View from the Top -- An Interview with Tom Jarosh, IBM general manager, AS/400

• 02/07/2000

MRS: Let’s just start by talking about how the AS/400 has evolved over the past year. What would you identify as the most significant changes that have taken place?

TJ: I think we had a watershed year. We essentially put the final touches on the transformation of the AS/400 to a modern server platform. The first thing we did was to adjust the product line and get rid of the complexity. We came into the year with server systems, custom servers and a lot of inflexibility and frustration for our customers. To address this issue, we introduced the 7xx line of processors and created a unified line of servers. We also brought the Northstar technology into that 7xx line across the board and so, continued on the path of aggressive price/performance and improved simplicity in the product line, which is something that customers always appreciate.

Second is the set of software enhancements that we provided both throughout the year, specifically in version four, release four. From an operating system point of view, I’d say that a couple of the key advances in this area include logical partitioning and clustering support, which we will continue to enhance and add to over time.

In a third category, I’d put the whole set of e-business transformation and middleware items--things like digital certificates, LDAP support, WebSphere availability, Java servlets, Enterprise Java Beans--all taken together as the set of tools that our customers need to have a fully functional e-business platform using the AS/400.

So, those would be the three areas--a set of hardware-related activities (product line simplicity and technology upgrade), a set of core operating system enhancements like LPAR and clustering, and a set of e-business tools and enablers.

MRS: It seems that this strategy is targeted primarily at the existing AS/400 user community. What has been done to attract new users?

TJ: I think our strategy very clearly addresses both existing and potential AS/400 users. For example, a year and a half ago, we had a set of customers who indicated that they wanted LPAR and clustering, and within a year we were able to deliver on that. In terms of making the AS/400 an attractive platform for new customers, we had to make the platform technically relevant. I think that we’re fully there now.

We aim our efforts at both the installed base of customers as well as driving to get, and being successful at getting over 20 percent of our customer sales each year--each quarter in fact--from new sales.

MRS: Let’s talk about the negatives from last year. By now, it is widely known that in 1999, IBM’s earnings were adversely affected by a decline in AS/400 sales. At the same time, the NetFinity Server line experienced significant growth. Can you comment on this?

TJ: The fundamental situation is that our historical success over the years and the history of the AS/400 has been in the core application marketplace. People run their businesses--their core businesses--with AS/400s. They run their inventory, they run their general ledgers, they run their accounts receivable or payable; they run their demand/deposit accounting applications, all those things. There was no option to not having those systems available on Jan. 1. So, that’s the set of applications that customers remediated, then locked down.

You can see it very clearly when you look at the ERP marketplace and the slowdown in ERP. Over a third, almost 40 percent of the AS/400 business comes from those new core applications, and that marketplace was down somewhere between 30 and 40 percent in aggregate. It impacted AS/400 more than other servers, because that’s our business. We have the leading market share in the midmarket in that core application arena and so, when those applications are the ones that customers say, “OK, I got ‘em ready, now I’m not touching ‘em,” we’re more impacted. We did have continuing success in extensions to those applications--we look at that in things like business intelligence, data warehousing--which continued to grow very nicely for us. Web-enablement and Net.Commerce surpassed our expectations, so people continued to add on and extend those applications to Internet-enablement and leverage with data mining, but not enough to overcome the slowdown in the core application set.

MRS: When are we going to make up for the slowdown in AS/400 sales? Have the orders been placed now, and will we begin to see them in February or March?

TJ: We expect that during the first quarter that people will start to move forward again--hopefully, quickly. When you talk to customers, they say, “If there are no problems, I’m going right after it. If there are some issues, it will take a while before things will pick back up.” Sometime in the middle to the end of the first quarter, we expect to see things back to normal and we expect the AS/400 to recover. We have a growth plan in place for next year; we’re funding all of our plans and all of our programs are clearly aimed at growth in the AS/400 marketplace.

MRS: Are there any indications that NetFinity sales benefited at the expense of AS/400 sales in 1999?

TJ: No, I don’t think so. Clearly, there’s an increasing role for NT-based servers including NetFinity in some of these application areas, but they also put a lot of that stuff in for file and print, for front-end Web servers, etc. There is momentum for NT in the marketplace; we’ve seen it in the growth of our Integrated NetFinity Server on the AS/400 even, where now, we sell almost 20 percent of AS/400s with an Integrated NetFinity Server on the box.

There are applications that have offerings on NT as well, but we’re not losing any AS/400 customers, we’re still adding AS/400 customers. We still added them in the ERP space, just not at the rate of historical levels, that’s all.

MRS: So what does that mean long term for the AS/400 if sales are not occurring at the rate of historical levels? Obviously there were some layoffs in Rochester announced this past week

TJ: They were very small, very minor. That’s just a little fine-tuning. I wouldn’t focus on that.

