Tag Archives: Technology

Open Season: A Short Industrial Drama

Cloud Foundry had a pretty good week with endorsements from Baidu and IBM. Both relationships were developed after I left VMware so what follows is purely speculation on my part. But some companies have a tough time getting over their history and playbooks, so it is easy to imagine how things went down.

Warning: this post contains serious “inside baseball” about the past and present of software standardization and open source mechanics. If you don’t know what ECMA oxymoronically used to mean or haven’t debated the merits of different open source licenses, you may want to stop reading right now (go see Pacific Rim or read up on Bitcoin instead). I may be the only person who gets some of these jokes. Apologies to David Mamet.

OPEN SEASON

Scene: a hipster office in SOMA populated by dogs, twenty-something Siamese programmers and two older gentlemen trying with limited success to project a casual air.

Characters:
Jim – a Pivotal executive
Dan – an IBM executive
Angel – an IBM standards executive

Dan: We’re from the IBM company and today is your lucky day. We have decided Cloud Foundry is going to be the platform-as-a-service for the cloud.

Jim: Oh…

Angel: It’s still early days for the cloud.

Dan: The way this will work is IBM will make Cloud Foundry open and therefore viable for the enterprise. We know how to do this and will tell you what you have to do.

Jim: I’m not sure I follow as our strategy has been to make Cloud Foundry as open as possible from day one. Am I missing something?

Dan: Cloud Foundry cannot be used in the enterprise until IBM gives it our blessing. It is critical that enterprises only use open technologies.

Jim: Open like the mainframe?

Dan: Watch your tone son. We’re from IBM and we make sure that enterprises are not locked into proprietary technologies.

Jim: I’m definitely not following you. What do you mean by “open”?

Dan: Openness depends on having a comprehensive governance strategy. We will work with you to create a Cloud Foundry Foundation to manage the governance of Cloud Foundry.

Jim: What exactly would such a Foundation do? And isn’t “Cloud Foundry Foundation” kind of awkward phrasing? Did you consider just Foundration? That domain might still be available.

Dan: The Cloud Foundry Foundation will handle the governance of Cloud Foundry. With a formal governance process as defined in bylaws, Cloud Foundry will then be open so enterprise customers can embrace it.

Jim: Hmm.. I assume you’d describe GE as an enterprise customer. They’ve embraced Cloud Foundry to the tune of investing $105 million. And they’ve never mentioned the word governance as far as I can recall. They have been known to throw around terms like productivity and time-to-market.

Dan: Let me help you understand how this will work. Do you remember Java and Linux? IBM made those technologies successful in the enterprise by ensuring they were open. We will do the same thing for Cloud Foundry. But you will need to follow our direction.

Jim: You’ll have to excuse me as I was in junior high school when you were running that playbook for Java and Linux. But I’m still not certain what this has to do with Cloud Foundry.

Dan: Enterprise customers expect new technologies have formal governance processes so they can trust them to be open. For example, it is critical there be explicit rules to specify the voting rights for different classes of membership and how to deal with conflicts of interest on the board of directors.

Jim: I am afraid I still don’t understand what this has to do with making it easier for customers to build applications for the cloud. I defer to your knowledge of the previous century as well as conflicts of interest, but it seems customers today are more focused on functioning code that solves their business problems than governance processes. But you should explain to me what governance you think is necessary.

Dan: The Cloud Foundry Foundation will be a legal entity with a steering committee which will define all the subcommittees necessary for different aspects of Cloud Foundry. Obviously, we will use Robert’s Rules of Order.

Jim: Is this how you created the Java programming model?

Dan: Exactly.

Jim: You do know the majority of enterprise Java development is done today with the Spring Framework which was developed to shelter developers from the horrors of committee-developed technologies like EJB?

Dan: Son, enterprises can’t build enterprise solutions without enterprise technologies like EJB. When you start doing transactions, it is no longer child’s play. You may have your simple solutions for simple problems, but IBM solves enterprise problems.

Jim: I won’t ask how it is that the biggest Internet companies on the planet somehow manage to do transactions at vastly greater scale than any enterprise that uses IBM technology. I guess I should also be surprised the cloud has gotten as far as it has without any committees and Robert’s Rules of Order.

Angel: It’s still early days for the cloud.

Jim: Your faith in committees is touching, but pretty much for every broadly successful technology in the world today, there was a committee-driven alternative that failed. Take IP vs. OSI, or HTML succeeding only by throwing away the vast standardized bulk of SGML. I think the world has learned from these experiences. We have seen over and over that committees are prone to making bad political tradeoffs, delivering least common denominator solutions and losing sight of the real problem at hand. Premature standardization is a killer; you need to allow for experimentation, evolution and finding the proverbial product-market fit.

Dan: Son, you need to understand how things work in the enterprise.

Jim: Is there more to IBM’s cloud strategy than a vague appeal for standards? Do you really think a bunch of random committees are going to keep up with Amazon Web Services? I guess it could be a good strategy if they’re laughing so hard they can’t get any work done.

