IBM Services, Software Strong in '98

Revenues reached record levels for IBM Corp. in 1998, fueled primarily by the company's aggressive campaign of widespread services and software sales. In fact, IBM's Global Services and Software segments flourished despite sagging revenue in the Hardware segment.

In 1998, IBM's market value grew by $69 billion, having grown by $146 billion since the company's major restructuring in 1993. Overall, revenues soared to $81.7 billion, the fourth consecutive year IBM reports record revenue growth, while the company's earnings rose to $6.3 billion.

The two main tributaries that will continue to feed IBM's river of revenue growth are services and software. In his letter to IBM shareholders, Chairman and CEO Louis V. Gerstner states that IBM is positioned to "win a disproportionate share" of the IT industry's growth. IBM Global Services, specifically, has grown in eight years from a $4 billion to a $24 billion business, with greater than a 20 percent annual growth rate.

The growing importance of the Internet and its influence on e-business support Gerstner's assertion that the PC's reign as "the driver of customer buying decisions and the primary platform for application development is over." The network has taken the PC's place, according to Gerstner, as only a small part of Internet access relies upon the desktop.

Gerstner points out that "the greatest competitive advantage" in the IT industry is no longer technology. "Technology changes much too quickly now for any company to build a sustainable competitive advantage on that basis alone," he says. The "winning edge" comes instead from how "you help customers use technology."

IBM is clearly emphasizing two areas -- Global Services and software, agrees Tom Bittman, VP and research director with Gartner Group (Stamford, Conn.). "Their services effort is growing fairly dramatically to be more and more complete, in terms of e-business services, outsourcing services, IT consulting, business consulting, etc. In many ways, IBM's business is services-centric."

Long term, server technology for IBM becomes less of an issue as the company continues to emphasize services, according to Bittman. "IBM is going to get to the point where they don't care whose server technology is sold," he says. "They can still make a lot of revenue in terms of services and software."

According to the annual report, IBM's Hardware segment generated approximately $35.4 billion in revenue in 1998, down from $36.6 billion in 1997. Specifically, IBM reports a loss of $992 million alone for the company's PC business.

Much of this hit can be traced back to "IBM's horrible inventory and channels problems in the first half of last year," according to Bittman. During this time, IBM allowed about 12 weeks of inventory to collect in the channel. "Basically, IBM at one point last year had two months of inventory that they had to swallow or not sell. This sort bulking up of inventory wasn't exclusive to IBM," he says, "A lot of vendors had this problem, but IBM had it probably a bit more."

One result of these inventory problems was a blow to revenue attributed to IBM's Personal Systems segment, which includes the Netfinity server brand. "We expected that Netfinity would be a profitable business last year, but it apparently wasn't, because they didn't lose $1 billion in PCs alone," Bittman says.

"We don't see a reason, after last year, for any of the servers to have a growth business," Bittman says. "This doesn't mean that segment isn't going to be profitable and last a long time. But in terms of the area that they're in, the price/performance of the server space is improving at a faster rate than those markets can grow."

The AS/400 brand, for example, will continue to make money long-term, but is going to remain flat or slightly decline in the coming years, though not as fast as the S/390, according to Bittman, who adds that this trend may be interrupted at times due to the introduction of new products.

The Intel server space is growing at a rapid rate, Bittman points out. "Within a couple of years, it will own half of the server technology space, based mostly on NT, but also on NetWare and Unix boxes," he adds. "It's important to note that what we're talking about here is the growth of servers from the low end. I don't want to imply that NT is going to take over the world.

"For those companies in the market for a server costing less than $100,000, the vast majority is, and will continue to be, NT," Bittman continues. "IBM will sell 10,000 to 15, 000 [AS/400] Model 170s per year, but at the same time, comparable NT systems will be selling by the millions. It's not that it's not going to do well, it's just a very small niche that the 170 is selling into."

Gerstner defends slumping hardware sales by reminding the market that powerful servers are needed to process all the information accumulated by e-business practices. Gerstner says he expects the overall IT industry to grow at an annual rate of 10 percent, to $1.6 trillion by 2002. Of that, the e-business segment is expected to grow to $600 billion and grow twice as fast as the industry overall.

Lee Kroon, senior industry analyst with D.H. Andrews Group (Cheshire, Conn.), anticipates IBM will continue to invest in its server brands. "Clearly, IBM still sees its server business as incredibly important for network computing, and definitely considers its servers to be, as they like to call it, the engines of e-business," he says. "To that extent, you're going to see IBM continuing to invest in the features that their servers are known for and that provide stability, reliability, security and high availability to network computing."