Big Blue’s Big Bet on Free

Big Blue’s timing couldn’t be better. With fears mounting that Microsoft

will grow more dominant in the wake of a proposed settlement of the Justice

Department’s antitrust suit, companies may be considering alternatives to

Microsoft’s Windows. Adding fuel to that is the persistent irritation in

Corporate America over pricey licensing fees for operating systems, including

Windows and Solaris by Sun Microsystems.

Linux, on the other hand, is open-source software that is not controlled by

any one company. To boost the Linux movement, IBM is giving away its own

software tools–$40 million worth. IBM hopes that will spark a blizzard of

development around Linux in the same way the free Internet exploded. "Linux

will do for software what the Internet did for networks," maintains IBM

president Samuel Palmisano.

IBM is placing the biggest bet of any computer maker on Linux. This year, Big

Blue will spend $1 billion, or 20% of its research-and-development budget, to

rejigger existing programs or set up new projects around Linux. So far, the $88

billion computer giant has made the software available on all of its servers,

trained 300 consultants to design Linux systems, reworked 2,800 programs created

by other companies, and marshaled 7,000 salespeople to spread the gospel.

"The more we encourage the development of Linux, the more it will drive our

business," says Irving Wladawsky-Berger, who heads IBM’s Linux efforts.

Linux is looked upon to solve some of Big Blue’s long-standing problems.

Unlike Microsoft and Sun Microsystems, IBM doesn’t have one operating system

that runs across all of its machines and throws off juicy profit margins. With

multiple operating systems, it’s costly for IBM to develop and support all

that software. Linux offers a single system that can potentially span all of IBM’s

machines. And, by seeding the market with Linux tools and wooing software

developers, IBM hopes to regain lost market share for low-end servers.

Luring developers to Linux is becoming all the rage. Linux is now the

fastest-growing server operating system. By next year, Linux is expected to

claim 32% of the server market, up from 27% last year, according to market

researcher IDC Corp. Microsoft’s ubiquitous Windows, however, will own 47% of

the market by the end of 2002, up from 41% in 2000. The big loser is Unix, which

is expected to slide to 10% next year from 14% last year.

How will IBM make money on free software? The idea is to use Linux to not

only sell expensive computers but also high-margin software and big-ticket

support and consulting services. Because nearly 60% of IBM’s revenue comes

from software and services, Linux plays into IBM’s business model better than

any other computer maker’s. IBM believes the new sales will greatly exceed any

revenue loss incurred from giving away the Linux operating system. MDS

Proteomics, a Toronto-based drug-research company, bought a Linux supercomputer

from IBM to do complex chemical calculations. MDS CEO Frank Gleeson says 50% of

its multimillion-dollar deal with IBM went toward consulting services and

software, while the rest was spent on hardware and a joint-development effort

with IBM researchers.

Today, Linux machines are IBM’s fastest-growing server segment, generating

about 2.5%, or $350 million, of IBM’s $14 billion server revenue. Next year

Big Blue’s Linux servers could reach $500 million, or 3.5% of server sales.

And that excluding software-and-services fees, makes Linux a $2 billion business

for IBM in 2002. Linux could prove to be a very big investment in the future,

say analysts.

On the surface, those numbers show promise. But IBM hasn’t shined in every

corner of the Linux business. Despite its huge investment in the software, IBM

is only the No. 3 seller of low-end Linux PC servers, with a 15% share, down

from 18% during the first quarter, according to IDC. Compaq Computer was No 1,

with 29% of the market, and Dell Computer was No 2, with a 19% share. Both

companies gained share, while IBM slipped.

IBM’s Irving Wladawsky-Berger, who heads IBM’s Linux efforts, says those

numbers don’t capture the bigger picture. He argues that analysts

underestimate IBM’s overall Linux position because they do not include sales

of mainframes and other high-performance systems. Wladawsky-Berger says IBM’s

PC server market share dipped because the company has never been a leader in

low-end servers, where Compaq and Dell are price leaders. In September, IBM

created a new sales post to focus on boosting low-end Linux servers. IBM plans

to add hundreds of new sales and technical support staff, offer more free

training and rebates to resellers, and to pre-install more Linux software on its

servers. Wladawsky-Berger expects to see market share gains in 2002.

IBM has its work cut out for it. Not every business is smitten with Linux. A

survey of 100 technology managers, by Goldman & Sachs in November found that

65% had no plans to use Linux in 2002. While Linux is often used to run simple

tasks, such as serving Web pages, tech execs say they’re reluctant to use it

for critical jobs, such as processing transactions, because there aren’t

enough corporate applications written for Linux.

Teamwork



To make sure there is plenty of Linux software, IBM has taken out its

checkbook. Some 2,000 IBM programmers have developed Linux versions of IBM’s

software, including its DB2 database program. Software research at IBM now

revolves around Linux: Dozens of projects are in the works, from security

programs that manage access to wireless networks to a joint venture with Citizen

Watch to develop a Linux timepiece. IBM also is pumping up its

sales-and-marketing juggernaut to make the job of running Linux systems a snap.

After a salesperson clinches a Linux deal, consultants swoop in to help set up

Linux systems or fix more serious problems–for a fee, of course.

Indeed, in the past year, IBM has persuaded big corporations, including oil

giant Royal Dutch/Shell Group and Venezuelan bank Banco Mercantil, to embrace

Linux. In 1999, IBM helped CBS Sportsline move its pga.com golf site from a

Windows system to Linux. The site functioned so well that last year, the

sports-information provider rolled out Linux to the rest of its online

properties, buying 375 servers from IBM to handle the task. Analysts estimate

that Sportsline saves $4 million a year in lower hardware, software, and

maintenance costs. Now, IBM has to prove it can profit from Linux, too.

By Spencer E Ante in New York in BusinessWeek. Copyright 2002 by The McGraw-Hill Companies, Inc