Industry Stratification Trend (Mar. 30, 1990)

BACKGROUNDER

1955-1980 Period. During the first 25 years or so of the computer industry's history, computer manufacturers basically competed with each other by trying to deliver superior price/performance with their hardware products. Led by people with a typical industrialist mentality, vendors almost routinely gave away their software, sometimes even services, perceiving them as a means to an end -- the end being to sell as many of their "black boxes" as possible. Some vendors (e.g., IBM in the 1950s and 1960s) also tried to aim their "black box"-solutions at the customers' real business problems. Nevertheless, even then, IBM continued to charge for the "boxes," not for the value of "solutions."

1975-1990 Period. At some point during the late 1970s, during the time the industry leader was losing substantial market share to the mostly Japanese-backed PCM competitors, some IBM executive must have awakened one morning and declared: "Enough, already!" In other words, since the "black box"-type competition turned out to be a losing game for the industry leader, the "Big Blue" decided to change the rules of the game. In August 1977, IBM started charging for its operating system software. It was the dawning of the "age of software and services."

THE NEW MACRO TREND

1990s... After having first addressed their "back room accounting" applications in the 1950s and the 1960s, computer users turned to their office and production automation projects in the 1970s and the 1980s. In most cases, however, this was done on a piece-meal basis -- one solution at a time. Now, an increasing number of large multinational corporations appear poised to enter the "brave new world" of networks, distributed databases, and global solutions. Not just because IBM is telling them that that's the wave of the future. But because it is the wave of the future! Some who have the foresight and the courage to try to conquer this as yet largely unoccupied turf, are likely to reap significant benefits. Not only will they gain a leadership role in their respective industries, but they may also be able to cash in on their pole position as founding members of a new breed of information services vendors. Ergo, by the end of the 1990s' decade, as the industry goes through a phase of stratification, it may be hard to tell a current user from a current vendor. What follows is an interpretation of how this macro trend may change your world...

PHOENIX, Mar. 30, 1990 - At IBM's last month's Executive Briefing in Palm Springs, George Conrades, the head of IBM's U.S. sales and marketing, said that in the 1960s, customers would have thought of IBM as "THINK" and "SERVICE" -- IBM's marketing slogans. "Increasingly we are becoming a consultant to the customer," he added. "We are in the solutions business. That means we are on the leading edge of change." Conrades also said that he was optimistic about IBM's success in this new business. This, he said, was "based on our belief in the ability to deliver what the marketplace wants -- the information."

That is why we asked Conrades during the question period if he would share with us his vision of the information service (not computer) industry in the 1990s. We explained that we could see that this new trend toward the bundling of products, software and services into global solutions will probably spell problems for some single-, and narrow-line vendors. And with a prospect of such industry shakeout, we wanted to know who, in Conrades' opinion, would be the major players in the information services (not computer) industry circa 2000.

"But Bob, that's how you make your money," replied Conrades, dodging the question while drawing a big laugh from the crowd at the same time. He then went on explain that all IBM is trying to do is be "responsive" (to customers). We could not help but think of a similar answer we got from Allen Krowe in May 1983, whom we then questioned about the reasons for IBM's change from rent to purchase (i.e., that it was "market-driven" !? -- see ACR Jul/83). As you know, IBM is now working hard on reversing Krowe's "market-driven" trend (see CMS BULLETIN 90-12, 3/27/90).

So, is IBM's "market-driven" trend of the 1990s going to end up in the same circular file of failed strategies as did Cary/Opel/Krowe's rent-to-purchase escapade? We don't think so. To understand the difference between the two IBM situations, let us turn to Mr. John Naisbitt, the author of the bestseller "Megatrends" from the early 1980s. "Trends are bottom-up, fads are top-down," was one of his postulates. In other words, new ideas, no matter how appealing at first (remember "hoola-hoops," or "cabbage-patch dolls," for example), have to find meaningful "grass roots" support in order to gain permanence. Otherwise, they end up as short-lived "fads."

IBM's rent-to-purchase strategy was born out of IBM's misguided strategy that, if the company became a low-cost producer (by mass-producing its products and then merchandising them off aggressively at low purchase prices), IBM would somehow be able to "hold the Japanese at the beaches." Meanwhile, just because IBM wanted to sell its products outright, didn't necessarily mean that the customers wanted to acquire them that way, did it?