MRS: OK, then tell me, clearly, the rate of growth and expansion in the marketplace is important--if you’re saying that these layoffs aren’t worth worrying about, that’s one thing, but if the rate of adoption of the AS/400 is slowing, what does that mean down the road?

TJ: What I said was that this year, the core application space slowed down. That’s a Year 2000 statement in the ERP space--period!

MRS: I’m just trying to make sure that I understand you correctly. Let’s move on. As we look ahead, if I don’t already have an AS/400, why should I buy one?

TJ: The AS/400 is the best application machine in the industry! When people are running their core application sets--whether those are things like community banking or ERP applications for middle and even large customers--there is no platform that provides the reliability, scalability, security and support that the AS/400 provides and that’s a clear competitive advantage against Unix and NT. That’s why people buy the AS/400. We sell it as a core machine that is enabled to leverage the world of the Internet now.

MRS: How do you position the AS/400 across from a solution that is built on a Unix or an NT system? Obviously, the price differential is significant. How do you justify that to new customers?

TJ: Actually, there’s a cost advantage to the AS/400 when you look at the total cost of ownership and there are several consultant reports that independently back that up in terms of looking at both the year-to-year decline in the cost of operating AS/400s, as well as the total cost of ownership for AS/400 vs. NT and Unix servers. The lifetime cost of an AS/400 is actually very competitive when you add in not needing so much staff, i.e. people like database administrators who you do need in an NT or Unix environment.

MRS: OK. Let’s talk a little bit about Sam Palmisano and the fact that he is now head of the server division. How have things changed since his arrival?

TJ: I don’t think that’s a direction that we want to go into. We can talk about the business, but I’m not going to talk about personalities.

MRS: Can you comment on his vision for the future of the server division? What makes you feel confident that he is committed to the AS/400?

TJ: You can look at some of his remarks that have been recorded externally. I know the impact of the AS/400 on the IBM company, and he knows the impact. With respect to the AS/400, we’re a very key element of the total set of businesses that IBM is in in the information technology industry. The AS/400 is a solid contributor and when we stumbled a little in the third quarter, the impact on IBM was clear. So, I think that in itself speaks to the fact that the AS/400 business is crucial to IBM, and therefore everybody from Lou [Gerstner] to Sam [Palmisano] all the way on down and around are very much focused on making sure that we continue on.

The AS/400 market is composed of the most loyal and most satisfied customers in the computer industry. It’s a very healthy business. It’s a good business for us this year and it’s going to be a better business for us next year.

MRS: Can you comment on what you view as opportunities for the AS/400 and also what you perceive as threats to the future of the AS/400?

TJ: We see an awful lot of opportunity in terms of the rebound of core application enablement next year--fueled by the Internet, fueled by the ability of customers and the desire of our clients to take these applications and provide them to an extended set of a constituency. For example, taking a core ordering system, Web-enabling it so that now individual end-user customers can flow through and enter orders directly, enabling self-service for payroll applications so employees can update their own records, update and do their own work. All that’s going to fuel transaction volumes, so that’s a number one key opportunity for us, and it’s why it’s so important that we have the technologies that allow us to leverage application strength.

The second major opportunity that we see for next year is in the application service provider (ASP) space. Based on the characteristics of the AS/400, we see right now a lot of momentum and success in the ASP space for the AS/400. The reason for that is as you move from ISP to ASP, now you’ve got customer data on a server, as opposed to just flowing through an ISP. This is now about getting end-user customers to a service provider with a core application on that machine. And, there, the characteristics of the AS/400, particularly the reliability and data integrity and quick deployment of the AS/400, logical partitioning--to be able to partition multiple users, multiple customers of the ASP’s environments on a single machine--all those characteristics come into play. So we’ve put in place competency centers for ASPs, a dedicated market development team, and a dedicated sales resource to go and attack that marketplace. All that’s in place.

MRS: How big is this ASP opportunity, really, relative to AS/400 sales overall?

TJ: Well, I can say that it’s growing at a faster rate than we anticipated already. We expected it to be modest next year, but we’re seeing a huge amount of interest already on the part of the marketplace--both from application providers that want to add an ASP model to wholesale application service providers that take applications from other people and then provide those, where they essentially are the operators of the application and then the sellers continue to be the solution providers themselves, the ISVs. We’re seeing both of these kinds of customers. Without getting into specific numbers, we see it as a very good opportunity for the AS/400. So, we’re aggressively attacking it. We think it will fuel growth next year.

MRS: Can you give me a sense of how you expect that will compare to other sales? You’re saying that it’s growing faster than you expected, but do you anticipate getting 20 percent, 30 percent of the total AS/400 revenue from ASPs or what?