Angel: It’s still early days for the cloud.

Dan: Let me give you a recent example. Have you heard of OpenStack? IBM is making OpenStack part of the open enterprise cloud.

Jim: I am familiar with OpenStack as it turns out. In fact, Cloud Foundry runs on OpenStack. I do seem to recall you guys jumped on the OpenStack bandwagon a couple years after it got started. Are you saying IBM is somehow responsible for OpenStack’s momentum?

Dan: IBM is making OpenStack open and acceptable for enterprises.

Jim: So what contributions have you made to OpenStack?

Angel: We have dozens of our best standards people working on OpenStack.

Jim: I was thinking more in terms of code. NASA and Rackspace have contributed major pieces of technology – what has IBM brought to OpenStack?

Angel: It’s still early days for the cloud.

Jim: Well, even if software development is not your focus, you do operate a lot of outsourced IT infrastructure. With IBM’s enterprise presence you must have a lot of customers running OpenStack today. How many megawatts of OpenStack capacity are you operating?

Angel: It’s still early days for the cloud.

Jim: I’m not sure where you guys have been for the last decade, but the world has changed. We now achieve openness at the engineering level, not with lawyers writing bylaws and Robert’s Rules of Order. The days of heavyweight governance via committees staffed by people whose primary skill is sleeping while sitting up have probably come and gone. Cloud Foundry is extremely open today by any practical measure. The code is all on GitHub under the very permissive Apache license. Is there something we’re missing?

Angel: What is this Geet Hub? Can you spell that for me?

Jim: GitHub is a public code repository. Anyone can submit a pull request and contribute code to the project. If you don’t like the vision or want to do something different that is more tailored to your specific needs, you can always fork the project and take it in whatever direction you want.

Dan: (visibly flinching and frothing) Are you mad? Anyone can just contribute code? To a product that will be used by enterprises?

Dan: You encourage people to fragment the project by modifying it and making derivative works? (pause)  Do you not know any history boy? We spent years trying to minimize Java fragmentation. Microsoft would taunt us that even Ivory soap was only 99 and 44/100th pure. Despite Herculean efforts, we never quite achieved it, but we tell ourselves, much like with the current economic recovery, it could have been so much worse. You would let anyone do whatever they want with the software? (aghast)

Dan: How will enterprises ensure they’re getting the official version of Cloud Foundry? Do you not see how critical it is to have a Foundation that controls Cloud Foundry?

Jim: The market decides what the best version of Cloud Foundry is, not some committee. If you don’t like the direction, you could always fork and go in whatever direction you think is most appropriate. One would think with 400,000 or so employees, IBM would have some people who could write code as opposed to committee minutes.

Dan: Surely you jest. We can’t rely on the market to make decisions for the enterprise. That is IBM’s role and has been since the dawn of information technology. If you don’t fully appreciate the criticality of governance, we can go elsewhere. We have options. We could bless OpenShit, sorry I mean OpenShift instead. I bet Red Hat would play ball. We’re old friends with their standards guys.

Jim: Good luck with that.

Dan: Or we could bring the full might of IBM’s research labs to bear and build our own platform-as-a-service. Don’t underestimate the technological prowess of the IBM company. We get more patents every year than any other company. We can write the letters IBM at the atomic level. We are going to positively own the burgeoning robotic game show contestant market. We can make WebSphere the application platform for the cloud. WebSphere is the biggest middleware on the planet, though I’m not sure why the development team was laughing when they said that. If you don’t hand over Cloud Foundry to the Cloud Foundry Foundation, we’ll just compete with you.

Jim: You’d think with all those great patents, you’d have more innovation to show in your product line and wouldn’t be here trying to figure out how to co-opt the fruits of someone else’s R&D. I get that what’s yours is yours, like the mainframe, but you’d also like what other people have developed to be under your control. You’re welcome to participate in the Cloud Foundry ecosystem on the same level playing field as everyone else, but we’re not going to distract ourselves from building a great platform with some giant bureaucratic foundation. If you want to compete, by all means compete, but at some point you’re going to have to write some code people actually want to use. Maybe you can create an IDE that lets people write code at the atomic level. And with all due respect, WebSphere at this point is just a middleware museum. It is about as relevant to the cloud as the mainframe.

Dan (quietly to Angel): They’re onto us. Our strategy of blessing different piece parts defined by multiple slow-moving and conflicted committees that don’t work together well and need busloads of consultants to make them limp along may not fly in the cloud. This may be a problem for our earnings roadmap. Our CFO told Wall Street we’d have $7 billion in cloud revenues by 2015 and SmartCloud unfortunately isn’t looking that smart.

Angel: It’s still early days for the cloud.

