. As a learning system, it will then improve its performance over time.

However, this learning will amount to a kind of intellectual property generation that can potentially be recycled (hence monetized) in a number of ways. The question of who owns this IP (IBM or the customer of a given Watson application?) will inevitably surface, and properly addressing this issue will condition the use of Watson in many critical or sensitive parts of a customer’s business.

BlueMix: More than just PaaS, a foundation for IBM’s ecosystem

The recent announcement of the BlueMix project, which amounts to the creation of a comprehensive PaaS offering encompassing all of IBM’s main middleware, further underscores the preeminence of software in IBM’s strategy. More than a set of products, BlueMix is also a vast endeavour to federate developers of various horizons (enterprise, cloud, mobile, et al.), as well as IBM’s partners, around an ambitious framework of software components, capable of addressing almost all types of development needs.

In addition, BlueMix is also presented as an answer to the emerging requirements of new development organizational models, such as DevOps. More broadly, BlueMix is intended to enable development and production teams to accelerate application development and evolution as well as deployment and update.

Enabling hybrid architecture

Even though BlueMix may appear complex, it is a particularly rich set of components that can be used on a modular basis but can, more broadly, address the needs of the soon-to-be dominant information systems model – hybrid architecture.

Hybrid architecture combines conventional information system elements with various flavors of private and public clouds, and will necessarily be the way forward for large, complex organizations, which cannot migrate all of their systems to cloud environments and will evolve their infrastructures over a relatively long period of time.

To such customers, BlueMix appears both as a reassuring offering and an opportunity to speed-up their evolution to the cloud. It will enable IBM customers to evolve at their own rhythm, optimizing both their cloud investments and their existing assets. Simultaneously, being able to use well-known IBM technologies in a cloud environment may help accelerate the transition, while attracting many of those customers to SoftLayer.

IBM’s broad commitment to open source technologies, also exemplified by Softlayer’s efforts to interface with OpenStack environments (Jumpgate), should also enable easier use of IBM/SoftLayer technologies or infrastructures by organizations that are not currently customers. Longer term, IBM can be expected to largely remain IaaS-agnostic despite its natural tropism towards SoftLayer.

Nevertheless, another major challenge for IBM will be to conquer new publics with this technology, notably “cloud natives” that may not naturally be attracted to IBM. The BlueMix offering and the accompanying programs are clearly designed towards this end, and will benefit from SoftLayer’s image and knowledge of this market. But in the longer term, getting BlueMix to be used in other IaaS environments will be equally important to IBM’s long-term success. As BlueMix is less compelling for these markets without an “IBM history”, IBM’s ability to create a truly vibrant ecosystem around its offering will be of critical importance, together with proper pricing and support.

For IBM, infrastructure continues to commoditize

IBM’s strategy clearly assumes that the vast majority of hardware and a large part of system level software will continue to commoditize. While staying in key niches of these markets (notably mainframes and parts of the Power-based systems), IBM will continue to divest from those commoditized markets.

Rumor has it that the company is attempting to sell its chip manufacturing business while staying in chip design and software development. This would result in IBM embracing the “fabless” model, which greatly reduces capital intensity in the chip business and emphasizes IP and software as the main competitive assets.

The same reasoning can apply to its software-defined networking (SDN) business, also the subject of similar rumors. Indeed, while SDN is still in the making, becoming infrastructure-agnostic in a market where IBM never really succeeded (networks) makes sense as it could facilitate industry support for other IBM software offerings such as BlueMix.

Increased reliance on the partners ecosystem

As IBM focuses on software as its primary product and on the cloud as its primary delivery model, it will remain increasingly selective on its investments in “other” areas. Of course, the z mainframe technology (and ecosystem) remains critical for revenue and profit flows, as do the Power-related technologies (notably for HPC, which includes infrastructures for Watson).

IBM will not exit either hardware or services, but resource allocation to these markets will be increasingly selective. As a result, IBM can be expected to continue reducing its workforce in a number of domains while expanding it in software and cloud related areas. The company will increasingly rely on its partner ecosystem to ensure customer proximity and intimacy. Choosing the right IBM channel or service partners will therefore be essential for customers.

Conclusion

All in all, IBM has a remarkable wealth of software assets and technologies to leverage. SoftLayer enables it to effectively deliver them via the cloud, and the company can support these offerings with world-class expertise and service capabilities. IBM does not need to dominate the raw IaaS market to establish itself as a leading cloud supplier, because Its specific positioning leaves room for many opportunities in this highly “coopetitive” enterprise market.

Focusing on software will enable IBM to pursue higher margins and benefit from low marginal costs (as opposed to most of non-industrialized service activities) while maintaining and reinforcing customer loyalty with the help of its ecosystem.

While the strategic orientation appears consistent and sound, the way IBM will execute on it remains to be seen. The company should be able to preserve and even improve profitability, while – assuming a less adverse economic environment – probably returning to limited growth by better leveraging its customer base.

However, to truly restore a sustainable ability to grow, IBM must conquer new customers and partners outside its current base, notably in the world of “cloud natives”. This will require Big Blue to demonstrate unprecedented agility and market responsiveness. It will also need to successfully expand and manage a rich partner ecosystem, competing with many other heavyweights who all see this ecosystem as the “Holy Grail” in the quest to dominate ICT markets.

Thursday, March 6th 2014
René Dugué
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Duquesne Advisory is a European firm, dedicated to researching, understanding and advising clients worldwide on opportunities and trends in Information and Communications technology.

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Duquesne Advisory delivers in-depth analyses of Information and Communications Technologies, their implementations and their markets. Research is based on critical observation of the market by the analysts and their on-going contacts with the vendor community, together with hands-on, practical experience in consulting engagements.

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