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IBM cloud efforts intensify as System z, Power hardware revenues tank

IBM's server hardware sales continue their decline as the company sharpens its focus on cloud software and services and ponders layoffs.

IBM's server hardware woes deepened this week as the company reported overall sales of that business plummeted some 26% in the fourth quarter, with its proprietary System z mainframes and mid-range Power systems particularly hard hit, dropping 37% and 31% respectively.

Big Blue's hardware profits for the fourth quarter alone were down $750 million compared to the same quarter last year and down some $1.5 billion for the entire year, the company's chief financial officer Martin Schroeter said during an earnings call on January 20, 2013.

This is a crucial year for IBM.
David Linthicumcloud consultant, Cloud Technology Partners

The continued bleak outlook for IBM's hardware business increases pressure on the company to make a successful, and faster, transition to focusing primarily on software and services, particularly in the cloud computing markets.

Schroeter said IBM is having "business problems" with some of its hardware lines, particularly the Power series and that the company would take actions in 2014 to solve those problems. He declined to specify how the company might approach this except to say IBM will continue to pursue converting its base of Unix users over to AIX and that the company does have Power 8 processor coming to market later this year.

What impact that might have in turning around that business remains to be seen. But clearly IBM has work to do in reinventing the Power series to make it more attractive in an increasingly cost-conscious IT world.

"The industry is transitioning away from proprietary hardware and toward industry standards that are more open and flexible," said Krista Macomber, hardware analyst with TBR, market researchers in Hampton, N.H. "They have to evolve that product line or kill it off and I don't think they are ready to do that yet. But they might be getting closer to doing that on the x86 (Series X)."

Just last week, IBM introduced a complete redesign of a traditional server rack with significantly increased density and server performance, called X6. Some industry insiders say it is an attempt to make System X more attractive to potential buyers. X6 is also compatible with the Power systems, and should enhance its competitive chances against the lower-cost Intel-based systems.

"(The X6) is smart innovation but in terms of stemming the profit declines, I don't think the X6 will have much impact by itself over the near term. Down the road it will help," Macomber said.

IBM's silver lining in the cloud

On a more encouraging note, IBM reported that total revenues from its software business were up 2% to $25.9 billion. This surge was led by its middleware products including Websphere, Tivoli and Rational which racked up $5.8 billion, a 5% increase over the previous quarter. Schroeter noted that IBM was also pleased with the sales of products from SoftLayer, which the company acquired in June 2013.

"We continue to position our business for the long term, while dealing with some significant business model issues in hardware," Schroeter said on a conference call this week. IBM's cloud computing revenue rose 69% last year to $4.4 billion, he said.

That positioning for the future became evident over the past couple of months as IBM executives have publicly stated in press briefings their intention is to integrate all the pieces of its software portfolio with OpenStack, along with making SoftLayer its primary cloud platform.

"We chose OpenStack as the platform because it is both a robust implementation for infrastructure services as well as a framework for incorporating new technologies," said Dennis Quan, vice president of strategy, IBM cloud services based in Raleigh, N.C. "It gives us the space we need to provision virtual networking or new ways to incorporate scale-out storage. [OpenStack] is not a research project, but a true product effort."

IBM has rolled out an OpenStack utility for its Platform Resource Scheduler product, which it claims can make virtual machine placement decisions in a cloud more intelligently than the OpenStack Nova compute API does.

IBM also demonstrated integration between OpenStack and its SmartCloud Entry product at last year's OpenStack Summit, but there are still more than 100 software products left to be integrated.

IBM plans to shut down the SmartCloud Enterprise Service in favor of SoftLayer on January 31, 2014. On top of that IBM also has to worry about expanding SoftLayer as it integrates software within its infrastructure. This is no small technical or financial undertaking: recently, IBM poured $1.2 billion into a data center expansion effort for SoftLayer, with the goal of operating 40 data centers globally by 2015.

Meanwhile, SoftLayer customers want to see IBM's offerings move beyond Infrastructure as a Service (IaaS). The ideal would be a common way to access products and better connect them through an online Software as a Service (SaaS) catalog, said Eric Alterman, CEO of the Brooklyn, N.Y.-based information-streaming company Flow Search Corp. Flow is a SoftLayer customer, but is also in the process of integrating Flow's software with IBM's Connections (formerly Lotus Notes).

"Conversations are going up the stack, as is the industry," Alterman said. "IBM has to figure out how it's going to compete beyond IaaS, at the app and integration layer. They have to win the SaaS layer."

Alterman knows it will be a tall order. "I'm optimistic, but there's plenty of execution left to do," he said.

IBM also must demonstrate SoftLayer as a viable platform for developers to use, according to James Staten, an analyst with Forrester Research, Inc., based in Cambridge, Mass. Now however, they're viewed more as a hosting provider and less of a cloud service provider, Staten said. 

"If they're not able to capture new apps, they will be in serious trouble -- stuck in the role of trying to milk just being an outsourcer and hoster," Staten said. "IBM can't afford that."

IBM must double down on cloud in 2014

IBM doesn't have unlimited time to "double down on cloud," according to David Linthicum, senior vice president with cloud consultancy Cloud Technology Partners in Boston.

"This is a crucial year for IBM," he said. "If they're unable to do that by the end of the year and get traction, it may be all she wrote."

While IBM has some work ahead of it, company officials believe SoftLayer will pay off over the long term.

"The SoftLayer acquisition is a big deal for us because we are able to establish this fairly large IaaS that sits on three continents with 100,000 servers and can serve as the foundation for our public cloud services going forward," Quan said.

The good news for IBM's future direction is that many more IT shops are aggressively storing data and applications on cloud-computing networks, rather than onsite. The bad news is they need many fewer new mid-range servers and mainframes.

IBM is adjusting to this quickening trend by offering more cloud services, eliminating jobs and divesting lower-margin businesses, according to Ginni Rometty, IBM's CEO, in a prepared statement.

The question is, can IBM build up its software and services business faster than its hardware business is declining.

Over this past week, IT watchers have speculated that IBM is trying to sell off its System X series of Intel-based servers. In the summer of 2013, some said that the company was in negotiations with Lenovo, which bought IBM's PC business a decade ago. The negotiations broke off reportedly because the two parties could not agree on a price.

The latest talks involve not only Lenovo coming back to negotiate again, but also Dell showing interest in purchasing the IBM series. In yesterday's conference call IBM reported that revenues from System x decreased 16%.

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Should IBM sell its System X servers?