Jim: I’ll tell you what. I’d hate for you to have to go back to Armonk and get yelled at by your CEO again for not working hard enough and not bothering to return customer calls. We’re doing a Cloud Foundry developer conference this fall and how about IBM sponsor breakfast there or something? You can buy some healthy fare and we can explain how in the past you would have brought donuts, but you’ve gotten religion about reducing middleware girth. You can even come to the advisory board meeting. And of course you can submit all the code you want to the project, but I realize that may not be your thing. But I do have one request if we’re going to work together: please don’t ever use that the word governance again in my presence.

Angel: It’s still early days for the cloud.

Jim: Yes, it’s still early days for the cloud…at IBM.

FINIS

Note: the voices in my head for this are the default Xtranormal voices. In the sequel, the Bernank will make an appearance.

Dino Watch: IBM’s Q2 Results

 Dinosaur World by mcdlttx, on Flickr
Creative Commons Attribution 2.0 Generic License  Image via Flickr 

Our favorite “technology” company IBM “beat” the number last week and saw its stock pop on Thursday after announcing earnings. Bloomberg cheered the results:

“IBM Raises Annual Forecast After Earnings Top Analyst Estimates”

International Business Machines Corp. (IBM), the largest computer-services company, topped estimates with its second-quarter earnings and raised its forecast for the year after cutting costs and buying back shares.

Excluding a $1 billion restructuring expense, earnings were $3.91 a share, the Armonk, New York-based company said today in a statement. That beat the $3.78 that analysts projected on average, according to data compiled by Bloomberg. The company now expects to earn at least $16.90 a share this year, up from the $16.70 it forecast earlier this year.

IBM has managed to increase profit by shifting away from low-margin businesses, cutting jobs and repurchasing stock — even as revenue slows.

And why not be ebullient? Just look at these results:

  • Revenue – down 3%
  • Net Profit – down 17%
  • EPS – down 13% (with buybacks, outstanding shares are down 4% over the last year)
    • Software – up 4%
  • Services – down 1%
  • Systems and Technology (aka Hardware) – down 12%

Investors and analysts seem to have bought into IBM’s narrative to pay no attention to the the top line and focus only on ever increasing profit forecasts, never mind whether they come from financial engineering or engineering engineering. They’re constantly “transforming” the company and getting rid of unprofitable businesses so even as revenues go down, profits will only go up, up, up (at some point, I will do a projection of where to expect the intersection between ever declining revenue and ever increasing profits). A couple financial notes on this quarter:

  • IBM is masterful in obfuscating their results and particularly forward guidance, as they guide to non-GAAP results as “most indicative of operational trajectory”. They sow a lot of confusion with a billion dollar write-off to lay off upwards of 8,000 employees (because companies that are killing it are always doing restructurings of this magnitude…). All this noise turns out to have obscured the fact they actually dropped their sacred future profit forecasts. It took the markets 24 hours to figure this out and IBM’s stock price gave up its initial pop from earnings.
  • Without a material drop in their effective tax rate, the results this quarter and last quarter would have been much worse. Pre-tax income was down 20%.
  • IBM’s all-important profit forecast previously included an assumption of a major divestiture, presumably the x86 server business, which they have walked back: “a substantial second-half gain that it was expecting in its prior view of earnings per share will not likely be achieved the end of 2013.”  Eventually, the cookie jar of one-time profit bumps will be empty as you can only sell off so many of the businesses your describe as crummy.
  • It looks like profits are starting to correlate with revenue after a long period of non-correlation (aka the financial engineering years). In the charts below, we see IBM’s revenue looks highly cyclical with the economical downturn in 2008-9 but the recent decline is harder to pin on macroeconomics. Perhaps we are at a technology inflection point? And the once monotonic five year profit trend looks like it is rolling over. We also should credit Sam Palmasaino for having exquisite timing and/or skill, leaving the CEO job at the end of 2012.

IBM Net Income TTM Chart

IBM Net Income TTM data by YCharts

IBM Revenue TTM Chart

IBM Revenue TTM data by YCharts

Meaningless Numbers

I love the plum double-digit growth numbers IBM cites for arbitrary slices of their business with no baselines so you have no idea if they contribute $1 or $1 billion. Somehow, they have an incredible growth portfolio that doesn’t move the needle for the company as a whole:

  • “Key branded middleware” up 9% – presumably this is things like WebSphere, DB2, Lotus and Tivoli, all brands that are irrelevant in the cloud era. But the “key” modifier implies some other segmentation game is being played.
  • “Growth markets revenue flat” – that single line pretty much sums up IBM.
  • “Smarter Planet revenue up more than 25% in the first half” – leaving aside any effort to figure out what might constitute Smarter Planet revenue, one might conclude the rest of IBM’s revenue comes from a Dumber Planet™. But as IBM’s revenue continues to decline, there is evidence the Dumber Planet is wising up ;-) 
  • “Cloud revenue up more than 70% in the first half” – given IBM’s paucity of cloud customer references, this may be the most nebulous of the bunch. IBM has said they’ll do $7 billion in cloud revenue by 2015, but their definition of cloud is of course cloudy. The cloud number I’d really like to see from IBM is their capex spend as a proxy for their cloud commitment. Total property, plant and equipment on the balance sheet has actually declined so far this year, while Google and Microsoft spent $3.5 billion on capex between them in the last quarter.

