Can Software Stop Sun’s Slide

It’s been a rough year for computer server manufacturer Sun Microsystems

Inc. Its free-spending Internet customers have gone the way of the dodo. The

soft economy has hurt demand across the board.

Most worrisome, it’s losing market share to hard-hitting competitors, such

as Dell Computer Corp. With its troubles mounting, Sun’s stock has plummeted

to less than $5, a 92% drop from its $64 peak in 2000.

So how do Sun execs plan to get out of this pickle? In a word, software.

While a stronger economy will help sales recover somewhat, the company’s top

brass think the hardware giant needs to act more like a software company to

address its long-term challenges. In a move underscoring the importance of the

strategy, Jonathan Schwartz, Sun’s chief competitive officer for the past

three years, took over the newly created position of executive vice-president

for software development on July 1. "Software is right at the center of the

future of this company," says Schwartz.

The software strategy, dubbed SunONE, for Open Net Environment, is designed

to spark sales across the company’s product lines, from servers to

data-storage gear. The idea is to use software, as a Trojan horse to get into

big corporate accounts that will then buy more of everything from Sun. The most

aggressive move is Sun’s decision to give away its entry-level

application-server software, a $3,000-and-up product that handles simple

e-business tasks like e-commerce transactions and runs the software for more

complex e-business functions. Once in the door, Sun figures it will more easily

sell additional software for things like controlling employee access to

networks. That should allow the company to grab a slice of the $28 billion

infrastructure-software market–and sell more hardware. To back up the effort,

the company in May set up a 1,000-person sales and service group dedicated to

selling software.

No question, Sun needs to do something about its sagging finances. The Palo

Alto company’s revenues for the fiscal year that ended June 30 are expected to

be about $12.4 billion, down 32% from a year ago. The company’s gross margins

have slipped to an estimated 40% this year, compared with 54% last year.

Although it is expected to break even in the June 30 quarter–the first time

that has happened in a year– many analysts question whether the economy alone

can spark renewed growth. "Sun has serious, serious technology and

strategic problems," says Bill Whyman, an analyst at the Precursor Group, a

research firm in Washington, D.C.

The company is being squeezed on both sides. Dell is concentrating on

sub-$10,000 servers and has boosted its share of the overall market to 7.4% in

the first quarter, from 5% in 2000, according to International Data Corp.

Meantime, IBM is a strategic threat at the high end because it can offer big

corporate customers complete, easy-to-use e-business systems with hardware,

software, and everything else they need. The result: Sun’s share of the server

market has dropped to 14.9% in the first quarter, from 17.0% in 2000, IDC says.

How will Sun’s new strategy help? At the moment, software accounts for less

than 5 percent of Sun’s overall revenues, according to Whyman, so even

doubling software sales would do little for top-line growth. Still, the

initiative will give Sun a broader product lineup to compete with IBM, and it

could fatten Sun’s profits. Business software carries gross margins north of

80 percent, compared with about 30 percent for most hardware. Doubling software

sales could add about 500 million dollars in gross profit, compared with 200

million dollars for a comparable revenue increase from hardware products. Sun

won’t specify its targets for software sales or hardware sales driven by

software.

For all its grand plans, Sun faces long odds given its track record. As far

back as 1993, Sun was promising to beef up its software business. Since then, it

has repeatedly tried–and failed–to become a bigger player in the market.

"I respect Sun a great deal," says Alfred S Chuang, CEO of BEA Systems

Inc, "But they have never proven they know how to sell software."

The biggest missed opportunity came in 1998. When America Online acquired Net

pioneer Netscape Communications Corp that year, it handed control over Netscape’s

software to Sun, giving Sun the two top-selling application servers at the time.

Although the market was tiny and fragmented among 40 companies, Sun’s 30

million dollar-plus in app-server sales was 10 percent of the total market,

twice that of its nearest competitor.

But Sun blew its lead. It tried to integrate the two application servers,

stumbled, and didn’t get a new product out the door for nearly two years.

Meanwhile, IBM and BEA introduced upgrades at least once a year. As the

app-server market boomed to 2 billion dollars annually, IBM and BEA dominated,

together selling more than half the app servers in the world. Sun is expected to

slip to a distant third this year, with a 12 percent share of the market,

according to AMR Research Inc. That puts it neck and neck with rival Microsoft

and database giant Oracle Corp.

SunONE is an attempt to take at least part of that market back. In May, Sun

started bundling, for free, its application server with its own Solaris

server-operating system. That’s only a first step. Later this year, the

company will offer the free version of its app-server software for Linux

operating systems and other UNIX programs–and, in a move akin to cats living

with dogs, for Windows. "We don’t think is the wisest

move for many reasons," says Schwartz. "But if that’s what customers

want, we’ll make that available to them." Sun says it is more important

to give customers options and compete on a product-for-product basis, rather

than lock them into a permanent relationship. "Our aim is to win with

innovation and quality," says Sun CEO Scott G McNealy.

And a good sales pitch. McNealy has forced Sun’s more than 300

vice-presidents to master Sun’s new message. He has had each one trained to

explain that Sun can offer complete e-business systems, then videotaped them all

giving a three-minute spiel. That should help execs push additional software to

go with its application-server product. Sun is selling integration software that

ties big computer systems together and works neatly with the application-server

software, directory software that controls the identities of people using a

computer network, and so-called portal software that makes it easier to share

information over a corporate network. Finally, by early next year, Sun will sell

two high-end versions of its app server that address specific needs of big

corporate customers, such as ensuring the reliability of their networks.

Sun’s pitch, that it can offer complete computer systems with hardware and

software, is resonating with some customers. They like the idea that one company

can respond quickly to any complaint.

Sun’s plans for the future could really get some attention. The company is

working on software, called N1, which is similar to the concept of grid

computing. Grid would allow a company to collect huge amounts of computing power

by using the Net to tap unused computers around the country. Sun’s N1 software

would enable grid computing so its customers could grab computing resources

whenever they needed them. The first version of N1 is expected early next year.

Put it all together, and Sun execs think they can finally compete for big

software deals. "Do we wish we could have done this faster? Sure,"

says McNealy. "But we absolutely have the right offerings at the right

place at the right time."

Still, Sun has a tough row to hoe in software. Ask competitors what they

think of Sun, and they don’t bristle–they scoff. "I think they’ve

lost their window. They had an opportunity to create a software business,"

says Scott Hebner, director of marketing for IBM’s app server, called

WebSphere. After years of scuffling, this may be Sun’s last shot to prove it

can get software right.

By Jim Kerstetter in San Francisco in BusinessWeek. Copyright 2002 by The McGraw-Hill Companies, Inc