Annex Newsflash 2005-34                            October 28, 2005


Updated 10/28/05, 9:10 AM PDT

Analysis of IBM's Business Strategy for Growth

Big Blue Thinks Small Is Big

SMB: "Top Growth Opportunity" for IBM

SCOTTSDALE, Oct 28 - "Mighty oaks from small acorns grow," goes an old saw.  Microsoft was once an SMB (small and medium size business), and Bill Gates was a relative nobody.  Today, Microsoft is a $266 billion (market cap)-mighty oak, double the size of Big Blue, and still the king of the IT hill, despite its waning power.  

Michael Dell and his Dell  Inc. were once also a tiny SMB operation.  Today, they are a $75 billion-PC juggernaut, outpacing by far even the market cap growth of the giant Microsoft (see the chart).  Larry Ellison and Oracle... the same story.  Scott McNealy and Sun Microsystems... ditto!  The tale of two Steve's... Jobs and Wozniak... and their start-up (Apple), conceived in a garage, is a famous Silicon Valley legend.  

Similar success stories abound in other industries, too, spinning the laurels yarn into permanent lore.

IBM's 2002 Epiphany

The fact that there are millions of entrepreneurial acorns like the above examples strewn all over the U.S. and the globe, ready for someone to nurture them into mighty oaks, seemed largely lost on Big Blue until late 2002.  That's when IBM experienced an epiphany.  His name was Sam Palmisano.  While the former Big Blue boss, Lou Gerstner, remained infatuated with bigness and empire building during his nine years at the helm, his successor worried more about how to get the stagnating giant back to growth.

"Do you know how SMB became the top growth opportunity for IBM?" Steve Solazzo, the head of IBM's SMB global marketing efforts, asked this writer during a recent meeting in New York before proceeding to answer his own question. "Because Sam (Palmisano) put it there."

Ever since early 2003, the SMB has been one of the two important prongs of IBM's growth strategy (the second being the "OnDemand Business" campaign - see the logo).  Here's what we said about it in February when IBM enhanced its "SMB Express" offerings:

IBM is putting its money where its mouth is.  Literally.  Big Blue is again trying to woo small and medium size businesses (SMB), the growth engine of the U.S. economy, whose revenue contribution to Big Blue sputtered last year, according to IBM's latest financial release (see "A Crescendo Finale!", Jan 2005, "Finally Heard!", Jan 2003, and "Finally Heard, Part II", Nov 2003).

(Excerpt from “IBM Thinks Small Is Big in Financing”, Feb 2005).

And here's what we said about SMB back in 1996:

There is an obvious mismatch between the 1996 IT opportunities and the IBM revenue plan. Bruce Harreld, IBM's chief strategist, whose talk followed Gerstner's, said that more than 50% of the 1996 IT revenue opportunity lies in the small and medium companies market, which is growing at 14% to 15% per year, i.e., almost double the growth rates of the industry. "Technology is allowing these guys to compete with the big boys in their industries," Harreld explained. He should know. That's exactly what Harreld did himself at Boston Chicken when competing with McDonald's, KFC and other food industry giants.

But despite this and other subsequent rhetoric about how important the small and medium companies are for IBM, the Big Blue is still heavily dependent on the "giants," it turns out. In 1996, for example, about 70% of IBM revenues will come from some 4,000 top customers, according to Bill Etherington, who heads up the company's industry units. "That's about a billion a week," he said.

(Excerpt from “Louis XIX of Armonk”, Aug. 1996).

Ever since, we have been recommending to IBM and to our other IT clients to look down the customer pyramid for acorns which they can help grow into mighty oaks (see "IT Industry: Whither Goeth It?," Jan 2004 - an Annex Bulletin on current and future industry trends).  WQe also suggested they price their offerings in such a way that they can share in the SMB clients' growth - on a usage or "per click" basis.  

Alas, better late than never...

Double-digit Growth

And how has IBM done since its 2002 SMB epiphany?  After a solid double-digit growth in 2003, IBM's SMB effort sputtered in 2004, before picking up steam again this year. 

Enter Solazzo, a 49-year IBM executive, whom Palmisano picked to head up the company's global SMB effort just over three months ago.  Solazzo has been there and done it all before when it comes to picking up and dusting off launching relative start-ups within Big Blue.  Back in 1999, Palmisano chose him to pick up the little-known penguin called Linux, and turn it into another track-burning engine of IBM's growth strategy (see "IBM Servers to Grow Again," Feb 2005).

