Why Bad News For IBM Is Good News Your Business, But Only If IT Exploits

By | February 8, 2015

The news from IBM, which has been uniformly grim for years, gives the impression of a venerable tech giant in a death spiral. I don’t succumb to such fatalism and believe Big Blue’s problems aren’t terminal, indeed my next column will offer suggestions for how it can adapt to the new world order of cloud IT. Still, there’s no denying that IBM has been making headlines for all the wrong reasons. As I detail in this column, after another weak quarter that saw IBM report the 11th straight decline in revenue, the company had to fend off doomsday rumors of impending employee cuts on a scale rarely seen outside of corporate bankruptcy. Yet the problems buffeting IBM (note that mega-investor Warren Buffett isn’t one of them) stem from disruptive technology and the resultant shift in business strategies that result from the evolution of IT into a utility-like service, aka the cloud. Declining profit margins and, in the case of HP and IBM also revenues, at established IT vendors like Cisco, HP, IBM and Microsoft are a sign that competitive pressures from alternative technology providers is working. The benefits of this disruptive shift largely accrue to customers, the buyers of IT products and services.

IBM’s revenues have been declining for years, but it’s margins held up until taking a precipitous plunge this year and while the company is too large and complex to pin the cause on any single factor, enterprise acceptance of cloud services and the escalating price war among the big three IaaS providers, Amazon, Google and Microsoft, are clearly major contributors. Data aggregated by RedMonk illustrates declining rates for basic IaaS services.

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Cloud pricing has been called a “race to zero” by some analysts and ironically, IBM’s own Softlayer division (acquired in mid-2013) is price competitive with the big three. The problem for IBM, but also HP, Dell, Oracle, Cisco, EMC and every other large technology provider built upon (and used to) fat margins from proprietary systems and overpriced support contracts, is supporting competitive cloud pricing given their existing corporate overhead. Cloud services, namely selling canned infrastructure at $25-30 per virtual machine per month, threatens the existing businesses of traditional IT infrastructure suppliers and calls into question the sustainability of their entire business model. Amazon, the IaaS price leader and trendsetter, is doing to IT infrastructure and its vendors what it did to packaged goods and local retailers, decimating their margins through a combination of technology, scale and ruthless competitiveness. RBC Capital Cloud Price Comparison Source: RBC Capital / Business Insider

RBC Capital Cloud Price Comparison
Source: RBC Capital / Business Insider

As I discuss in the column, the market cloud services while small is exploding. IDC estimates that spending on all forms of cloud services will have “five-year compound annual growth rate (CAGR) of 22.8%, which is about six times the rate of growth for the overall IT market.” If correct, IDC estimates that by 2018, “public IT cloud services will account for more than half of worldwide software, server, and storage spending growth.”

One look at cloud pricing illustrates the challenge to old tech IT vendors. Google posted a detailed pricing example designed to illustrate its advantages versus AWS, however its numbers present an even starker contrast with the costs for traditional on-premise IT equipment. Using a prototypical three-tier application with server four components, each independently scalable depending on load, the analysis shows that the monthly cost on would be just over $1,000 on Google CLoud: $910 for the base load and $110 for peak capacity to handle 10x loads several times a day. Compare this to a $200,000 VMware EVO:RAIL system designed for the same sorts of virtualized workloads. In other words, you could run five of Google’s three-tier applications for three years for the price of a single converged (and highly cloud-optimized) on-premise system. Nevermind the fact that Google and company will continue improving through price cuts and system upgrades over time, even as dedicated, on-premise hardware technologically decays and fades to obsolescence.

Give credit to IBM leadership for recognizing the problem. Discussing the company’s latest quarterly results, IBM’s CFO identifies its fundamental challenge:

“For 2015, specifically, we are dealing with some transitions in our business,” Martin Schroeter, IBM’s chief financial officer, said on a conference call with analysts.

“For example, while we are fully participating in the shift to cloud, margins are impacted by the level of investment we’re making and the fact that the business is not yet at scale. We will see some year-to-year benefit to margins in 2015 as the business ramps, but we won’t be at scale.”

Unfortunately, the cure for IBM (and other old tech firms), in the form of radical cuts in employees resulting from the replacement of labor-intensive custom IT consulting and support services by automated, standardized cloud infrastructure, may be (or at least seem to be) worse than the disease.

IBM-GOOG-MSFT_empl_rev-empl

Look at the numbers. Google runs its entire business with 54,000 employees. The vast majority are in product development and marketing, not IT  operations and support. IBM has over 400,000 employees, but here most are in consulting, service and support. The transition from customized, on-premise IT infrastructure to standardized, utility services renders many jobs superfluous.

I contend that the symbiosis between corporate giants and Main Street business, infamously summarized by GM’s then CEO, is ancient history. What’s good for General Motors or IBM isn’t necessarily good for America. In IT, the democratizing effect of commodified technology, universal connectivity and resultant utility (cloud) information services levels the digital playing field between tiny startups and multinational corporations. Turning IT into a utility effectively ends the rapacious exploitation of a customer’s technological ignorance by big IT vendors. If your business isn’t taking advantage of cloud economics, more enlightened competitors will soon be eating your lunch. It’s time for organizations large and small to rebuild information systems and business applications upon a platform of adaptable, metered utilities, not static, dedicated plant and equipment.