The problem for dinosaurs: if the meteor doesn’t get you, the (dust) cloud will.

Image: IBM Sales Team, Yucatan Penisula, 66 million years ago

Enter The Matrix: Microsoft’s Reorg

image

The new super-matrixed structure doubles down on “integrated innovation”, a model that has historically been tantalizingly just out of grasp from an execution standpoint. The new theory is shorter product cycles will mitigate failures of alignment across teams.

The pendulum swings to functional away from divisions that had clear customer focus and segmentation (ironically, Steven Sinofsky wins philosophically, even as he and most of his disciples lose personally).

The Microsoft org chart cartoon with guns pointed between organizations is getting a lot of airplay. It is worth pointing out it has always been the engineering organizations that had this kind of dynamic (sometimes even implicitly instigated by senior management – there was a a time when internal competition was in many ways more vigorous than external competition) and that there still are multiple engineering organizations. Windows and Office, for example, will always have different priorities, no matter what the organization.

This move elevates some of the strongest engineering managers in the company, but they will have to successfully step up to operate at a whole new level.

The marketing reorg will probably take a long time to sort out, with both new leadership and lots of people moving, which means Microsoft will likely be more internally focused than it should for 6-12 months.

I continue to believe the best, long-term strategy for the company is to proactively split itself up. This reorg of course makes that harder as everything gets mashed into one gigantic blob that will try to successfully span from your house to the warehouse, from the mom and pop shop to the Fortune 500’s top and from the wrist of your arm to the cloud server farm (Rap Genius here I come…).

One of the reasons I believe in splitting the company up is the succession issue. For the all the criticism SteveB gets (some very valid, some completely ridiculous), his are a very difficult set of shoes to fill. I can’t count the number of times I have asked people calling for Ballmer’s head who they would replace him with, only to hear crickets or worse, truly untenable alternatives offered up. This reorg doesn’t bring to light any internal potential candidates and with the elimination of the division presidents, also removes the “mini-CEO” presidential training grounds. Steve is still planning to run the company for a few more years (he has said many times he intends to stay until his youngest child goes to college and has been known to bellow “…and if the kid has to repeat a year, you get me for another year!”), so perhaps there is time to develop an internal candidate. But my guess is the next long-term CEO of Microsoft is not at the company today.

Meanwhile, some of the better posts on the reorg I have seen:

  • Hal Berenson dives deep into internal succession candidates.
  • Ben Thompson on the perils of functional organization in large companies, with the obligatory Apple comparison.
  • Xconomy doesn’t quite go line-by-line, but dissects some of the blather in Microsoft’s memo on the reorg (thereby saving me from having to do something similar). This memo is not an auspicious start for the new marketing leadership (though I suspect the writing team is not new).

A Cretaceous Checkpoint

In our last installment of doing tomorrow’s technological paleontology today, I laid out my case for why IBM’s future looks different than the last decade because financial engineering isn’t the kind of engineering necessary to make the transition to the cloud. For my efforts, I got a lot of financially-oriented pushback that basically amounted to “past performance is in fact an indicator of future performance” and pointers to predictions from all-knowing Wall Street analysts who think IBM stock is going ever higher. I don’t pretend to know where the stock market is going in the short term, but I do believe IBM faces massive headwinds in the midst of a generational shift in technology. Interestingly, people associated with IBM were unanimous in their agreement with my thesis, both publicly and privately.

Since then (March 30), we’ve seen:

  • IBM miss big for Q1 – they missed on both revenue and profit and both declined in absolute terms. The revenue miss was over a billion dollars so in all likelihood they have pushed considerable revenue into Q2. They reiterated their full year guidance so Q1 is evidently just a blip in their mind. CEO Rometty berated the sales force, saying “Despite a solid start and good client demand we did not close a number of software and mainframe transactions that have moved into the second quarter” and sent a video message to employees telling them to work harder and to actually call back customers. Executives were reassigned. Upwards of 8,000 employees are getting laid off. Obviously, there are no issues with the product portfolio or strategy,
  • IBM try unsuccessfully to sell its x86 server business to Lenovo – they couldn’t call out a business they want to sell as underperforming, so the venerable mainframe took the blame this quarter, but its server business overall is seeing double digit revenue declines and IBM’s x86 business is a big part of the problem. Lenovo thought the price was too high so it doesn’t look like IBM’s PC divestiture will be repeated on IBM’s terms. IBM seems to be saying they want to keep milking their big iron installed base but don’t think they can compete in the mainline server hardware business going forward (and make no mistake, cloud is consuming a ton of servers).
  • IBM buy SoftLayer for $2 billion – so maybe SmartCloud wasn’t the be-all and end-all of clouds it had been touted as and perhaps no one at IBM could figure out what “autonomic” meant either. This is a big acquisition and very different than the legacy software rollups IBM has been doing of late. They paid a pretty good premium, there is integration risk and this is real money that is no longer available for financial engineering. Everyone has looked at SoftLayer (including a few of my former employers) and this pencils out primarily a people acquisition. We’ll see if IBM can retain hosting talent, especially when it sounds like full-on integration is in the cards. As Barb Darrow reported:

    Dennis Quan, IBM’s vice president of SmartCloud, told me the plan is to build a “compelling IaaS layer that leverages IBM strengths in open standard-based private cloud, enterprise workloads and use of Openstack married with the speed and scale of what SoftLayer has today.”

