Big Blue's Big Bet on Free Software

It's pouring cash into an all-out effort to promote Linux

By Spencer E. Ante in New York
Business Week

December 10, 2001

Over the next month, you may see a television ad called "The Heist." In it, a security guard calls the cops to investigate the disappearance of his company's servers. Then a doughnut-munching techie tells him the company consolidated all the work that was being done by a roomful of servers onto a single mainframe running Linux, the operating system that is available to anyone for free. A tad geeky for you? Put down that remote: IBM (IBM ) says Linux is ready for prime time--and it's spending a third of its TV ad budget this quarter to make the software a household name.

Big Blue's timing couldn't be better. With fears mounting that Microsoft Corp. (MSFT ) will grow more dominant in the wake of a proposed settlement of the Justice Dept.'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 Inc.

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," said IBM President Samuel J. Palmisano at the LinuxWorld Conference earlier this year.

It had better. 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, the exec heading IBM's Linux efforts.

Wladawsky-Berger is counting on Linux 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. Sun Microsystems Chairman Scott G. McNealy sees the plan as self-serving: "IBM is trying to coopt the Linux developer because the IBM software developer is on life support."

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. Consider MDS Proteomics, a Toronto-based drug-research company. MDS 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, estimates Sanford C. Bernstein & Co. analyst Toni Sacconaghi. Next year he predicts, Big Blue's Linux servers could reach $500 million, or 3.5% of server sales. And that doesn't include software-and-services fees, potentially making Linux a $2 billion business for IBM in 2002. Linux is "an investment in the future that could be very big," says Sacconaghi.

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 Corp. was No. 1, with 29% of the market, and Dell Computer Corp. was No. 2, with a 19% share. Both companies gained share, while IBM slipped.

IBM's Wladawsky-Berger 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 November Goldman, Sachs & Co. survey of 100 technology managers 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 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. "We feel pretty confident that we're going to rely 100% on Linux," says Dan Leichstenschlag, chief technology officer at CBS Sportsline.

Linux is helping CBS save money. Now, IBM has to prove it can profit from Linux, too.

Linux Lovefest

IBM is spending $1 billion to help increase corporate use of the fast-growing open-source operating system. Here's where the money is going:

2,000 programmers--the most of any computer company--are developing Linux versions of IBM (IBM ) software, including its WebSphere application server. IBM also has 10 centers around the world to help other software makers rework applications for Linux.

From tiny Intel-based servers to huge mainframes, IBM has tweaked all the models in its four server families to run Linux. It's paying off: Bernstein & Co. estimates that IBM will sell $350 million worth of Linux computers this year, $500 million worth in 2002.

Big Blue is spending at least $100 million this year to develop training, consulting, and support services for Linux systems. Corporate customers get help on everything from designing Linux systems to online tutorials.

More than 7,000 of IBM's 30,000-member global salesforce are pitching Linux to customers. And this quarter, one-third of IBM's TV ads are about Linux. The goal: Establish IBM as the leading Linux company.

Most software research at IBM now revolves around Linux. There are dozens of projects, including software tools to make it easier to write Linux applications. Most of the projects are two to three years from showing up in commercial products.

Copyright 2001