IBM cutting new component deals

IBM today announced a $3 billion, five-year deal with EMC under which Big Blue will supply drives, components, and technology to the storage manufacturer. The agreement follows on the heels of a multibillion dollar pact to provide its competitor on the PC front, Dell Computer, with disk drives and other parts--but also comes on the same day that IBM reported its PC division lost nearly $1 billion last year, largely due to price competition.

Such moves bring into relief a side of IBM that will likely drive much of the computing giant's revenue growth in the next century: Big Blue will be a big supplier of electronic components, especially microprocessors.

Companies like EMC and Dell can cut costs and take advantage of cutting-edge technology by teaming up with IBM, while the latter reaps additional revenue from the factories it's already running. Both EMC and Dell, for instance, may begin to buy IBM's PowerPC chips under these deals for use in certain enterprise storage devices.

The key to IBM's strategy is its giant microelectronics business, which this week saw a change in upper management. The division, known for its state-of-the-art chip fabrication facilities and processor technology breakthroughs, could pan out as one of the company's most successful merchant OEM market operations, cranking out everything from chips in cell phones to satellites.

This is "IBM the behemoth" finally deploying all its strengths, according to Roger Kay, an analyst at International Data Corporation (IDC).

"You have to have a multifaceted revenue stream today," he added, noting that IBM is in a better position than most PC makers to do this because of its huge component-making operations which dwarfs even its largest U.S. PC competitors.

Meanwhile, today's massive PC loss "points to the long-term difficulty of making money off of PCs," Kay said.

Big Blue's shift in emphasis toward being a component supplier to the industry, combined with a possible de-emphasis on manufacturing finished PC, fits with the observations of Wall Street analysts.

In a recent report from BancBoston Robertson Stephens, analysts stated that IBM is struggling with its computer-based earnings. IBM continues to grow the number of PCs and servers it ships, but profit is declining because of price competition.

But the report labeled IBM's business model "the best in the computer industry given the high level of recurring revenue" that come from its disparate divisions, according to Dan Niles, computer analyst at BancBoston.

The EMC and Dell deals both point to large potential revenue streams for IBM Microelectronics. Each cite advanced chips as future components that may be purchased from IBM. EMC stated this clearly today, saying "the agreement is likely to include other IBM technologies, such as microprocessors and advanced custom chips."

IBM Microelectronics' OEM business is part of a push by a recently formed IBM umbrella organization called the Technology Group. This group, in addition to IBM Micro, also encompasses separate IBM divisions which make hard drives and displays, for example.

The big push from the Microelectronics--which also makes PowerPC chips for IBM AS/400 and RS/6000 computer lines and for Apple Computer's Macintosh--is coming as Michael Attardo steps down as general manager and John Kelly takes over.

Kelly has formulated a game plan which calls for delivering chips and components to the following key markets: server computers, storage devices, wired communications, wireless devices, Internet devices (dubbed "pervasive computing"), and chip packaging, also referred to as "interconnects."

Attardo grew this business from $150 million in 1992 to $3 billion in 1998. A 20-year IBM veteran, Kelly is likely to follow suit. Previously he headed up development of technologies in IBM's server group, which includes the AS/400, RS/6000, and 390 mainframe computers.

Some of the deals IBM Microelectronics has cut recently include:

• DSP Communications: This week DSP announced chips for Japan's Personal Digital Cellular standard cell phone market. These will be manufactured for DSP using IBM's advanced Silicon Germanium (SiGe) technology.

• Hughes, Nortel, and Harris Semiconductor: IBM is building SiGe components for a wide range of devices these companies sell, including networking equipment and satellites.

• Juniper Networks: IBM supplies basic technology for a chip the company uses in its routers/a>.

• Nexabit Networks: IBM provides customized chips for a high-capacity data switch.

• Kyocera, 3Com, and Sagem of France: Past supply agreements with these companies. IBM Micro has supplied printer chips to Kyocera, modem chips to 3Com, and processors for Sagem's digital TV set-top boxes.

In another deal announced today, IBM will partner with Sharp on "pervasive computing"--the concept of controlling automobiles, home appliances, and other devices equipped with integrated circuits via a network--and the pact may presage further cooperation between the two companies on components.

PC companies that IBM competes with will also look to Big Blue for chips. Specifically Dell may "look to IBM for I/O chips and other subsystems for servers," said a source close to Dell.

At the time of last month's announcement, Dell cited IBM's cutting-edge copper and SOI chip technologies as key attractions.

Indeed, in one respect, this is one of the oddest alliances. Analysts have cited IBM as one of Dell's keenest competitors vying for corporate PC customers. "We have heard from multiple accounts that IBM has become very aggressive and as a result is winning a fair amount of their bids, especially against Dell," according to BancBoston Robertson Stephens.

But IBM may find that this kind of competition doesn't make it much money nor generate adequate revenue as PC prices continue to drop--which is impacting all PC maker's bottom lines.

"IBM has more potential than any other computer company" to transform itself, said Kay. Meanwhile PC makers like Gateway, which is the diametric opposite of IBM in terms of internal assets and company structure, are struggling to find new ways to drive revenue growth.

"Gateway has no proprietary technology like IBM, so they're scrambling to sell a stream of services rather than just a PC" to make more money, he said.

Services is another IBM key strength and a deal with Dell may in the offing here too.

The upshot is that IBM growth markets are everywhere but PC boxes. "IBM has identified services, software, and the sale of its leadership [hardware] technologies as key growth areas for the company," IBM said today.