    To non-IBMers, this sounds like a matter of glomming together at least two disparate sets of technology. A Frankencloud of sorts.

  • IBM complain that Amazon beat them for the CIA cloud deal – IBM cried foul after AWS won a $600 million deal to build a private cloud for the CIA. Evidently IBM was so upset about losing they filed a formal protest. It looks like IBM tried to buy the business with a lower bid so they could tell customers they run the CIA’s cloud but their complaint ended up highlighting the inadequacy of their cloud offerings. The GAO concluded Amazon offered a “superior technical solution”, Amazon’s proposal was “low” risk while IBM’s was “high” risk and that the CIA “reasonably determined that IBM failed to clearly establish the capability of its existing public cloud to auto-scale all applications”.  Tip to IBM: if it requires a busload of consultants, it isn’t auto-scaling. It is a bad sign when IBM can’t even win government contracts, although one could argue that the best way to impede the ever increasing scope of the all-seeing eye of our government would be to outsource the surveillance state to IBM.

 

Yup, all is going swimmingly in Armonk. I maintain my view that mean reversion is happening, the rainy day fund has been depleted, IBM can’t innovate on technology at a time they must, they’re still way behind on cloud, the big industry trends are against them and their traditional customers are not going to save them time because they have their own set of problems.

I originally thought because of the size of the Q1 miss, IBM would have no problem with Q2 but now I think there is a decent probability they will miss again (currency effects are likely to play a role). At some point, people will start to realize the problem is not a sales force slacking off, but more fundamental.

In our next visit to the late Cretaceous period, we’ll look at Oracle, a company besotted with recreating the business model from IBM’s glory days and who also claim to be afflicted with the lazy sales force disease.

Disclosure: I sold my tiny number of IBM shares that I acquired through no fault of my own at $208.

Press Releases We’d Like to See: Iceland Embraces the Bitcoin Economy

Continuing our series of monetary-themed press releases we’d like to see (but probably won’t):

Iceland Embraces the Bitcoin Economy
Unveils comprehensive program for
21st century financial leadership

REYKJAVIK, Iceland — May 1, 2013 — The Republic of Iceland today announced a comprehensive program to make Iceland the leading nation state in the emerging Bitcoin economy.

“Bitcoin is a math-based, digital currency that provides the foundation for addressing many of the financial challenges afflicting both the real economy and the digital economy today,” said Snorri Thorodinsónssónssónssónssón, Minister of Finance and Economic Affairs for the Republic of Iceland. “With our abundant, low-cost geothermal power and our formative experiences in the recent global financial crisis, no nation is better positioned than Iceland to help develop a new set of digital financial institutions the 21st century so desperately needs.”

Bitcoin’s many benefits – including cryptographically secure transactions, lower transaction costs, fraud mitigation, nearly instantaneous payments across the globe, transparent accounting and reduced dependence on “too big to fail” banks – make it the obvious foundation upon which to build a new financial system. As Iceland develops its digital economy powered by geothermal energy, a Bitcoin-based economy broadly benefits digital businesses hosted in Iceland, creates opportunities for new Bitcoin-based businesses and increases overall economic efficiency.

“Iceland intends to be at the vanguard of the new digital economy,” Thorodinsónssónssónssónssón continued. “While some may put their confidence in the resolve of policymakers, we put our confidence in the cryptographic assurance arising from the second preimage resistance of the SHA-256 hashing algorithm.”

The government’s comprehensive program includes:

  • Bitcoin Payments – Iceland will immediately accept Bitcoin as valid payment for all government transactions including taxes, customs, duties and other fees.
  • Government Finance – Iceland will sell the first Bitcoin-denominated government bonds and offer its citizens the option of Bitcoin-denominated assets in government pension plans.
  • Economic Development – in conjunction with the burgeoning data center industry in Iceland, the government will incentivize new Bitcoin-based businesses, including exchanges, mining operations and a new generation of financial institutions, to locate and grow in Iceland.
  • The Icelandic Bitcoin Furnace – the Icelandic government will sponsor the crowdsourced design of a custom, ASIC-based Bitcoin mining device for the home. The device will offer terahash-class mining performance along with highly efficient heat recirculation for the long Icelandic winters. The government has reserved significant 28nm semiconductor fabrication capacity for production of the final design, which will also be made available as an open source reference design.
  • Advisory Services – Iceland will make its expertise in Bitcoin available to other sovereign nations interested in joining the 21st century financial economy through a range of consultative services. These services will initially be available through Icelandic embassies in Athens, Dublin, Lisbon, Madrid, Nicosia, Paris, Singapore and Zurich.

