As a long-term holder of IBM's (NYSE:IBM) common stock, I became concerned about IBM's business model after the two recent earnings misses. I began my research aiming to determine whether or not the public cloud was the hidden cause behind IBM's poor results.
The public cloud is a relatively new and powerful enterprise computing concept whereby clouds are built by Service Providers, provided to enterprise customers offsite and these customers are charged a "usage only" rate.
The public cloud movement is lead by Amazon (NASDAQ:AMZN). Amazon developed the idea from its excess computing capacity which was created to handle Black Friday and the holiday shopping season. Since Amazon was not using the massive spare capacity during the balance of the year, they began selling the excess capacity to businesses.
Giants such as Google (NASDAQ:GOOG) and Microsoft (NASDAQ:MSFT) have also created public cloud offerings for enterprise customers. The competition amongst these participants is essentially commoditizing enterprise computing and driving down prices.
According to a research note, The Clouds Part Implications of It-as-a-Service provided by John Roy, PhD, at UBS, the Client-Server Era is over, and the new IT-as-a-Service Era is being ushered in by the Cloud.
After speaking with Mr. Roy, I learned more about the public cloud. The public cloud is an efficient and cost effective computing model for start-up enterprises and businesses conducting most of their business over the web, the latter being businesses like Amazon or Facebook (NASDAQ:FB). However, according to Mr. Roy, as businesses grow, the need for data safety and reliability will most likely lead companies to adapt a hybrid model.
Mr. Roy pointed to Salesforce.com (NYSE:CRM) as an example of the Hybrid approach. Salesforce.com prides itself on being a quintessential cloud company. Salesforce.com even has both a cloud and a no software moniker in the company logo! Yet because data is essential to Salesforce.com's customers, and ultimately to Salesforce.com's business model, Saleforce.com has built its own private cloud, utilizing a public/private cloud hybrid model.
According to John Roy, "As far a pricing the two alternatives (public vs. private cloud), due to the uptime, recovery and regulatory requirements of enterprises building out on the public cloud, achieving the same level of functionality as the private cloud would cost you an arm and a leg."
In addition to Google and Microsoft, Oracle (NYSE:ORCL), Facebook, EMC (NYSE:EMC), Dell (NASDAQ:DELL), Cisco (NASDAQ:CSCO), HP (NYSE:HPQ), Verizon (NYSE:VZ) and many others have been positioning the companies for the Cloud.
According to the UBS research note, IBM is positioned to move in all directions, with public, private and hybrid cloud offerings.
The UBS research note discussed several other important technical issues that will be sorted out in the coming years as enterprise customers make their IT decisions. Readers with further interest are encouraged to learn more about Open Stack, Horizontal Stack and Vertical Stack.
The public cloud is pressuring IBM's service contract margins, and the commoditization of infrastructure in the cloud is putting pressure on IBM's hardware margins.
The combination of lower selling prices (service and hardware) and unexecuted contracts, possibly due to customers educating themselves on their cloud options, appear to be behind IBM's recent poor revenue results.
There is an enormous opportunity for IBM as enterprises transition into the cloud. IBM will have an opportunity to work with customers who wish to build internal private clouds. IBM can also support companies moving towards the public cloud as they have done with IBM SmartCloud for Avnet's Cloud Solutions in India. And IBM can offer customers hybrid solutions.
The competition is fierce. IBM's customers have choices, and IBM's customers do not necessarily have to utilize IBM for the entire computing architecture and infrastructure as they have in the past, which opens the door to competitors.
It is essential that IBM appreciate its existing customer relationships and continue to develop new business relationships. In order for IBM to remain relevant, the company must execute in the IT-as-a-Service Era with excellence in both sales and service.
The bottom line, while IBM does face some margin pressure from the transition to the cloud, the cloud is providing IBM an opportunity for future business. IBM has offerings to meet the customer needs in public, private or hybrid cloud adaptation. $100 billion in annual revenue ain't what it used to be, competitors are gaining on IBM. Customer focus (listening, understanding, adapting and servicing with excellence) and execution is the key to IBM's future.
Disclosure: I am long IBM. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.