[OT]: IBM's view on how chips make 'valued-added' proposition

From: John Smith (a_at_nonymous.com)
Date: 06/09/04 

Date: Wed, 9 Jun 2004 08:14:03 -0400

IBM's Computer-Server Business
Puts the Squeeze on Rivals

By WILLIAM M. BULKELEY
Staff Reporter of THE WALL STREET JOURNAL
June 9, 2004; Page B1

ARMONK, N.Y. -- Big Blue is back in Big Iron.

International Business Machines Corp., once a doormat for rivals hawking
cheaper and faster computers, is making strong gains in the $46 billion
global market for heavy-duty "servers" that power most big businesses.

IBM's server surge hasn't gained much notice, in part because it has been
overshadowed by a slowdown in the company's giant services business, which
accounts for about half of its total revenue. But it has put the squeeze on
competitors. Servers -- essentially any computer bigger than a desktop
model -- coordinate computer networks, crunch data, dish out Web pages,
retrieve customer records and perform other tasks.

After regaining the top spot in servers in 2002, IBM captured 32% of the
world-wide market last year, widening its lead over Hewlett-Packard Co., at
27%, and a sinking Sun Microsystems Corp., with 12%, according to
International Data Corp., a market-research firm in Framingham, Mass. Dell
Inc., the only other major company that is growing in server-market share,
stood at 9%.

IBM's gains also defy widespread predictions that the computer landscape is
moving toward domination by low-priced, low-profit "Wintel" machines based
on Intel Corp. microchips running Microsoft Corp.'s Windows software. It
also stands to be a long-term revenue builder for IBM, since servers drive
add-on sales of software, peripheral equipment and some service business.

Although IBM has had success selling Wintel boxes of its own, its most
powerful, higher-priced models use IBM-made chips and a variety of other
operating-system software. Some are smaller, modernized versions of its
giant mainframes of yore, once the engine of IBM's profitability. Indeed,
IBM says the key to its gains was its decision to continue designing and
manufacturing a proprietary line of microprocessors, the miniature brains of
computing, instead of standardizing on Intel chips as many competitors have
done. IBM also has been selling more servers that run on the free Linux
operating software, the bane of Microsoft.

IBM's strategy is to capture the high-profit part of the server market by
using its chips to design machines with unique advantages, and avoid
competing with Dell for the low-margin commodity business. Innovation can
"break monopolies," says IBM server chief Bill Zeitler.

German computer-services giant Sparkassen InformatikGmbH earlier this year
placed one of the largest server orders in history -- 20 new-style IBM
mainframes for an estimated $200 million (Sparkassen wouldn't discuss
prices). Among other recent wins: the American Society for the Prevention of
Cruelty to Animals, which replaced an H-P server with an IBM, and Alpine
Electronics, a unit of Alps Electric Co. that was a longtime H-P customer.
Alpine switched to IBM servers last year after concluding Big Blue's
technology made its computers cheaper to operate, says Vasile Giulea,
information-technology manager at the car-audio maker,

Steven Milunovich, an analyst with Merrill Lynch & Co., predicts that IBM
and Dell should continue to gain share in servers "while H-P and Sun are
caught in a squeeze."

IBM's Mr. Zeitler says his boss, Chief Executive Sam Palmisano, sees 15 to
20 points of server market share "up for grabs," with IBM well-positioned to
gain. Mr. Zeitler says the server industry should see four or five years of
growth because of replacement of old machines and huge new demand from
computing-intensive applications like high-tech security tags, digitization
of movies and video, and the computerization of health care.

IBM's rivals say they will hold their own. At Sun, Clark Masters, executive
vice president for enterprise systems, says his company has plenty of
resources to continue designing high-performance chips for its computers. He
adds that Sun's recent decision to buy Intel-compatible chips from Advanced
Micro Devices Inc. for use in low-end servers will make them
price-competitive with IBM's and H-P's low-end models.