No diacritical marks were harmed in the making of this post.

And if you are a Bitcoin-related (or other cryptocurrency) startup, whether you are in Iceland or not, I want to talk to you. See the About page for information on how to contact me.

IBM: How Much Longer Do the Good Times Last?

 Dinosaur World by mcdlttx, on Flickr
Creative Commons Attribution 2.0 Generic License  by  mcdlttx 

I have not written about IBM for a while (or really anything ;-), but one of my recurring themes is IBM’s wholesale transition from what was once the world’s premier technology company (admittedly this was decades ago, but their relative and inflation-adjusted historical dominance is clear) into a financial engineering company. For students of the technology company lifecycle, they offer a fascinating career option for once-dominant companies.

This recent quote from a “former IBM exec who spoke on the condition of anonymity” prompted revisiting the company and again asking some questions about their business model and future prospects:

“Realizing this, IBM’s become a holding company of sorts, buying assets, integrating them and reselling them as an IBM brand.”

“IBM does not want to fund its own development because past history shows we’re not very good at it.”

Stock Performance

IBM has been a remarkably successful stock in recent years (and is about 12% of the gain propelling the DJIA to record highs since the 2009 low) and Wall Street loves the company as a result. Here are returns over the last five years:

IBM Chart

IBM data by YCharts

Top line growth however looks more like the surf report for a birdbath on a windless day, even as the bottom line is up over 50% in the same period:

IBM Revenue TTM Chart

IBM Revenue TTM data by YCharts

IBM’s strong bottom line growth has come from cost cutting and financial engineering, not growth in the business. The strategy they laid out in 2007 has worked quite well in terms of profit growth. Like most technology companies, IBM has a “roadmap” of what they’re going to do, but uniquely, it is a financial roadmap. Amid the roadmap’s blizzard of numbers, revenue growth only merits some hand-waving platitudes. They skillfully focus on profit growth for each segment, obscuring the lack of overall revenue growth. And the billions of dollars in euphemistically described “enterprise productivity” savings have come from squeezing employees, curbing retirement benefits (e.g. shifting from monthly to annual 401k contributions) and moving offshore aggressively (IBM arguably now stands for Indian Business Model). Cringley has chronicled how IBM has become the poster child for cutting your way to prosperity at the expense of customers and employees.

Now Wall Street views technology companies through a different lens, as seen in this comparison of IBM and Microsoft when IBM eclipsed Microsoft in value as well as a recent explanation of the market premiums by a Wall Street analyst. While not quite as absurd as David Einhorn telling Apple how to run its business, catering to Wall Street has taken IBM to a different place than they’d go as a technology company left to its own devices. It isn’t a coincidence each successive generation of powerhouse technology company is more open in its disdain of Wall Street. So while IBM’s financial engineering strategy has worked brilliantly to date, there are questions about how much longer this strategy will work, much less provide superior returns.

Where is the Innovation?

“IBM does not want to fund its own development because past history shows we’re not very good at it.”

IBM is the perennial leader in terms of patents issued, garnering them a wave of beneficent press every year. But if we define innovation as requiring both invention and market impact, it is hard to point to a single, material innovation IBM has delivered in the 21st century. Things like Watson or the latest nanotechnology transistor advance are duly milked for PR, but they don’t ever seem to turn into world-beater products that move the needle. When specific IBM patents are examined, they tend to be egregious examples of all that is wrong with the patent system and the company often finds itself magnanimously “contributing” what they had touted as great inventions to the public domain in the wake of backlash.

But the biggest innovation challenge for IBM, as we’ll elaborate on below, is their also-ran status in cloud computing. My comments from 2008 still hold today:

Meanwhile, on a more serious note, timesharing is back with a vengeance yet there is no sign IBM has ambitions to be a major player in the cloud computing era. Instead they’re fiddling with avatars while the on-premise business starts a long, slow burn. Where is the “one billion dollar” data center capex announcement that signals their ambition to play with the Amazons, Googles and Microsofts? Perhaps it is harder to make a “billion dollar” commitment when it requires real dollars as opposed to “soft” and/or exaggerated dollars? Or has IBM committed all its free cash flow to financial engineering, forcing them to watch the next generation of computing from the sidelines? Selling servers and consultants by the hour is a far cry from offering (anything)-as-a-service. In the cloud world, if you build it as a vendor, you also have to be willing to operate it at scale. And enterprise-scale is dwarfed by Internet-scale, so enterprise chops are not enough. Outsourcing “your mess for less” isn’t a service. One can only speculate that virtual conference rooms in Second Life are inhibiting IBM’s ability to define their strategy. I am still hoping they do OnDemand 2.0 and kill two birds with one slogan.

