On December, 4th 2013 IBM's (NYSE:IBM) John Kelly (SVP and Director of Research) did a presentation at the 2013 Credit Suisse Technology Conference. The analyst asked some questions which seemed to be mostly dictated by Wall Street's concerns about IBM and, at least in my opinion, John Kelly gave some pretty good answers.
Especially a few statements on IBM's mainframe business struck a chord with me. As they were made here and there in different contexts, I don't have a single, comprehensive quote to support my point (and the transcript is rather imprecise), hence I will try to summarize the subject in this article.
According to Wikipedia, mainframe computers are used primarily by corporate and governmental organizations for critical applications, bulk data processing such as census, industry and consumer statistics, enterprise resource planning and transaction processing.
Several manufacturers produced mainframe computers from the late 1950s through the 1970s. The group of manufacturers was first known as "IBM and the Seven Dwarfs", later as "IBM and the BUNCH". IBM's dominance grew out of their 700/7000 series and, later, the development of the 360 series mainframes.
Interestingly, in the early 1990s, there was a rough consensus among industry analysts that the mainframe was a dying market as mainframe platforms were increasingly replaced by personal computer networks. InfoWorld's Stewart Alsop famously predicted that the last mainframe would be unplugged in 1996.
That trend started to turn around in the late 1990s as corporations found new uses for their existing mainframes and as the price of data networking collapsed in most parts of the world, encouraging trends toward more centralized computing. The growth of e-business also dramatically increased the number of back-end transactions processed by mainframe software as well as the size and throughput of databases. Batch processing, such as billing, became even more important (and larger) with the growth of e-business, and mainframes are particularly adept at large scale batch computing. Another factor currently increasing mainframe use is the development of the Linux operating system, which arrived on IBM mainframe systems in 1999 and is typically run in scores or hundreds of virtual machines on a single mainframe. In fact, IBM is known for having supported open-source software very early on. Rapid expansion and development in emerging markets, particularly People's Republic of China, is also spurring major mainframe investments to solve exceptionally difficult computing problems, e.g. providing unified, extremely high volume online transaction processing databases for 1 billion consumers across multiple industries (banking, insurance, credit reporting, government services, etc.)
Today, IBM mainframes dominate the mainframe market at well over 90% market share. The company has its own large research and development organization designing new, homegrown CPUs. Furthermore, IBM is rapidly expanding its software business, including its mainframe software portfolio, to seek additional revenue and profits.
The Future of Mainframe Computers
After this encyclopedic introduction, we will be able to understand much better what John Kelly had to say about the subject a few days ago. First of all, he perhaps surprised attending analysts (or at least Stewart Alsop) by stating that IBM's "mainframe business will continue to be very substantial" in spite of the recent slump in China (which was due to political issues). The explanation follows a few minutes later:
In the enterprise space systems of record, all of the big databases of banks and retailers and businesses reside historically in private datacenters. Those are by and large either staying on those systems in mainframes and UNIX systems or they are migrating to tower or to private clouds. That world is evolving and some of that will go to public clouds, but probably not a great deal.
This is very interesting. Everybody assumes that the cloud will basically take away IBM's old business and move it to public clouds where the company faces stiff competition by Amazon's (NASDAQ:AMZN) AWS and others. However, IBM seems pretty sure that this won't happen or at least not in this way. And not because they just close their eyes and ignore the technology of the future:
Our first efforts in cloud and we built what was probably the world's first cloud inside my research center in Yorktown years ago. But we then went after private clouds for big enterprise customers and so we built and developed internally very sophisticated, very resilient, very secured private clouds for large enterprises.
Our competitor came at more from public cloud and infrastructure as a service lowest cross point et cetera. So we came at it from different ends. We realized recently that we needed to play more on the lower cost side. We needed to have lower cost on ramps for smaller enterprises.
