BUSINESSWEEK ONLINE : JULY 5, 1999 ISSUE
INFORMATION TECHNOLOGY

Bringing Mainframe Might to PC Servers
After falling way behind, IBM is snatching back the business

When IBM (IBM) Chairman Louis V. Gerstner Jr. held his annual briefing for Wall Street analysts last year, he was brutally frank about the computer giant's PC server business, a segment of the industry that was fueling spectacular growth at rivals Compaq Computer Corp. (CPQ) and Dell Computer Corp (DELL). ''We missed this one so badly that I don't even like to think about it,'' he told analysts. ''We let Compaq run out and grab the PC server business.'' How much did Compaq snatch? Its 38% market share in 1997 was more than triple IBM's.

Now, however, Gerstner can hardly contain his glee. ''We've got great momentum,'' he crows. Indeed, for the first time in years, IBM is winning back customers and giving competitors fits. According to market researcher International Data Corp., sales of IBM's Intel-based Netfinity servers are up 63% in the first quarter of this year from the same quarter a year ago. IBM's market share for the same period climbed from 11% to 14%. And, in the past six months, IBM says it has won more than $50 million in PC server business with important customers such as Chase Manhattan (CMB), McDonald's (MCD), and Kinko's. Even sweeter: In over half of those deals, IBM says it is replacing Compaq equipment. Concedes Mary McDonnel, a Compaq vice-president for servers: ''We have seen IBM come back a little bit.'' But she insists Compaq isn't losing big time to IBM. ''It's ebb and flow,'' she says.

It's the flow that IBM must have. Intel-based servers account for $1 out of every $4 spent on computer servers worldwide. By 2003, that will be $1 out of every $2, according to IDC. That's because PC servers are getting more sophisticated and handling a bigger workload. Typically, PC servers connect small groups of users, say, a departmental E-mail system or a group's local files. But as the power of Intel (INTC) chips has grown, PC servers have gained the oomph to run such corporate jobs as Web sites and complex databases.

That's cutting into IBM's sluggish mainframe sales, a $4 billion business with 60% gross profit margins, analysts say. IBM's Netfinity line, on the other hand, may have 30% gross profit margins, but it's a $1.2 billion business that grew 100% last quarter. ''This is a high-growth market,'' says IDC analyst Amir Ahari. ''The last thing IBM wants is to be blindsided like it was in desktops. They let the PC market slip past them.''

Instead, IBM hopes to zip past rivals. To do that, the company has given its PC servers a complete technology overhaul while pumping up its marketing, including spending $5 million a year just on customer research. The key makeover ingredient: putting the best of its mainframe knowhow and reliability into the smaller, cheaper machines. At the same time, Big Blue has rolled out the red carpet for wary customers, winning over the likes of Blockbuster Entertainment Corp. (VIA.B) and Fuji Photo Film Co (FUJIY). ''Whatever a customer is going to spend on [Windows] NT and Intel-architecture products, my mission is to get the most of that we can,'' says David Thomas, general manager of IBM's PC company.

DOUBLE WHAMMY. Yet as Thomas sets off on his mission, he may find himself facing competitors armed with IBM's own expertise. Indeed, IBM is supplying rivals such as Dell with much of the same cutting-edge technology that is going into its own PC servers. That could be a double whammy for Thomas, since he still has to overcome earlier missteps and convince customers that IBM's servers are much better than a few years ago, when they were seen as pokey and humdrum.

That's why IBM decided to give its tiny PC servers mainframe might. In the summer of 1997, the computer giant plucked some of its top engineering talent from other computer groups and told them to go to work. Now, like its older mainframe cousins, IBM's PC servers simply refuse to fail. ''We tried everything that could happen,'' says Frank Governale, vice-president for operations at CBS News (CBS), which bought 14 Netfinity servers. CBS News was looking for servers to replace an aging 12-year-old system, but it wanted machines that were ultrareliable. IBM set up a Netfinity server and had a CBS technician start pulling out parts, including the power supply and disk drives. The machine just kept running.

Should something still go awry, IBM has an answer for that, too. Every machine has software designed to monitor the entire system, constantly on the lookout for impending failures--before the server can crash. The software senses something is about to go kaput, say a disk drive or power supply, and automatically sends a message to an IBM service center. If the problem can't be fixed online, a repair person is then dispatched with a new part. ''They're bringing mainframe discipline to the Intel-based server business,'' says systems analyst Dale Joseph of Bayer Corp., which is replacing its Compaq servers. The company will eventually have 100 IBM Netfinity servers to run E-mail and Notes software.

Thanks to other mainframe smarts, once the technicians arrive, they don't even need to turn off the ailing computer to replace the parts. IBM technologies called Hot Add and Hot Plug let the technicians swap or add parts as the machine is running. And on June 23, IBM unveiled a new top-of-the-line model starting at $80,000 and its latest mainframe-like technology, software that will connect up to 64 Netfinity computers, making the servers as powerful as a supercomputer. Says Michael Liebow, director of strategy for the Netfinity line: ''All we're doing is cherry-picking the best [mainframe] technology and bringing it to the Intel space.''

COMMITMENT. The changes are paying off. When Fuji went looking for PC servers to power a mini photo-processing lab it plans to sell to retailers, every company gave the standard price quote for the hardware--over the phone. But IBM's salespeople first asked to meet with Fuji to find out more about what the company was doing. Then they gave Fuji managers a tour of IBM's research operation, including a peek at some Internet technology that will help Fuji put its photo-processing system on the Web. The result: a $4.4 million contract for the servers and a commitment for future E-commerce business. ''I thought I was just buying hardware,'' says Bill Diminno, general manager of Fuji's Commercial Markets Div. ''Instead, I'm buying a lot of knowledge.''

To be sure, IBM is still No.3 in server sales: Compaq and Dell remain in the lead. And while Compaq has been struggling, Dell has been going gangbusters, edging out IBM for the No.2 slot by increasing its server sales in the first quarter 73%, according to IDC. Moreover, IBM may not be helping its own cause. The company is selling its winning technology to rivals. In April, IBM and Dell announced a deal valued at $16 billion for IBM chip, storage, and monitor technology that will certainly go into Dell servers. Meanwhile, Hewlett-Packard Co. (HWP) has licensed IBM's Hot Add and Hot Plug technology for its servers. Quips Michael D. Lambert, senior vice-president of Dell's Enterprise Systems Group: ''They probably make money off us and lose money on desktops and servers.''

True, IBM's PC business--which includes PC servers--lost nearly $1 billion last year. Most of that, however, was in desktop PCs, and analysts expect the business to at least break even this year. IBM's Thomas counters that the numbers don't tell the entire story. ''A lot of the profits we derive from our PC business show up in other segments [of IBM],'' he says. For example, maintenance or services sold along with Netfinity servers are booked as revenue by IBM's Global Services unit. ''It's never going to look exactly the same [as Compaq or Dell],'' says Thomas. Maybe not. But if Thomas can keep the momentum going in PC servers, then those comments might just fade away.

By Ira Sager in Somers, N.Y.

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