How Low Can Big Blue Go

Last summer, as IBM was beefing up its line of high-end computer servers,
general manager Rod Adkins decided that employees needed a boost. Mugging for a
company video, he pulled on a pair of boxing gloves and shiny trunks, climbed
into a makeshift ring and, in a mock fight, promptly knocked out his opponent.
The logo on the other guy’s trunks: Sun Microsystems.

Turns out that was just round one. As demand dries up, server makers are now
hitting harder than ever on price, transforming this high-end business into a
game of how low can you go. IBM is looking tough to beat. On October 4, it
unveiled its most powerful servers yet. They came out just two weeks after Sun
started selling its brawniest box, the Starcat. While Sun’s servers are in
some ways more powerful, the Regatta sells for about one-third the price,
ranging from $450,000 to $1.7 million per box.

IBM’s assault couldn’t have come at a worse time for Sun, the leader in
the $19 billion global market for Unix servers. Spending on big-ticket computer
equipment continues to suffer as anxiety over the terrorist attacks and the US
response compounds the already jittery tech market. Sun had to warn Wall Street
on October 5 that its fiscal first-quarter loss will grow to at least $170
million and revenue will fall 30% from last year as dot-com and telecom business
evaporates. That forced Sun CEO Scott McNealy to cut 9% of his workforce, ending
his quest to weather the downturn without layoffs.

IBM’s latest salvo in the server wars is also bad news for its other
competitors. The No 3 and 4 players in the market, Hewlett-Packard and Compaq
Computer, already weakened, are ill-equipped to fight a price war. As they try
to sell shareholders on their proposed merger, they are fighting to hang on to
customers who fear the deal’s distractions will translate into lousy service.

The real fight, though, is between IBM and Sun. Three years ago, IBM realized
that Sun was trouncing it in high-end server sales. So it focused on lower
prices and improved technology. By 2000, IBM was offering discounts of more than
50%, sometimes throwing in free gear or services. The strategy worked. IBM
raised its market share to 20% in this year’s second quarter, up from 15% last
year, according to UBS Warburg.

Price lure

With only 1% of revenue and 4% of operating profits from high-end Unix
servers, IBM can afford to dramatically slash hardware prices. That helps lure
in high-margin services and software business. Sun, by contrast, depends on its
most expensive servers for 10% of revenue and 25% of operating profits, says an
analyst with Sanford C Bernstein. The lower IBM prices, combined with new added
features, means savings “in the millions,” says Regatta customer Joe
Giacometti, who buys technology for grocery giant Ahold USA.

Sun is hardly taking it lying down. It is about to release lower-priced
servers to appeal to cash-strapped customers. And when spending on tech gear
picks up, Sun executives also believe the rewards of continued investment in
research and development will boost its lead on IBM.

With Unix server revenue projected to fall 9% this year, the real game for
both IBM and Sun may simply be snatching customers from HP and Compaq. Together,
HP and Compaq own 27% of the market, but questions about their proposed marriage
are causing many customers to consider switching.

Other long-term customers are willing to give HP and Compaq the benefit of
the doubt for now. “At this point, focus is everything,” says Craig
Murphy, CTO at airline-reservations giant Sabre, which agreed this summer to
move to Compaq servers in a long-term contract. But as the IBM juggernaut chugs
along, getting and keeping more customers like Murphy won’t be easy for any of
Big Blue’s rivals.

By Andrew Park in Dallas, with Peter Burrows in San Mateo and
Spencer E Ante
in New York in BusinessWeek. Copyright 2001 by The McGraw-Hill Companies, Inc

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