In the latest (third) quarter, the SMB segment grew at more than double the IBM overall rate (10% vs. 4% - both figures adjusted for the sale of IBM's PC business to Lenovo).  At over $18 billion in annual revenues, the SMB now represents about one-fifth of total IBM total.

More importantly, the SMB market is highly profitable.  That's in part because many smaller contracts are shorter in duration and do not carry the high upfront marketing costs that large megadeals entail.  Also, since the SMB market is still sparsely saturated from an IT vendor perspective, many deals are sole-sourced, thus affording the provider higher margins.

And how is Solazzo going about his business of keeping the SMB on the double-digit growth track?  By trying to fuel and tap into the creative juices of the SMB entrepreneurs.

"A fundamental flaw is to approach the SMB market with dumbed-down products" (scaled-down versions of the large enterprise market offerings), Solazzo opined at this week's "SMB Summit" that IBM staged for analysts and consultants in New York.  Instead, Big Blue set out to develop and offer the kinds of solutions that stimulate the creativity and entrepreneurship of mid-market leaders.

That's because the SMB market drives innovation and generates 10 times the number of patents that the large enterprises create.  The SMB also creates 75% of net new jobs in US; 2/3rds of employment in Western Europe; and 3/4th of employment in Asia/Pacific.

IBM sees as its "sweet spot" the medium size companies, those with 100 to 999 employees on the above slide from the Solazzo presentaion - thus our visual interpretation of IBM's SMB view (right).   

Infrastructure and business solutions, that account for almost 60% of the market, are each growing in double digits, according to IBM.  Here are some specific industries and technologies and their growth rates:

Fast-growth technologies:

– Wireless 40%

– Digital Media 24%

– Online Gaming 49%

– Retail 20%

– Health Care 8%

– E&TS 20%

And then, of course, there are the emerging markets.  No surprise there about their importance to our clients and readers (see "Global Investments: Yin-Yang Pacific Tsunamis," Oct 2005; Global Investments: New "Drang Nach Osten", Sep 2005).  For SMB, the growth rates in major countries mirror that of IBM as a whole.

Fast-growth countries/regions:

– China 19%

– India 15%

– CEMA (Russia and Eastern Europe) 10%

– Brazil 7%

Services Join SMB Effort: "Partner or Perish"

IBM Global Services, lead by its Business Consulting segment, joined Big Blue's global SMB push in a big way just over a year ago.  Yet IGS already accounts for about 40% of IBM's total SMB revenue, and is spending about $300 million annually on this market development.

Jim Corgel, general manager of IBM Global Services (IGS) SMB marketing, estimates the SMB opportunity to be over $250 billion annually (see the chart).  Many of IBM's service solutions are offered with usage-based pricing.  They allow the vendor to share in the customer's success.  Which is another change in the way of doing business in the services sector that we have been advocating for the last 10 years.

Another was selling through business partners.  The latter now generate some $32 billion, or one-third, of IBM's annual revenues.  About 60% of that total comes in the form of hardware and software.  The rest accrues as services. 

"For each one percent share gain of small ISV (Independent Software Vendors) business, IBM gets $200 million in new revenues," said Buell Duncan, who heads up IBM's global ISV partnering effort.

"It's partner or perish," agreed IGS's Corgel.

Partner of perish.  The message sounds pretty ominous for the remaining "do it yourself"-types around the IT industry.  

"It's really amazing how much IBM has changed," one of the consultants who participated in the SMB Summit told this writer.  "It is opening up, partnering, asking for input from us and from customers, and using it in its plans.  By contrast, Microsoft, for example, is acting the way IBM of the old used to.  It no longer innovates.  It only seeks to protect its turf."

In short, while Big Blue is trying to nurture millions of acorns around the world into budding new forests, Microsoft, an erstwhile acorn, is acting like a mighty oak that wants to be the sole tree in a forest (an oxymoron).  We only need to look at the IBM of the old to see what lies ahead for Microsoft if it continues on such a path.

Meanwhile, the IBM shareholders have something to look forward to: Sharing in the rise and prosperity of the SMB entrepreneurs world over.

Happy bargain hunting!

Bob Djurdjevic

For additional Annex Research reports, check out... 