As you know, customers' decisions to buy versus lease have a lot more to do with their own balance sheets than with that of the vendor. So, even at the peak of IBM's purchase activity (which we put at roughly mid-1988), the vast majority of high-end users, for example, continued to lease their mainframes -- either through IBM's or through independent leasing companies. In other words, IBM's move was "top-down," to borrow Naisbitt's terminology, not "bottom-up."

The quest for global integrated solutions, on the other hand, is a "bottom-up" trend. It is born out of most users' fear of the complexities of the "wired world of the 1990s." And fear is a powerful buying force. IBM happens to have "read" this trend early, and positioned itself to take advantage of it before others clued in (see our CMS BULLETIN 86-29, 7/07/86). That's a "bottom-up" change, however, which is the reason it is likely to survive the decade ahead. "Trends, like horses, are easier to ride in the direction they are already going,", concluded Naisbitt, as evidently did IBM.

IBM Driving The Demand For Bundled Solutions

If you know where to look, you will find IBM as the driving force behind this new industry trend. Since July 1984 (see "IBM Software Prices To Skyrocket" -- CMS BULLETIN 84-02, 7/19/84), we have been periodically explaining to you the reasons behind IBM's software price hikes and its increased emphasis on this business segment. In July 1986, we did the same with respect to IBM's systems integration strategies, and its new self-appointed role as the world's top consultant (see "Systems Integration/Solution Selling: New Role/Old Tactics" -- CMS BULLETIN 86-29, 7/07/86).

Finally, in August 1987, we also commented about "possibly the most important aspect of CSA[1], is that this bundling of service will make IBM more competitive across the board." This report repeated our October 1986 observation about the CSA, that "it represents a combination of bundling and volume discounting... Some IBM competitors may grumble that IBM's bundling of maintenance isn't fair... but bigger and more pragmatic IBM competitors (e.g. DEC) are busy copying IBM's tactics themselves."

Industry Stratification

In other words, after a few years in the "incubation stage," the new industry trend toward bundled global solutions should have finally become obvious to most informed participants in the industry. What will be the consequences of this new trend?

1. Value-added Pricing. One of the consequences of the demand for global integrated solutions will be a change in the way the industry prices things. Customers will be paying for the value added of the best solution for their global "Problem X." They will obtain the solution from a vendor prepared to provide such a "soup-to-nuts" service, over a multi-year period of time.

1.1 Pricing "Sub-Trend." An inevitable "sub-trend" inherent in such pricing changes will be a gradual transfer of wealth from the hard to the soft assets. As Jim Cannavino, the head of IBM's Personal Systems LOB, told us in Palm Springs, "in 1900, the U.S. manufacturing (sector) represented 75% of the U.S. employment. Today, this percentage is about 28%." By the year 2000, it will be down (conservatively estimated) to less than 25%, according to another senior IBM executive, Steve Schwartz. "The future is in the software and services," Cannavino predicted.

When told of our 1986-dated theory of "free MIPS" ("except perhaps for the mainframes for the time being"), this IBM executive who formerly headed up the company's mainframe (DSD) division, disagreed with our conservative assessment. Cannavino said that when he was a young engineer, he advocated that IBM should "give its mainframes away and charge only for the MVS" (i.e., its operating system).

By the end of this decade, 85% of the U.S. work force will be employed by companies with 200 employees or less, according to Conrades. "Today, there are five million small companies (with less than 50 employees) in the U.S.," he said. "But there is only a 30% (MIS) penetration! Two thirds of the revenue in the small and mid-range market comes from software and services."

1.2 Pricing "Sub-Trend." Another "sub-trend" will be a slowdown in the overall "price/performance" improvement in the industry, measured in terms of the price of the total solution's price/performance. That's because the "cheap" hardware will become an ever decreasing component of the users' total costs. On the other hand, while a single vendor with an early jump on the market enjoys a (temporary) monopoly with its unique solution in a given industry segment, the prices may well actually increase until such time that the competition catches up.