TJ: It’s too early to tell. We’re actually trying to do that work right now to come up with what revenue should we try to drive from that segment. We’re still working on exactly how we’re going to deploy resources to attack the opportunity and what we’re going derive from that next year.

MRS: Have you already got customers signed up?

TJ: Yes. Right now, we’ve probably got about 20 application providers that are running ASPs and another 10 wholesale service providers. At this point, we’re predominantly in the U.S. and we’ve got a backlog of over 50 customers that we’re working with.

I think it’s a whole new market opportunity and it’s one that requires the dedication of resources to attack it as it develops. We’re not missing any time--it’s just on the horizon right now. It’s not limited to the U.S., there’s interest all over the world. I’ve met with service providers in Europe and in Asia, particularly in Japan, who are very interested in this model and we have resources in place to develop this market as it develops, with the AS/400 in mind.

MRS: Can you highlight what you view as the threats facing the AS/400?

TJ: Certainly, we compete every day with Windows NT, and next year, there will be a lot of momentum on Windows 2000. But by the time they’ve launched, we will have shipped our 700,000th AS/400 and we think that’s a decent head start. But we compete every day with them. And, we’re very focused on making sure that we have a solid offering and value proposition to our customers that’s compelling. When we engage, predominantly we win.

MRS: The AS/400 has historically been viewed as a robust platform, from a technology standpoint. But from a marketing standpoint, critics argue that it’s not clear as to where it fits relative to other servers offered by IBM. There seems to be overlap at both the high end and the low end, particularly with respect to the RS/6000 and NetFinity. Can you comment on this?

TJ: We think that IBM has a very strong advantage in the marketplace, in that we have a full range of servers. We have the System 390, which serves the needs of our largest customers very, very effectively. We continue to see growth in capacity requirements for the 390. Certainly, there is a market for NT systems and Unix systems. There’s a set of customers that say, “I’m an NT shop,” or, “I’m a Unix shop.” So, our RS/6000 line and our NetFinity line play very well in those marketplaces. But we also have a very strong AS/400 market and about 80 percent of our AS/400 business comes from our installed base. And, each year 20 percent of our business comes from new customers. That’s a pretty good business model. We continue to add in each year, in succeeding years, those customers. Rarely do we lose an AS/400 customer, so the base of installed customers continues to grow at about that 20 percent rate. We’ve looked at and positioned our servers, and when you look at where we go after new customers for the AS/400, it’s in core applications for mid and small markets, and in remote, global locations of our largest customers, and it’s Domino across all sets of customers. We have a very strong Domino offering.

So, we have a very clearly defined place for us to go and drive the AS/400 based on its characteristics--core applications in medium and small, geographically dispersed locations of large companies where they’re looking for a very highly reliable, low staffing requirement in their worldwide geographic locations, and Domino across all size customers.

MRS: Can you comment on what is going to happen after the scheduled price increase goes into effect Feb. 1?

TJ: What we have announced is that for upgrades, that price increase is effective Feb. 1 for upgrades from older models to newer models. We’ve done that in the past based upon the decline in residual values of those older models. If you don’t make that adjustment, then you open yourself up for the opportunity for brokers to buy old systems, upgrade them at cheaper prices and then undercut your current prices. All we are trying to do is to hold our current prices and reflect the fact that based upon the value that our new systems provide that it has an impact on older systems. So customers that are staying current with technology aren’t impacted at all, and for those customers that haven’t stayed current, we gave two months notice that we were going to change and increase upgrade pricing. And for the most part, customers and business partners have said that makes sense. There has been very little negative feedback on that strategy. Most of our competitors don’t even provide an upgrade path. When you have an NT server, you throw out the old one and bring in a new one. We protect our customers’ investments and allow them to upgrade in place, to keep the serial numbers, to extend their leases, to move I/O components onto new boxes and protect that base. And if you go and look at the price/performance of those upgrades, even with and after the price increase, we are providing more price/performance with those upgrades than we ever have in history.

MRS: In five years, where do you see the AS/400 and what do you want people to be saying about the AS/400?

TJ: I still think the AS/400 will continue to be a solid system in the marketplace in five years. We’re making development investments now that will yield system enhancements from a technology point of view in four or five years and we wouldn’t be spending that money if we didn’t expect a return on that investment. So, I clearly expect that as far as we can see into the future, we’re investing in the future of the AS/400. I expect it to continue to play an increasingly important role as a core application machine and in the world of e-business enablement. And by that, I mean as we move toward customers needing highly reliable application and transaction and data servers connected to the Internet, enabling a huge increased volume of transactions that the world of tying new users to these servers, that that will fuel the growth for the AS/400 for many years to come.

The bottom line is that the AS/400 is a vital business. It’s a marketplace within the IT industry--we have a very solid offering and it’s going to be around for a long time.