Industry shift to services fuels IBM spree

IBM uses its fat checkbook to cash in on services-oriented architecture--and run from downward price pressure.

IBM has become one the software industry's most generous sugar daddies, ever-ready to buy smaller companies with technology that it covets.

The computing giant announced plans in the past three weeks to acquire three software companies: FileNet, MRO Software and Webify. If they all go through, the bill will total more than $2.3 billion.

And that's just the announcements made in the last month. If all recent deals go through, IBM will have shelled out more than $9 billion (all in cash) since 2003 on acquisitions, with the bulk of the money going to 31 software companies.

Beyond the benefit of added revenue, the thing that has unleashed IBM's purse strings is the computing industry's shift to service-oriented architectures, said the company's IBM's top software strategist Kristof Kloeckner.

"Services-oriented architecture in this case is really not just a buzzword. In this context, it's an operational strategy," said Kloeckner, vice president of strategy and technology for the IBM Software group.

Acquisitions of software companies--coupled with internal development and aggressive partner programs--are giving IBM the broad product portfolio it needs for the move to services-oriented architectures, or SOAs, Kloeckner said.

"We provide the enabling infrastructure. This needs to be fairly comprehensive. What's included covers the technology shifts within the industry," he said.

Snapping up smaller software companies has been a standard play in the business software industry game book as IBM competes against Oracle, SAP, Microsoft and Sun Microsystems to be a one-stop shop for corporate customers .

Indeed, IBM could face a , or an IBM competitor like Oracle could purchase another stand-alone content management company.

SOA is an approach to designing back-end systems in a modular way and, usually, around industry standards. If done well, a company can reuse software components, rather than duplicate existing work, and more easily share information among disparate systems.

Business software providers, including SAP and Oracle, are rearchitecting their own products to usher in growing use of SOA.

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To IBM and its massive consulting organization, the rebirth of the SOA concept during the past two years couldn't be better news, said Forrester Research analyst John Rymer.

"For IBM, SOA is the best thing that's ever happened. It's all about leveraging what you got. It can't be done strictly with products; it requires services. And the largest companies are the ones most aggressively adopting it," Rymer said. "The stars are in alignment."

Rymer noted that IBM's software acquisitions are increasingly being coordinated and funded with IBM's business consulting group.

For example, the purchase of privately held Webify was orchestrated by IBM software and IBM's services division. Webify sells a "framework" for building software applications, where much of the code is prewritten and designed for specific industries, such as insurance and financial services. Having reusable software improves margins for IBM's custom application development services business, Rymer noted.

The combination of software and services has become integral to IBM's strategy to growing its revenue and fleeing from low-price competition.

Software provides better profit margins in comparison to IBM's hardware business and traditional services business. The company expects that software will contribute between 8 percent and 10 percent profit growth in the coming years, according to a presentation by Steve Mills, IBM's Software general manager and senior vice president.

With revenue from its mainframe-related software staying flat or falling, IBM is counting on higher growth rates from it branded middleware: Tivoli systems management, DB2 information management, WebSphere application infrastructure, Lotus collaboration and Rational development tools.

In IBM's model, acquisitions contribute 2 percent to 3 percent of revenue growth and fill out its branded middleware portfolio, which represents almost half of the software group's $15.8 billion yearly revenue.

Some IBM competitors contend that IBM's aggressive acquisition strategy is hiding its anemic level of organic revenue.

Alfred Chuang, CEO of middleware company BEA Systems, said IBM's "sustained growth is totally based on buying things." He took a dim view of the planned FileNet acquisition, adding that BEA had no interest in purchasing the company.

"Primarily, it is really being able to offer our customers solutions faster and in a more integrated fashion. Some will involve removing duplication from the market."
--Kristof Kloeckner, VP of software strategy, IBM

Analysts noted that IBM's attempt to purchase of FileNet differs from most IBM's technology-driven purchases in that there was so much product overlap. In this case, IBM is more motivated by deepening its reach to FileNet's customers so it can sell more services, hardware and software, said AMR Research analyst Jim Shepherd.

IBM's Kloeckner said IBM generally pursues technology when it buys other companies, but in a consolidating software industry, IBM is clearly one of the consolidators.

"Primarily, it is really being able to offer our customers solutions faster and in a more integrated fashion. Some will involve removing duplication from market," he said.

By contrast, Oracle CEO Larry Ellison proclaimed his company is a "survivor and consolidator " and purchased a large installed base of applications customers from PeopleSoft and others.

Microsoft also has picked up its pace of acquisitions, though it has generally stayed clear from larger ones. The purchase of application providers Great Plains Software and Navision have posed significant integration challenges.

Another important facet to IBM's software spending spree is the pace of commoditization in the software industry. Like highly similar hardware servers based on the same standards specifications, many software components, such as application servers and development tools, are highly similar and difficult to differentiate.

By purchasing software companies with advanced features, IBM is trying to stay a few steps ahead of the downward price pressure from forces such as open-source and hosted services, Kloeckner said.

IBM seeks to get involved in the more complicated customer engagements that tap into all of IBM's resources, including its software and business consulting experts, Kloeckner said.

"In some instances, customers are happy with good enough products," he said. "Much of the value is how you put together the pieces."

He added that the company is always eyeing emerging markets, such as the convergence of telecommunications and television, or "enterprise mashups" where workers combine business systems with outside Web services like mapping.

Staking out the toughest computing problems typically leads to multiyear engagements with large corporations, noted Forrester's Rymer.

On the other hand, IBM's products tend to be complicated because they are designed to address a wide range of requirements, he said. Microsoft, by contrast, focuses on making its products be approachable by a very high number of customers.

IBM's most recent large acquisitions pose some new challenges, analysts noted.

With a great deal of product overlap, IBM will have a hard time integrating its FileNet acquisition--if it isn't outbid by Oracle, research firm Gartner said.

And IBM's planned buy of MRO Software, which makes asset management software, would push IBM into what some analysts said is the applications area. IBM has taken pains to stay out of the packaged application business because it does not want to compete with potential partners that would build applications on IBM's infrastructure software.

Despite these hurdles, IBM continues to focus on the anticipated rise in SOA spending, which gives life to both its software and services business. In fact, IBM has established centers meant to reuse many of the custom software "assets" it develops in service engagements.

"They're trying to gain the high ground because there's a new market coming along," Rymer said. "And IBM is not ceding that market to Oracle and SAP. They will participate and will seek to capture that growth."

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