1.3 Pricing "Sub-Trend." Given the above "rising price" market scenario, the third pricing "sub-trend" will be a renewed preference for leasing as a method of acquisition (as opposed to purchase). That's not just because the vendors like IBM will drive it that way so as to maximize the return on their "rising price" products (e.g., software). It is also because the massive investments which huge global integration projects may put a crimp on the users' ability to fund them out of their own cash flows.

1.4 Pricing "Sub-Trend." Finally, the fourth "sub-trend" is that the above financing requirements will likely result in the birth of a new breed of lessors, whether captive (as with ICC), or independent (actual examples are yet to come). Unlike the traditional computer lessors which focused on the financing of hardware with ever-declining residual values, the new breed of lessors will also have to become industry application specialists in order to accurately assess the changes (up or down) in the value of the assets which they help finance. Needless to say, if any of the current independent lessors are to play a significant role in this "brave new world" of the 1990s, they will have to invest heavily in the upgrading of their peoples' professional MIS skills, including those of their senior management (see CMS BULLETIN 88-49, 8/31/88).

2. Proficient Users Turning Vendors. Users who first become very proficient with implementation of their industry's integrated global solutions are likely to market that "know how" to other users in competition with today's computer vendors. The competition between IBM and EDS, for example, which has intensified in the last 12 months after EDS/Hitachi's buyout of NAS, is only one of the early examples of this phenomenon. By the end of the 1990s decade, we suspect that it will be rather difficult to differentiate the vendors from the users using the same definitions as we know them today.

Forecast. Answering the question which IBM's Conrades dodged, by the time the next millennium begins, we suspect that there will only be about six leading "cross-industry vendors" left in this new information services market. Among the U.S.-based companies, besides IBM, of course, you can expect to still find EDS, DEC and AT&T as cross-industry "general contractors." The rest of today's U.S. "vendors," will be selling most of their products and/or services to one of the above "general contractors," rather than to the end users.

In addition, there will be a new crop of "user vendors" (even as this today appears a contradiction in terms) which will compete with the above "general contractors" in specific industries. Currently, it looks like American Airlines, Boeing, American Express, Citicorp, Aetna -- to mention some front runners in the airline, aerospace, financial services, banking and insurance industries -- will be the leaders. But this industry pecking order can easily change during the next decade, as a 10 year-time frame offers ample opportunities for major corporate "faux pas." Just ask IBM...

3. Single-, Narrow-line Vendors Turning Sub-contractors. As for the single-, or narrow-line vendors (e.g., Compaq, Apple, StorageTek, SUN Micro, etc...), they will find the sledding much tougher in this new "bundled" world of the 1990s. Since customers will be paying for "solutions" value added not "boxes," it will be very hard for a narrow-line company to single out the "boxes" out of a big bundle with which it can compete. Consequently, the narrow-line vendors will be forced, either to exit the market, or to reposition their marketing strategies from the "end user" sales, to selling to the "general contractors" as in 2. above.

4. Technological Foundries, Trouble For Japanese. Fueling both the "general contractor" and the "subcontractor" products, will be the various "technological foundries," including those of today's vertically integrated vendors like IBM, Fujitsu, Hitachi etc. In the mainframe business, we expect to see the above three vendors still around in this role as the "Big Apple" drops on New York's Times Square signaling the "year 2000." But, their customers will have changed.

IBM may still be producing most of the basic chip technology for its own consumption in year 2000, but it may also be selling it to some other enterprising "general contractors." Other general technological foundries (mostly Japanese), on the other hand, will be selling their goods either to the "general contractors" as depicted in 2. above, or to the "sub-contractors" as in 3. above.

In either case, however, unless they do a 180�-turnaround, the Japanese computer makers are likely to be virtually shut out of the global integrated solution markets of the 1990s. That's because IBM, EDS, AT&T, DEC -- to mention some of the U.S.-based multinationals -- have all demonstrated greater international software and service aptitudes than did the Japanese, who have mainly focused on developing their domestic, and/or the neighboring Asian markets based on largely hardware-related solutions. In addition, the market potential which the opening up of Eastern Europe will represent in the coming decade, should give the European language-vendors an edge over the Asian-ones. The key word in the above assessment being "should." As IBM has so aptly demonstrated, having a "built-in" advantage and capitalizing on it can mean two entirely different things...

[1]1987.The latter included deep discounts which perplexed the industry.