Sun's changing horizon

Despite Sun Microsystems' recent financial calamities, industry veterans say the battered company is hardly on the verge of collapse.

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Patent Politics

Battered company maps strategy for comeback

By Mike Ricciuti
Staff Writer, CNET News.com
October 7, 2003, 4:00 AM PT

These days, any news about Sun Microsystems seems decidedly glum.

Last week, the company reported a $1 billion tax charge and warned of a significant quarterly loss, an announcement that financial analysts seized on as evidence that Sun's core server hardware business is losing out to cut-rate competition from Intel. Then, Merrill Lynch analyst Steven Milunovich issued an open letter Thursday to Sun CEO Scott McNealy, urging him to cut expenses through additional layoffs to avoid becoming "irrelevant to most users, and eventually acquired."

But even in the face of this barrage, industry veterans say the company is hardly on the verge of collapse.

In essence, technology analysts and customers say, there are two Suns: One is the financially stressed company that depended excessively on Unix servers, became bloated on dot-com sales, hired more workers than it needed and, admittedly, signed too many expensive real-estate leases. The other is the technological innovator--known for spawning networked computing and Java--that is driving the latest industry advances in hardware architectures and on-demand systems.


What's new:
Industry veterans say although Sun has warned of a hefty loss and analysts are calling for drastic changes, the company has viable plans for the future.

Bottom line:
Projects such as Sun's N1 systems management initiative will help the company withstand competitors. But the company's lagging server business could keep it from moving ahead.

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To only focus on the first version--the Sun of old--is to miss the big picture, said Tony Scott, chief technology officer at General Motors, one of Sun's largest and most influential customers. "All of that infrastructure that Sun pioneered is valuable, important and will not go away. There is a lot more ground to be plowed where Sun has a lot of strengths," he said.

While acknowledging the company's immediate problems, he and others say Sun has laid out a viable technology plan for the future. Sun announced parts of that strategy at its SunNetwork conference last month.

Some of the company's most valuable assets, including its intellectual capital and new products in development, such as its N1 systems management initiative, will help Sun tackle new markets. Sun also has launched the Java Enterprise System, a no-nonsense, $100 per user software bundle that's already winning praise and customers, and its highly respected research and development unit is making progress on more efficient and powerful hardware.

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Above all, while Sun has lost some sales in recent months, the company's most important and influential customers are staying put, according to analysts and sources close to the company. Regardless of what critics say, the company still has about $5.7 billion in cash and marketable securities.

"I think Sun is back on track, from a product strategy standpoint, and I think they have some very significant assets, like Java, that if they are smart they can capitalize on," said Stephen O'Grady, an analyst with market researcher RedMonk.

From Sun's point of view, that's the good news. The bad news is that erosion to its Sparc server business is undeniable--and not likely to go away.

And should Sun continue to stumble, the wolves won't be far off. Sun hasn't "turned the corner in thinking their way entirely through a software business model...Their model is incomplete in terms of delivering software products to the marketplace," said Steve Mills, vice president in charge of software at IBM, one of Sun's main rivals.

Others see vulnerabilities in the company's management, specifically at the top. For example, though the rebellious McNealy has toned down his historically strident rhetoric in recent months, customers still want to focus less on what some call his obsession--the evils of Microsoft--and more on what Sun can do for them.

"We have told McNealy that he does fixate on Microsoft too much," General Motors' Scott said. "There are areas where there is real competition between the companies, but I think the competition is more on an industry-influence level."

The new Sun rising
If the Sun of old is fading into the distance, what will the new Sun look like? Perhaps the answer can be gleaned from another large computer company that was once thought to be headed for extinction: IBM.

When sales of Big Blue's proprietary mainframe and minicomputer systems began to tank around 1993, the company poured its resources into services--rather than products--that would help customers do business. A decade later, the IBM Global Services brand is an industry powerhouse.

With its N1 initiative, Sun wants to gradually move away from being a pieces-parts supplier and become essentially a giant systems integrator--a middleman role that makes disparate hardware and software work together, regardless of brand. Sun argues that it can better manage internal systems and reduce the artificial switching costs that have dominated technologies for years, Greg Papadopoulos, Sun's chief technology officer, said in an interview with CNET News.com.

In the process, Sun will reach into a deep stockpile of technologies that it has developed for years and finally turn them into commercially viable products. Some of its inventions, such as Jini--Java-based software for linking devices over a network--and related technology Jxta have languished as Sun struggled to devise a market strategy for them.

For instance, McNealy told CNET News.com last month that Sun was late in introducing its Java 2 Enterprise Edition application server, despite the fact that Sun owns at least three application server products.

Where it could all go wrong
The company's strategy, however, is far from bulletproof. For one thing, Sun's crumbling server business could be a persistent anchor that keeps the company from moving ahead.

If sales of Sun's Sparc systems decline faster than the company can increase sales of its Java Enterprise System and eventually N1, it may be in serious trouble. That, in turn, could result in calls to cut Sun's work force--including the man at the top.

Few people are calling for McNealy's ouster, but Merrill Lynch's Milunovich and others insist that Sun needs a solid No. 2 executive. "Even Larry Ellison needed Ray Lane," Milunovich wrote of Oracle's CEO and his former right-hand man.

In response, a Sun representative said the company has "a very deep management team. We have a team of COOs." The company has resisted repeated suggestions from Wall Street analysts to cut its massive research and development operations, which continue to grow despite losses.

Sun's product revenue declined 20 percent annually, according to figures released for the June quarter. But spending on research and development is 14 percent higher than it was at the peak of the dot-com boom, when revenue was 38 percent higher, according to J.P. Morgan. Papadopoulos said that level of spending is imperative if the company is to build the enterprise-scale infrastructure it needs to make N1 a success.

To keep its server gravy train running as long as possible, Sun has cut prices in response to increased competition. The company's unit shipments are in line with targets, but it is selling more low-cost, low-margin servers as opposed to more profitable Sparc systems.

Still, its server revenue is down, in contrast to rebounding sales from IBM, Dell and other competitors that also have cut prices, according to the report by Milunovich.

No hard numbers are yet available for recent months, but many analysts believe Sun has lost market share to IBM, which emphasizes sales of Linux and Windows-based servers. While sales have been sluggish because of overall spending on technology throughout the industry, analysts believe that Sun has taken a bigger hit--indicating that customers are moving away from big Unix products.

That leads to another troubling possibility: Some analysts, such as Bill Shope at J.P. Morgan, think that the improving tech economy may actually accelerate the move away from Sun's Unix servers to cheaper Linux systems because companies that finally have money to spend will attempt to maximize their investments. That means more affordable Intel servers running Linux or Microsoft's Windows systems could look even more attractive.

As a countermeasure, Sun is pushing software for business intelligence and corporate portals as a way to boost server sales.

To complement the Java Enterprise System for server software, the company also has announced a desktop bundle called the Java Desktop System, which includes StarOffice and other software. To combat market leader Microsoft Office, Sun has priced the software at $100 per computer per year or $50 per employee per year.

On paper, the N1 plan looks like a solid proposition that builds on the two dominant industry trends: Web services, for easy integration of systems, and utility or on-demand computing, which lessens installation headaches.

Now, all McNealy and Co. need to do is build it.

"At least from a software perspective, I think they have a good story to tell, and they are doing things to be successful," RedMonk's O'Grady said. "Whether they can execute is up in the air, but customers we have spoken to say this is interesting."

CNET News.com's Martin LaMonica contributed to this report. 

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