Indirect proposition: Inside IBM UK software supremo's profit plan

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By | Gavin Clarke 8th January 2014 10:03

Indirect proposition: Inside IBM UK software supremo's profit plan

Partners and tackling that PC myth...

Interview IBM’s Stephen Smith shrugs off our suggestion there’s more pressure on him now than ever before. And no wonder: he is a man with a profit-generating plan.

Smith is the UK and Ireland head of IBM’s Software Group – a unit that’s home to some of the biggest names in software, never mind the Big Blue brand itself.

As a whole, the group houses DB2, WebSphere, Informix, Rational, Tivoli and Lotus. By next year the plan is that these products will generate half of IBM’s profits.

That’s under the mandate of a 2010 roadmap that says "about" 50 per cent of profits will come from software by 2015 – up from 45 per cent now. If it hits the 50 per cent number, software will widen its lead over hardware and the renowned services unit.

The plan also calls for an EPS of $20, meaning Smith’s group must also inflate profits for shareholders.

The goal is more remarkable given software accounts for just a quarter of IBM’s net sales – 24 per cent. Services are still the big earner, accounting for 56 per cent.

“Listen, there’s pressure on us every day,” Smith told The Register during a recent interview. “That’s nothing new.”

Smith, who took post 18 months ago following various senior executive roles at IBM in the UK and Europe, needs to be clever: he's required not just to sell more, but sell more without incurring additional costs. Running the UK and Ireland operation means Smith will be contributing to the overall success of IBM software and systems group, run by executive vice president and group executive Steve Mills in the US.

So what’s the plan for extracting a disproportionate amount of profit from his unit?

Partners. Smith plans to sign up more in 2014, whom he hopes will customise and distribute more of software group's products. The idea is IBM can reach more customers working through third parties than it could going direct. Smith calls this switch a cultural change. Also, IBM is hiring and training more people with the “right” skills to make "complex" sales.

Software has become a more profitable venture in the tech business then either hardware or services. Hardware needs to be shipped and stored while prices have gone down, and you can the laws of physics mean you can only sell one unit per customer. Services only grows as you hire more bodies. But the same code can be sold again and again. Also, code doesn’t take up shelf space or demand a salary.

And yet Smith faces two major hurdles.

Smith: ROI is more aggressive, but it it’s something we relish

One is new entrants: startups like Dropbox and big names like Amazon are turning their attention not just to IBM’s traditional enterprise base but are signing up small-and-medium-sized businesses that are important for IBM’s growth.

Cloud startups like Dropbox pose a problem because they are viral in their sign-up and billing. This is what has given them a foot in the door at SMBs and the departments of big companies, and resulted in CIOs' business-collaboration platforms becoming based on Dropbox before they know it.

Amazon has started to prove a serious contender in enterprise IT infrastructure. So serious that IBM spent 2013 fighting a US government decision to award a $600m, 10-year CIA cloud hosting contract to AWS.

IBM complained to the US Government Accounting Office (GAO) that Amazon’s bid was $54m cheaper and the GAO found in favour of IBM. Amazon took the case to the Federal Court of Claims, which found for Amazon, saying AWS was simply a better cloud.

In the midst of this, IBM is also battling a legacy image problem – the perception that, unlike new entrants, IBM is only suited to “big” customers and that it's relatively slow.

“We are seeing more and more new entrants,” Smith told The Reg. “We are having to become more agile and flexible to deal with a plethora of new competitors – competitors we are not used to.

“I still think there’s a huge challenge for IBM in being able to communicate the breadth and depth of its portfolio,” Smith said. “There’s lots of traditionally held views out there that are lost in time... I’ve met customers who still think we sell PCs and that’s a long way from where we are.”

For the record, IBM sold its PC business to Chinese manufacturer Lenovo for $1.24bn in 2004, as part of a strategy to move out of low-priced commodity businesses. IBM’s decision today looks farsighted as Dell has gone private and Hewlett-Packard struggles to reverse losses at the hands of tablets.

Smith calls the idea that IBM is only for big businesses an “absolute myth”, saying IBM’s software acquisitions mean there’s plenty for SMBs.