2005 IT:  Big Blue Thinks Small Is Big (Oct 2005); Fujitsu's Cautious Optimism (Oct 2005);  Global Investments: Yin-Yang Pacific Tsunamis (Oct 2005); IBM: Springboard Quarter (Oct 2005); Top Wall St Firms Bump Up Investments  (Oct 2005); Accenture: A Whopper Quarter  (Oct 2005);  Global Investments: New "Drang Nach Osten" (Sep 2005);  HP: Sweet Turnaround (Aug 2005);  Dell Spooks Street (Aug 2005); EDS Ups Its Forecast (Aug 2005);  Capgemini Beats Forecast (July 2005);  Fujitsu: Losses Reversed; Forecast Upgraded (July 2005);  IBM: Polaris Eclipses T-Rex (July 2005);   IBM Bounces Back (July 2005); Accenture: Smashing Records (July 2005); Merrill's New Bull (EDS) (May 2005);  IBM Trumps Trump (May 2005);  Tweaking Big Blue (May 2005); Hurd's First RBI (May 2005); Dell Rings the Bell (May 2005); Stock Buybacks: The Phantom Is Back (May 2005); EDS Misfiring on All Cylinders (May 2005);  HP Surges, Dell Slumps; Lenovo Completes IBM Deal (May 2005);  Fujitsu Revenues Flat, Lower Net (Apr 2005); Capgemini Jettisons Healthcare in N.A. (Apr 2005); HP: From India to Poland (Apr 2005); IBM: Slammed and Dunked (Apr 2005); Hurd Advice: Up Mount Market Cap (Apr 2005); Accenture: Roaring Ahead (Apr 2005);  Fujitsu Unveils New Servers (Mar 2005);  EDS Executive Suite; HP's New CEO (Mar 2005);  An iSeries Revival (Mar 2005); EDS Booster Club Fees Rise (Mar 2005);  An Upside-Down View (Mar 2005);   The Worst of Both Worlds (Mar 2005);  Octathlon 2005: Accenture Wins (Mar 2005);  IBM Global Services: Smaller, Shorter - Better? (Mar 2005);  IBM 5-yr Forecast: Quality over Quantity (Mar 2005); Rumor Lifts EDS', Fujitsu's Shares (Mar 2005); Capgemini: Turning the Corner (Feb 2005);  IBM Servers to Grow Again (Feb 2005);  Carly's Fickle Fans (Feb 2005);  CSC: Gearing Down on Purpose (Feb 2005);  EDS: Grossly Overpriced Stock (Feb 2005);  IBM Historical Update: 2004 Shot in the Arm (Feb 2005); New HeadTurners Series #1 (Feb 2005); IBM: A Crescendo Finale! (Jan 2005); Accenture: Strong Finish, Better Start (Jan 2005); Annex Coverage 2004: IT Services Dominate (Jan 2005)

2004 IT: EDS: The Titanium Stock (and other Wall Street tales) (Dec 2004); IBM PC: Good Riddance (Dec 2004); Fujitsu: Recovery Continues (Nov 2004);  IBM Server Renaissance (Nov 2004);  HP Hits Home Run (Nov 2004); Capgemini: Revenue, Stock Soars (Nov 2004); EDS: Jordan's Swan Song? (Nov 2004);  To Russia with Love and $ (Oct 2004); IBM: Slow Quarter No Longer (Oct 2004); Accenture: Revenues, Profits Up, Stock Down (Oct 2004); Capgemini: A Takeover Target? (Oct 2004); Sellout of America (Oct 2004); Spy Wars (Sep 2004); Outsourcing Boomerang (Sep 2004); EDS to Cut Up to 20,000 More Jobs (Sep 2004); Capgemini Stock Plummets on Unexpected Loss (Sep 2004); HP Savaged by Wall Street (Aug 2004); Moody's Lowers the Boon on EDS (July 2004); HP: Delivering Value Horizontally (June 2004); Accenture: Revving Up a Notch (June 2004); Beware Your CFO! (May 2004)IBM: Changing of the Guard (May 2004); Capgemini: Texas-size Home Run (May 2004); Following the Money (May 2004);  EDS: On a Wink and a Prayer (Apr 2004); HPS Wins by a Nose! (Octathlon 2004); Accenture: Burning the Track (Mar 2004);  IGS: "Crown Jewel" Restored? (Mar 2004); HP: Still No Cigar (Feb 2004); Cap Gemini: Another, Smaller Loss (Feb 2004); CSC: Good Quarter Gets Boos (Feb 2004); EDS: "Hot Air Jordan" Flaunts Flop as Feat (Feb 2004); IT Industry: Whither Goeth It? (Jan 2004); Cronyism Is Alive and Well at EDS" (Jan 2004)

Or just click on and use "financial engineering" or similar  keywords.

Volume XXI, Annex Newsflash 2005-34
October 28, 2005

Bob Djurdjevic, Editor
(c) Copyright 2005 by Annex Research, Inc. All rights reserved.

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