IBM says bye-bye to hardware and hello to the cloud

Here are two things you didn’t know about IBM: More than 200,000 of its employees are located in the Netherlands, and it is the third-largest seller of software applications in the world.

OK, the first item isn’t exactly correct; those 200,000 employees are only in Holland on paper — it’s a perfectly legal tax dodge. But the second item is exactly right, says Forrester Research analyst Andrew Bartels. By next year, he says, IBM’s application business will be worth about $8 billion, behind SAP and Oracle and ahead of Microsoft, excluding sales of Office. “IBM simply doesn’t like to talk about the application business because it makes its partners uncomfortable,” Bartels tells me.

The software business as a whole is the company’s second-largest income source, raking in $25.9 billion last year, more than a quarter of IBM’s total revenue, so it’s no surprise that IBM is moving to become a software and services company. But the speed at which the transformation is happening is startling, and the company is going to look very different in a few years — because it has to.

In its most recent quarter, revenue from IBM’s systems and technology business, which sells mainframes, servers, and other hardware, fell 26 percent to $4.3 billion in the fourth quarter, while cloud-related revenue rose 69 percent to $4.4 billion. That’s right: The cloud business is soaring, while hardware is tanking.

IBM is headed for the cloud

Indeed, on Monday IBM kicked off a campaign to rebrand itself as a cloud company, committing $1 billion to new cloud capabilities. That effort includes putting its portfolio of business software into the cloud, not just selling it in separate packages to individual businesses. Don’t forget: IBM spent $2 billion last year to acquire SoftLayer, a public cloud IaaS (infrastructure as a service) provider that complemented IBM’s private cloud business.

IBM sold its PC business years to Lenovo years ago, in its first big move away from computer hardware. More recently, it’s pulled away from its x86 server business, finally selling the remains of that business to Lenovo earlier this year. Now it appears that IBM will stop manufacturing semiconductor chips, according to multiple news reports. (IBM declined to comment.)

Getting rid of old products is not a new strategy for IBM. Over the years, the company has spun off typewriters, copiers, printers, satellite communications, networking services, and hard disk drives, as well as PCs, servers, and perhaps now chips. As “Lex,” the influential but anonymous columnist for the Financial Times, puts it: “When IBM sees profit draining away, it sells, and its timing is usually good.”

But there’s plenty of profit in the cloud, so IBM is moving there at full speed.

Bye-bye, Mr. Chips

IBM’s apparent decision to sell off its chip manufacturing business isn’t nearly as surprising as some pundits seemed think. It makes sense in the context of IBM’s overall shift away from hardware, and it also reflects the ability of IBM to get the advanced chips it needs for its systems business.

“IBM never really wanted to be in the semiconductor business,” says Nathan Brookwood, a principal analyst at Insight 64. “It realized decades ago that it had to have a semiconductor business to be competitive in mainframes. But at that time, there wasn’t much of a foundry industry, and what there was of it, was not very advanced.” IBM built its own, and it made significant advances over the years to stay competitive.

But in recent years, IBM has worked closely with Global Foundries, a chipmaker spun off by AMD, and it seems confident that Global can meet its needs, says Brookwood. Simply put, why should IBM build at great expense when it can rent the capacity it needs?

Some analysts fret that selling off its foundry business would hurt IBM’s ability to develop the advanced chips it needs for projects like Watson and other supercomputers. But the company has large and capable groups doing research around the Power platform and the like, and those groups would probably stay with IBM, adds Brookwood.

More cloud, fewer people?

IBM is quite open about its pivot away from hardware. But it’s much less open about what that may mean for employees. In a blog post kicking off the cloud campaign titled “Rethinking IBM: The company as a service,” IBM Senior Vice President Robert LeBlanc acknowledged the cultural shift, saying:

Like other long-successful companies, we have to change our existing mindset and adapt to a fast-changing environment. IBM started off as a tabulating machine company before becoming a leader in programmable computing, and, later, bringing the personal computer to the enterprise and helping corporations capitalize on the Internet. And we’re making the transition again.

In an interview with the New York Times, LeBlanc said, “The model is different in the cloud. It is a little more self-service. I don’t need as much SGA.” That’s ominous. SGA — sales, general business, and administrative costs — usually includes personnel. Given Wall Street’s unhappiness with IBM’s overall financial performance, layoffs, or at least a reduction in the work force by other means, could well be coming.

After the last disappointing quarter, CEO Virginia Rometty and other top IBM execs said they will forgo their bonuses, a gesture designed to show Wall Street a degree of seriousness and to tell employees that they are willing to make — as well as demand — sacrifices.

That probably won’t go down very well for people who get fired, but IBM is executing a very sharp turn. Everybody had better hold on very tight.