IBM does recognize that there have been problems, but this does not mean the company totally missed the boat:
Many, many large enterprises are dabbling around or doing like light weight things sort of front office things, with the AWS offering. But and that's okay. And you can also, lots of them are also doing it on SoftLayer. I mean we have as many hosting services and it's the cost point is actually below AWS et cetera. But they don't have access to this core system of record data.
Here we are starting to understand IBM's competitive advantage: As a huge amount of businesses has always based computing on IBM's mainframes, Big Blue is the only company around that can provide a smooth connection between the "old" technology (which nevertheless "will continue to be very substantial") and the private and public cloud systems:
So a real example would be a bank. They have tremendous records on buying patterns, financial records on their customers, but yet the personal that comes through the front door of their branch office or through their website or through their mobile device, is coming through a different avenue and they need to bring these two things together. So that they know more about their client, they can offer higher value services as a bank by bringing the systems of records and system engagement together.
That will occur on a cloud, that service those analytics will pull data from the back office, front office together on a cloud. We are extremely well-positioned to be the winner in that space for the enterprise because we are the only guys that have majority of that data on our systems and the systems record.
And with the acquisition of SoftLayer we now have the ability to hit any cost point, any size business on the front-end of this and pulled it together. So we are going after that intersection of those two areas from the cloud perspective.
Cloud 1.0 it's infrastructure as a service. That is not what cloud is going to be all about. Cloud and sophisticated value added services on the cloud is where the talk is going. And I think with our acquisition again a soft layer in our core organic capabilities, we are going to produce cloud based services at levels of security as an example that no one else in the world can possibly do.
The words "added services" finally lead me back to the title of this article: Is IBM the Apple of enterprise computing?
Definition of Enterprise Computing
According to Techopedia, enterprise computing is:
sometimes sold to business users as an entire platform that can be applied broadly across an organization and then further customized by users within each area. This means the analytics, reporting, database management and other applications are standard across the system, while the application packages being used and the data being accessed in each area will be different. In this sense, enterprise computing is a departure from finding single software solutions to specific business problems, such as inventory or accounting software. Instead, enterprise computing is intended to offer integrated solutions to these problems.
There is no doubt that IBM is one of the global leaders in enterprise computing. But what makes the business model similar to Apple's?
The IBM "Ecosystem"
There is a rough consensus among industry analysts about what is Apple's (NASDAQ:AAPL) greatest strength: its ecosystem. Apple not only creates a consistent and unique experience for each of its devices individually, but has created a more complete and user-friendly ecosystem. So if you just own an iPhone, you may still switch to Android, but if you also own an iPad, iPod and some optional accessories, your total investment in the Apple platform has become too great and by switching to another system, you would just lose too much of your investment. It all starts with a phone, but there is no end in sight.
However, Apple's success also strongly depends on soft factors like design, brand, fashion, hype. Due to the strength of its ecosystem, the company won't lose customers at a fast pace, but if the wind of fashion changes (maybe only temporarily), it still might not be able to sell its goods at the same high margins as before.
On the contrary, IBM's "ecosystem" is deeply rooted in enterprise infrastructures worldwide. At an age of more than 60 years, it's definitely out of fashion, but as we have read in the encyclopedic introduction, banks, hospitals, e-businesses and all high volume online transaction processing databases across multiple industries (banking, insurance, credit reporting, government services, etc.) require mainframe computers. That's why John Kelly states that IBM's "mainframe business will continue to be very substantial". However, even these businesses continue to evolve, as they need to adapt to global competitive challenges. They won't be able to just keep their good old mainframes running in their backyards, they will need to move some of their computing to the cloud, they will need additional services, software, consulting. Everything they do will need to fit perfectly to the "old" infrastructure and must smoothly interact with it. As I've already laid out in another article, this disruption brought about by cloud computing is the perfect environment for IBM's success. It is just like a disruption which forced all of Apple's customers to buy new apps and accessories.
But due to the deep roots of mainframe computing and its monopoly-like market share in this area, IBM's business model could easily be even more sticky than Apple's.
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.