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Oracle turns to service for future

After making its name as a database maker, the company may move increasingly toward an area likely to provide the growth it needs: services.

Upon closer inspection, the signs of Oracle's condition were evident: Its database sales registered only a slight heartbeat, and its applications revenues did not provide the lifeblood that the company had been counting on.

As a result, Oracle (ORCL) found itself reporting unexpectedly weak second-quarter earnings and revenues--causing the stock to plummet nearly 30 percent and Related story: Oracle stock plummets 29 percent set a volume record for trading on Nasdaq today.

If there was any doubt that Oracle was in need of new places to expand, this news took care of it. Now, Oracle--which built its name as a database maker--will likely move with accelerated pace toward a different area with growth potential: services.

Despite the weak 3.4 percent growth for Oracle's licensing business, the No. 1 database software maker posted a 40.9 percent jump in its services business. That accounted for 60 percent of its $1.6 billion revenues in the second quarter.

"Customers no longer want to integrate equipment," said James Moore, an analyst with Alex. Brown. "They prefer to buy the applications, database, services, and receive competitive pricing all from one company."

The move toward services by big technology companies is not a new one. IBM (IBM) has proven that it pays to become the type of total solutions provider that Moore suggests.

Digital (DEC) and Unisys (UIS) are other examples of companies that have turned to services to generate revenue growth instead of simply spewing out products.

IBM's services was the fastest area of growth for Big Blue in the third quarter. Revenues from its services rose 19.7 percent to $4.7 billion in the quarter, up from last year. Compare that to a drop in hardware, software and maintenance revenues for IBM, along with a weak 0.6 percent rise in its rentals and financing revenues in the quarter over the previous year.

At the same time, however, services tend to generate a lower gross profit margin than software or hardware sales. So analysts say there is little chance that IBM, Oracle, and other manufacturers would one day evolve into to largely a services company.

IBM's gross margin on services was 20.3 percent for the quarter, compared with 33.8 percent for hardware and as high as 70.3 percent for software. Even maintenance, rentals, and financing outperformed services on gross margins. And its the gross margins that help drive profits.

Aside from the relatively thin profit margin, a chicken-and-egg dynamic will prevent many companies from evolving into service-only businesses. It is the sale of applications, for example, that will drive the need for servicing, notes Esther Schreiber, an analyst with Credit Suisse First Boston.

Oracle has previously said its gross margins on its services business is comparable to that of its products. Overall, its services revenues include software maintenance and support, consulting, and training and education.

Schreiber acknowledged that profit margins on its education and training tend to be similar to that of its software sales, but she said margins on consulting are less than that of software.

Even with these smaller margins, many analysts agree that Oracle and other companies can scarcely afford to ignore this potential market as the industry becomes increasingly competitive.

"As more an more companies consolidate around fewer and fewer platforms, companies like Digital and Unisys will lose out," said James Pickrel, an analyst with Hambrecht & Quist. "For a lot of these guys, the hardware [business] model is not supportable, so they change their organization to match the new realities and survive on lower margins if they build their company right."

Digital seems to have figured that out. Last month, chairman Robert Palmer said the company's worldwide services operation will be the primary driver of the company's growth this year.

"Today, customers spend 47 percent of their IT budgets on services, and industry projections indicate that spending will be closer to 60 percent by the year 2000," according to a statement Palmer issued at Digital's annual shareholders meeting. "We are in a strong position to take advantage of this growth."