Analysis: Do zEnterprise Results Signal a Slowdown for the Mainframe Market?

With another strong quarterly showing for System z, IBM seems to have put its recent run of mainframe woes behind it. Or has it?

Has IBM Corp. put its recent run of mainframe woes behind it? It has for the present, according to the latest server market report from market-watcher International Data Corp. (IDC). Big Blue sold more than $1 billion worth of Big Iron hardware in the first quarter of 2011.

Encouraging, yes, but although mainframe sales were up over the same period last year, they were down -- by more than 41 percent -- from the fourth quarter of 2010. Does this augur a slowdown in the booming mainframe market?

Probably not. First, although Big Iron sales were off by a huge margin from their torrid performance in Q4 of 2010, they were up -- by nearly the same huge margin -- from their anemic performance during the year-ago period. In other words, IBM generated almost half again as much in mainframe revenues (a 41 percent increase) as it did in the first quarter of 2010.

Although mainframe sales account for a fraction of server shipments, they continue to account for a disproportionate share of server revenues: IDC has Big Iron hardware accounting for just under one-tenth (8.8 percent) of worldwide server sales. This was during a period in which IDC measured a huge increase in demand for pricey RISC-Unix servers -- which had sales amounting to one-fifth (22.5 percent) of all server market revenues.

Thus, even with a strong showing for RISC-Unix -- its first positive growth in almost three years -- mainframes still accounted for almost one-tenth of server revenues.

Then there's this: the three-month period of October, November, and December 2010 marked the first full quarter during which Big Blue's next-gen mainframe system, zEnterprise, was available and shipping. During that same period, IDC says, Big Iron posted its fastest-ever growth rate, with mainframe revenues surging by almost 70 percent.

In Q4 of last year, in fact, IBM sold $1.7 billion of zEnterprise hardware, indicating plenty of pent-up demand. That's the main reason IBM wasn't able to build on its red-hot Q4 in the first quarter of this year.

The expectation of zEnterprise wasn't solely to blame for lackluster sales. Thanks to a brutal correction in the enterprise server market, mainframe sales suffered through most of 2009.

By early 2010, however, the volume server market had started to recover, although sales of mainframe servers were still depressed. Big-Iron shops had money to spend, but many -- most, it now seems -- were waiting. And why not? After all, overall capacity increases with each new generation of Big Iron CMOS, and Big Iron hardware pricing remains relatively flat.

Then there's IBM's MSU -- millions of service units -- pricing scheme, which tends to benefit customers. Big Blue and many mainframe ISVs license software on the basis of consumed millions of MSU (or, alternately, in terms of total MSU capacity), but IBM's newer, beefier mainframes typically have lower MSU ratings than do their predecessors. Why would a Big-Iron shop spend about the same amount of money on a z11 system that has less capacity -- and delivers less MSU-bang-for-its-buck -- than a next-gen system?

Add to the mix that big-ticket server sales are traditionally strongest in the final quarter of the year. In IDC's server market report for Q4 of 2008, for example, System z was the only one of IBM's four server businesses to post year-over-year revenue increase. This was during the same period in which sales of commodity servers plunged precipitously, prompting both market watchers to warn of historic declines. (Q4 of 2008 was bad, but the first quarter of 2009 was even worse. Both IDC and Gartner named it the most brutal period on record.)

IBM may have itself to blame for this: in late 2009, Big Blue disclosed that it was prepping a major refresh of its mainframe CMOS to ship sometime in late 2010, depressing demand for IBM's z11 mainframes, such that -- in combination with other setbacks -- Big Blue yielded server market bragging rights to rival Hewlett-Packard Co. (HP) in the second quarter of 2010.

Leaderboard Leapfrog

IBM regained server market bragging rights in Q4 of 2010, thanks to zEnterprise's showing, then lost them in the first quarter of this year. HP outgained Big Blue by more than 2 percent -- a difference of $274 million.

In other words, if IBM's mainframe unit had turned in a performance even approaching (say, at 75 percent) that of the last three months of 2010, Big Blue would have retained server market bragging rights.

As it happens, however, there's reason to think IBM could again wrest the server market crown from HP. According to IDC, HP's victory was the result of "improved demand" for its x64 ProLiant Servers and Itanium-based Integrity systems. However, HP, IBM, Dell Computer Corp., and other large vendors are facing significant pricing pressure from white-box purveyors of commodity x64 servers -- the nebulous "Other" of IDC's taxonomy. (Cisco Systems Inc., which pushed its way into the enterprise server segment two years ago, is grouped in IDC's "Other" category.)

These vendors grew their revenues almost on par with HP (10.6 percent versus HP's 10.8 percent) and actually surpassed Fujitsu and Dell.

What's more, Oracle announced plans to discontinue support for Intel Corp.'s Itanium processor in the second quarter of 2011. It's unknown what effect, if any, this will have on demand for Itanium servers such as HP's Integrity line, but some see Oracle's move as part of a strategy to disadvantage HP, increase its software licensing revenues, or boost its showing in the enterprise server segment.

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