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