H-P, meanwhile, has been touting a "high tech, low-cost" strategy that it
says will eventually prevail over IBM's "high tech, high-cost" strategy.
Mark Hudson, H-P's server marketing chief, says his company's long-term plan
to phase out servers based on its proprietary chips in favor of Intel chips
is good for customers, allowing it to provide "industry-standard components"
at prices "that customers will like."

It has been a slow but steady climb for IBM, which saw its near-monopoly in
business computing destroyed by competitors starting in the late 1980s. It
hit a low of 23% of the server market in the IDC survey of 2000.

Even before that, when things were looking their grimmest, then-CEO Louis V.
Gerstner Jr. asked the company's technologists why IBM shouldn't simply buy
microprocessors from outsiders, as other computer vendors were starting to
do. Ravi Arimilli, who heads the engineering team that designs chips for
IBM's servers, says Mr. Gerstner's question forced the chip designers "to do
something dramatic."

Their solution: the first chip to include two processors on a single piece
of silicon, called the Power4. The design cut costs and boosted performance.
Intel recently announced it will introduce chips with more than one
processor next year.

The Power4 chip became the heart of both IBM's family of servers running the
Unix operating system that is popular in business computing, and of a line
of midrange proprietary computers called the iSeries. Versions are also
being used in IBM supercomputers, including one called Blue Gene being built
for the U.S. Energy Department's Lawrence Livermore Labs that is supposed to
be the world's fastest computer. This year, the new Power5 chip started
rolling out of IBM's $3 billion semiconductor fabrication plant in East
Fishkill, N.Y.

Fossil Inc., a maker of watches and wallets based outside Dallas, considered
IBM and several other vendors when it needed to create a world-wide computer
system to unify units in 13 countries. Ed Jurica, Fossil's chief information
officer, says he was persuaded by the IBM machines' ability to run many
different software programs simultaneously.

That capability, known as "virtualization," stems in part from the
two-in-one processor design of the Power4. Mr. Jurica says Fossil is running
27 software applications on four IBM servers, minimizing the number of
computers he needs in his computer room. "We saved space and we can change
the system in a day" without having to buy a new computer, Mr. Jurica says.

Some critics question whether IBM's bet on chips will pay off long term,
given the continuing industrywide trend of growth in Intel-based servers.
Indeed, IBM's Intel-based server product line was its fastest growing last
year. Laura Conigliaro, analyst at Goldman Sachs Group Inc., calls IBM's
chip operation an expensive "albatross" that the company "has chosen to
stand by because of its strategic importance to the [server] systems group."

Another vital reason that IBM makes its own chips is to preserve its
near-monopoly in mainframe, the most expensive servers. These computers use
an operating-system software that runs only on IBM's chips. Japan's Fujitsu
Ltd. and Hitachi Ltd. dropped out of the mainframe business in 2002 because
they couldn't afford the cost of continuing to develop new chips to match
IBM's, though Unisys Corp. remains a niche competitor. IBM's mainframe sales
rose 34% in its first quarter, after a 7% rise in 2003, and its mainframe
plant in Poughkeepsie, N.Y., is running three shifts a day to meet demand.

IBM's chip business is supposed to stand on its own, and market to other
customers. In recent years IBM won the microprocessor business of all the
major video-game makers, and also sells the microprocessors used in Apple
Computer Inc.'s Macintoshes.

But IBM engineers haven't been able to scale up the production of a number
of types of chips ordered by other companies, so it isn't using the new
plant's full capacity. IBM's chip business reported a loss of $154 million
in this year's first quarter, on top of a $252 million deficit last year.
IBM executives vow it will break even by year end.

Earlier this year, IBM merged the chip business into the larger server
business -- and made chip executives' bonuses dependent on server profits
rather than just chip sales -- to reflect the fact that "the reason we have
chips plants is because we're in the systems business," says Mr. Zeitler. In
the first quarter, IBM's combined systems and technology group had a pretax
profit of $170 million on $3.78 billion in sales. That compares with
Hewlett-Packard's $120 million profit on $4 billion in server and
data-storage sales.

 URL for this article:
http://online.wsj.com/article/0,,SB108674389886532377,00.html

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