What about Cloud?

IBM’s value proposition since Lou Gerstner brought the company back from the brink has basically been “we’ll bring you up to average in IT” with IBM (human) services providing the glue to hold it all together (also known as “your mess for less” though it is intentionally really hard to tell whether the cost savings promised in the IBM sales spreadsheet actually panned out as promised).

We can argue about whether IBM offers IT capabilities at the 50th percentile (or 30th or 60th), but for roughly half of enterprises, IBM offered an improvement on what they could do themselves (and IT is arguably the opposite of Lake Wobegon – a land where everyone is below average ;-). The challenge for IBM is cloud providers are more like 80th or 90th percentile (or higher) in their capabilities and have far better cost structures through software as opposed to busloads of consultants. The fraction of the market IBM can compete for will shrink due to cloud computing as complexity gets engineered out.

At the same time, the pendulum has swung away from outsourcing and in-sourcing now has cachet (perhaps in no small part to the quality of the outsourcing experience), which reverses the tailwind that has propelled IBM since Gerstner.

IBM has half-heartedly rolled out SmartCloud, which is at best difficult to understand (e.g. IBM’s definition of self-service is very different than the rest of the industry and requires human involvement to process orders and/or conceal their offerings from critical eyes). Tellingly, their top level message around cloud is a vague plea for open standards which is typically the last refuge of scoundrels and the uncompetitive.

The chip guys used to talk about a “poker chip” which was the cost of a single fab. The cost of a poker chip went up with every generation and now runs in the billions. You need cash to play the game. For cloud, the poker chip is the cost of a cloud-scale data center, which can run into the hundreds of millions of dollars. At minimum, you need a few of them scattered around the globe. To cater to IBM’s preferred kind of enterprise customer, you probably need more than a few to offer granular jurisdictional compliance. We see the pretty pictures of massive datacenters belonging to Facebook, Google and Microsoft, but where are IBM’s poker chips? If you buy chips to play the cloud poker game, that money is not available for dividends or buybacks (and vice versa). You’d think IBM would be anxious to show the world vast structures stuffed to the gills with mainframes, demonstrating once and for all their claim that mainframes really are the best place to run the most modern workloads. Or maybe they just don’t have them.

Some will argue there will always be room for integration between and on top of software services, but cloud leaders are ruthlessly removing humans from the nuts and bolts of IT operations. IBM lacks meaningful or competitive cloud technology assets and per the IBM executive above, they don’t seem particularly confident in their ability to develop new technology. The other option is to “move up the stack” and offer business consulting, which is certainly the way IBM positions the company. But contrary to the story, IBM remains extremely exposed to menial IT functions that are disappearing in the cloud era. And their intense focus on cost reduction through off-shoring doesn’t add to their business consulting skills. The rise of the cloud brings IBM’s inability to innovate to the fore and poses a real threat to their current business model.

Where is the Thought Leadership?

One thing IBM has historically done pretty well is thought leadership. Particularly for a company of their size, they had remarkable discipline in aligning a sprawling empire (at least from the outside) top-down around a common story supported by strong advertising, marketing and top-down sales relationships. Their embrace of Java and then Linux/OSS felt like technology leadership at the time but in fact it  represented IBM’s outsourcing of technology leadership. They had moved from innovating to endorsing technology and felt comfortable in their ability to remain on top as an integrator of the piece parts. In fact, the more piece parts coming from different centers of gravity, the better for the consultant.

I believe OnDemand was a milestone in IBM’s thought leadership history, It was obviously well before its time and presaged a lot of what we take for granted with cloud computing. My theory is IBM quickly discovered they were ahead of the market, and way, way, way ahead of their typical, lower percentile customers who just weren’t going to be early adopters. So OnDemand quietly disappeared. Nor are there any obvious technology or product artifacts from the effort. I suspect they still have deep scars from the experience that are impacting their ability to wholeheartedly embrace cloud, even if they had the means to do so.

IBM’s most recent storyline has been Smarter Planet and it is a different beast than former campaigns. It unambiguously puts a business value message first, and aims foremost at governments and those selling to governments. This was partly a reflection of the timing (it rolled out in November 2008, in the depths of the financial crisis) and IBM wanted to dine at the trough of government stimulus spending. But it is also also a reflection of the sophistication (or lack thereof) of the typical big IBM customer. Governments are rarely among the most able and discerning of IT customers (yes, there are lots of recent efforts to put a positive spin on their need to do better, but when you look at the lowest percentiles of IT organizations, lets just stipulate that governments are well represented).

Meanwhile, cloud computing has become the high order bit for IT today and IBM is hard to find. They’re not only not shaping the discussion to their advantage, they’re not really in the debate. Cloud leaders don’t use IBM and if you want to seriously play in cloud, IBM is hardly going to make your list of strategic partners or suppliers.

Where is the Customer Success?

