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IBM reaches for more software dollars; But Microsoft continues to loom as a giant problem


ARMONK, N.Y. - John M. Thompson wanted to keep International Business Machines Corp.'s software workers happy.

So when the software chief met new employees after IBM agreed to buy Tivoli Systems Inc. in January 1996, he didn't hesitate on a key question: Yes, the Friday beer bashes would continue. In fact, Thompson wrote a personal check to foot the bill.

IBM software workers might get more than a few beers today. With hardware sales down, the world's top computer maker is betting more on software, a business it once treated as an afterthought. IBM sees software's 75 percent profit margins and $13 billion in revenue as crucial to boosting sales and earnings without resorting to the cost-cutting of the past.

"To convince Wall Street they've really emerged from the dark days, they have to produce meaningful revenue growth," said Ulric Weil, an analyst at Friedman, Billings, Ramsey & Co.

Software may be IBM's best shot.

IBM's software sales rose 3.8 percent in the first nine months of 1998, anemic compared with Microsoft Corp.'s 23 percent rise, yet better than the 5.6 percent drop in IBM hardware sales.

Software contributes about a third of IBM's gross profit, what's left after subtracting costs of

goods from sales, while accounting for 16 percent of revenue. Software's profit margins are more than double hardware's 32 percent and more than triple the 21 percent for IBM's services business, often heralded as the company's growth engine.

"You don't need a whole lot of [software] growth to affect the bottom line," said CIBC Oppenheimer analyst Jim Poyner.

IBM had no reason to tap software in the 1960s and 1970s, when it controlled almost 80 percent of the emerging computer market. In selling its trademark mainframes, IBM rarely touted the programs that ran them, even though until last summer, when it was eclipsed by Microsoft, IBM was the world's biggest software company.

"They're a sleeping giant," said Laurie McCabe at Summit Strategies, a Boston researcher. "They've got these pretty good solutions and nobody thinks of them as a software business."

Now, IBM's using a boom in online commerce and computer networks as the opportunity to spruce up existing products and build new programs. It's betting that companies will use its software in every part of their businesses - from controlling inventory to creating Web sites.

To reach that goal, IBM will add 1,000 salespeople during the next 12 to 18 months to the 400 who work on database and other heavy-duty programs that compete with products from Oracle Corp., the top database-software maker.

It's also going after Computer Associates International Inc., the No. 4 U.S. software maker, with Tivoli products that monitor computer systems.

And once again, it's attacking its old nemesis Microsoft, pitting its Lotus Notes document-sharing software against Microsoft products.

"Software more and more is a crucial part of the revenue stream," said Jeffrey Maxick, an analyst at Madison Securities. "You're not going to see the hardware growth you saw in the past."

IBM's come a long way from the early 1990s, when it lost $16 billion in a three-year stretch, made salespeople wear blue suits and white shirts and was mired in bureaucracy that workers today call "Dilbertesque" after the cartoon drone named Dilbert.

IBM shares recovered too. IBM set at record of $189.50 a week ago, more than eight times its low of 21 in September 1993.

Still, much of the rebound can be traced to cost-cutting. IBM slashed nearly 37,000 jobs, or 14 percent of its workers, in the early 1990s.

It also has benefited from cuts in its tax rate to 30 percent from 36 percent in 1997 and gains in its services business. Overall sales growth at IBM rose just 3.2 percent during the first nine months.

Now, Chief Executive Officer Louis Gerstner is faced with wringing more growth from his slimmed-down businesses.

That's where Thompson comes in.

A native Canadian and 32-year IBM veteran, Thompson, 56, is aiming to jack up software sales to more than 10 percent a year before adjusting for currency fluctuations. He wants to widen gross margins to 80 percent to 85 percent, from 75 percent.

Investors could reward IBM if Thompson meets his goals.

"People are going to pay a lot more per share if IBM can show double-digit revenue growth," said Robert Finch, an investment manager at Aeltus Investment Management, a Hartford, Conn.-based firm that owns 1.5 million IBM shares.

Meeting Thompson's goals won't be easy, since some potential software customers are computer makers, unlikely to buy from rival IBM. Selling software to these companies "is an uphill battle," McCabe said.

Thompson had more to repair than slack sales when Gerstner tapped him in 1995 to head the new software division.

A big blunder came in the late 1980s, when IBM invested millions of dollars in the OS/2 computer

operating system, only to see Microsoft pummel the software in the marketplace. IBM still updates OS/2 but has turned its attention elsewhere.

Thompson began by speeding up product decisions.

Thompson moved quickly to support Java, the computer language created by Sun Microsystems Inc. that lets software run on all operating systems. Rather than the typical committee meetings to debate strategy, IBM adopted Java in three months.

Thompson also loosened up the workplace. IBM's main software office in Somers, N.Y., now has the occasional wine and beer gathering. Its Silicon Valley site in Cupertino, Calif., features a pool table and vintage 1980s video games.

And so far, the strategy of selling software that helps companies conduct their business online appears to be paying off.

Revenue from DB2 databases for Microsoft's Windows NT operating system more than doubled during the first three quarters of this year, said Steve Mills, general manager of IBM Software Solutions. He declined to give specific sales figures.

Tivoli, Lotus Notes and MQSeries, which directs information on networks, are posting sales gains as well, analysts said.

Competitors - especially Microsoft - aren't standing still.

"When I start getting questions from clients on IBM software, I'll know the company's succeeding," said Dan Kusnetzky, at International Data Corp., who covers the software industry for the Framingham, Mass.-based researcher. "Right now, the questions revolve around Microsoft."

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