Underlying all this is the computing paradigm shift that is cloud. This is a multi-faceted problem, and it's not just the fact IBM faces a new line up of competitors. Cloud poses a particular problem for those making and selling software, companies like IBM and units like IBM's software group.

IBM makes some chunky ol' enterprise software and like others in this field – Oracle and SAP – it’s business model has been site licenses and maintenance. IBM's software group has made its money by selling and supporting staples like WebSphere and DB2.

But just as growth is down at Oracle and SAP, so it’s falling at IBM.

Don't buy the software, float the software

Customers are thinking twice about the need to purchase a license for a piece of software. Instead, they realise they can rent time on or outsource the job to a service provider's servers instead, or they can virtualise the software on their own high-density servers.

A byproduct of cloud is that customers’ expectations are becoming more pronounced when it comes to actually buying new software. They expect ROI in six to 12 months, not two to three years as they did in the past, Smith said.

In IBM's recent third quarter results, Software Group worldwide made $5.8bn while its sales grew – albeit modestly, by one per cent.

But, still, software did do better than hardware and services: hardware fell a whopping 17 per cent and services was down four per cent

The biggest sellers in the software group were Rational developer tools and something IBM is calling Social Workforce Solutions, which includes Lotus - up 12 and 14 per cent. Information management (DB2, Informix and BI tools), and Tivoli systems management grew two per cent respectively.

But what of the WebSphere middleware portfolio – home of the app server? This was the toast of enterprise sales during the 2000s. Now it's the biggest loser, with no growth at all during the third quarter.

Compare that to early 2004, the heyday of the battle of the Java application servers and middleware. Back then, WebSphere revenue was growing by 24 per cent a quarter.

And remember that one per cent Q3 growth for Software Group that was reported late last year? Back in 2004, WebSphere’s income helped the software group hit quarterly growth of 11 per cent to $3.5bn.

“I’d be fooling you and everyone else if I didn’t say it wasn’t more of a challenge in this current environment - you have to work an awful lot harder on articulating a business proposition” - Stephen Smith

IBM is making some money from cloud, but not much from what we can see.

IBM doesn’t break out revenue from its cloud business but in the third quarter said cloud revenue grew 70 per cent to “more” than $1bn. Of this, $460bn was delivered “as a service” - meaning from IBM’s own Smart Cloud with the rest of the money, we assume, coming from sale of IBM software, hardware and services to help others set up and run their own clouds.

“I’d be fooling you and everyone else if I didn’t say it wasn’t more of a challenge in this current environment - you have to work an awful lot harder on articulating a business proposition,” Smith told us just before the Q3 results were announced.

“ROI is more aggressive, but it it’s something we relish. You have to work that harder, it’s so competitive out there now. It’s driven by economic factors and the rate and pace of change is so fast,” Smith said.

The answer for IBM’s challenge is to reach a broader market by selling more software through partners.

Smith told The Reg he’s shifted resources away from face-to-face and direct sales to third parties to achieve scale. His goal is to sign up more partners in 2014.

“It’s where I see the growth coming from and what the market is demanding as we look to branch into non and less traditional IBM areas,” he said. “Traditionally, software has been a very high touch face to face approach that we have relied on... we are now looking to go to market with our partners.”

“We don’t have the scale to deal with the amount of demand there is. A key part of strategy from a 2015 perspective in the UK is to extend out through the ecosystem system and market he challenge, the ISVs, the resellers a key part of what we are drying to drive.”

He said sales have been re-tooled, with the software group in the UK and Ireland hiring and training the “right” kind of salespeople.

IBM has been laying off staff - 6,000 have gone globally since 2009 and 300 from the UK and Ireland last year as part of cost cutting and restructuring.

Smith wouldn’t comment on plans in the UK and Ireland for further layoffs, but did claim his sales team was growing.

He said his team has been hiring, while IBM is looking at more training, so sales can make “a more complex value proposition” rather than “traditional product based sales".

He added: “What you are seeing in IBM it’s fair to say is a rebalancing in terms of the skills to respond to the market opportunities. We are making huge investments in people.”

Smith and his team in the UK and Ireland now have 12 months left to see whether the strategy of partners and a smarter workforce pays off. ®