IBM does a great job with their advertising and customer case studies, which tends to mask the bigger question: where are the customers with a big IBM technology reliance who are leading their industries through application of technology? What disrupter relies on IBM for their technology and/or consulting services? Who is successfully holding off the disrupters and/or revolutionizing their industry using IBM technology or business consulting? Which of today’s startups undergoing explosive growth have done it on an IBM platform?  [Pause here and wait for the crickets].

With no offense to (Sri) Lanka Bell (“a leading telecommunications service provider” and SmartCloud adopter) or the Memphis Police Department (who did some statistical analysis in SPSS), these are not world-beater customers doing breakthrough things with cutting edge technologies. Those IBM TV ads about Smarter Analytics are really about SPSS, a 45-year old product that IBM had to acquire? How many IBM “big data” case studies are running on good old IMS (which shares a birth year with SPSS)? Granted IBM does a nice job making its late majority adopters look good, but it is hard to find IBM customer examples that live up to the rhetoric.

Broadly, I am seeing much greater enterprise customer awareness of the deficiencies in their in-house and traditional outsourced IT capabilities. As technology moves into broad deployment across all industries, almost every company is now a technology company to a greater degree and has to compete against technology-based startups using 21st century technology. Om Malik makes this point really well by pointing out who is buying technology companies now; it isn’t just other technology companies any more. And these are the companies who are IBM’s traditional bread and butter customers.

As a result, there is a business imperative to “do better” when it comes to IT. Some companies are even asking how to walk away from all their IT investments, not because “IT doesn’t matter”, but because it matters so much and the current platforms are such a drag they see starting from scratch as the only option. It will be interesting to see if anyone pulls this off, or if it remains a material advantage for new entrants.

Critically for IBM, this mindset is taking hold amongst companies who historically lived the idea you couldn’t get fired for buying IBM. They’re actually concluding their IBM dependency might not just get them fired, but it could kill them. I remember visiting one household name a few years ago where they proudly showed me the building full of IBM consultants and the CIO responded to my “you have to get off the mainframe – you’re stuck in the land that Moore’s Law forgot” pitch with a retort that began with a patronizing “Son, there’s something you need to understand…” That company has since seen the light and has decided IBM must play a far less significant role in their future if they want to stay competitive.

And when it comes to creating success for their customers, IBM’s pure enterprise footprint looks like an ever bigger liability. They can talk about selling to Chief Marketing Officers all they want, but the reality is IBM can’t bring hundreds of millions of customers to the discussion the way an Amazon, Apple, Google or Microsoft can who actually touch customers at scale and can bring that understanding and technology to bear for customers. Watson makes for a nice demo and game show contestant, but how does it really compete with Google Now or Siri in terms of reach (make your own WebSphere joke here) or even scale? The consumerization of IT as much as anything is the world moving away from IBM.

The Case Against IBM

That got really long. To summarize, the good times rarely last forever and IBM is unlikely to continue to outperform:

  1. Wall Street may love IBM (which is an indictment unto itself…) but mean reversion looks inexorable. IBM has put itself in thrall to Wall Street and achieved superior earnings growth through non-sustainable cost cutting and financial measures. What is good for Wall Street in this case isn’t good for customers or the long term success of the company. Historically low interest rates have also been part of the IBM story (borrowing at a rate below your dividend rate to buy back stock is cash flow accretive) and that too will mean revert one of these days.
  2. IBM is a technology company that doesn’t really innovate. Cost cutting only takes you so far; eventually it cuts muscle as opposed to fat. Real technology companies do actual (non-financial) engineering, but IBM has committed its cash to growing EPS. IBM doesn’t even bother trying to tell a growth story (they should at least be able to grow with  global GDP). Meanwhile, they have lots of legacy business at risk. In particular, IBM makes the bulk of its revenue from busloads of consultants and the plurality of its profits from the mainframe. And a rats’ nest of a legacy software rollup doesn’t make you a software company, investor relations slides to the contrary (are there any IBM software acquisitions that aren’t in harvest mode and have seen material investment?).
  3. The company is missing the boat on cloud computing. IBM is largely an observer in the biggest trend in IT, which directly undermines the core of IBM’s business model. And the legacy software acquisition model of the last decade will not work as well applied to SaaS applications – software services require on-going innovation, don’t drag consulting to the same degree and the economics are not as accretive given the capex needs.
  4. The big industry trends are against IBM. Not just cloud, but also outsourcing swinging back to in-sourcing and the consumerization of IT. IBM is fighting these trends, not setting an alternative agenda.
  5. IBM’s customers are in crisis. Historical affinities of even the most complacent customers will be put to the test in the face of existential, technology-based business threats. You can only paint laggards as technology leaders for so long and if the IT center of gravity is shifting from the CIO to the CMO, IBM’s lack of consumer assets or DNA hurts them relative to the competition.

Disclosure: ironically, I am long IBM though not by any action on my part, and have been too lazy to do anything about it. This post hopefully will motivate me to rectify that.