IBM Chases Vintage OS/400, HP-UX Servers with the i5

This newsletter has spent the past few weeks delving into the guts of the eServer i5 “Squadron” servers, their Power5 processors, and i5/OS V5R3. This week, I want to talk about IBM‘s marketing and sales plan for the platform. According to the top brass in the iSeries division, IBM is going to be pushing on several fronts to try to grow the OS/400 server business and pump up the OS/400 ecosystem on which it depends.

I recently had a chance to talk to Al Zollar, general manager of the iSeries line, and Cecelia Marrese, vice president of marketing for the iSeries, about what they hope to accomplish with the new product line. Not that this is necessarily indicative of the health of the iSeries line, but from those meetings I can tell you that they both seem to be a lot more comfortable and optimistic about where the iSeries is and where it is going. This is reflected as much in body language as in what they said.

Zollar told me that he wanted to keep the iSeries line, now the eServer i5, in the press and in the minds of customers as they consider platforms. And one thing IBM will do to make this happen is to keep significant iSeries announcements coming out at a steady pace and with the latest IBM technologies. “We are moving away from big bang announcements and moving on a roadmap where we have something significant to say to our customers every quarter,” he explained. “This will keep a level of interest and vitality in the platform.” It will also help with publicity, as the IT trade press that is consumed by IT workers, from system admins to chief information officers, will see a steady stream of i5 announcements.

But the strategy goes far beyond that. While the attention is good, the best kind of sales pitch is a competitive price for OS/400 servers and their related software. To that end, as we explained a few weeks ago, IBM cut memory prices by 20 to 60 percent and cut storage prices by 20 percent, it dropped the price of activating Power4 and Power5 processors on the iSeries and i5 line, and said that it would keep the common components (such as server processors, memory, and disks) at parity with the pSeries (soon to be “eServer p5”) Unix server line, which has historically had much lower list price tags and much higher discounts than for the iSeries. While IBM will almost certainly not close the gap at the retail level (even if customers bring in Sun Microsystems and Hewlett-Packard with competitive Unix, Linux, or Windows systems), the gap is considerably smaller, and the unique advantages of the iSeries over the alternatives make it possible to sell against those alternatives. Before, the sticker price was so high on the iSeries that business partners couldn’t even get their foot in the data center door to make a pitch. With these price cuts, which people like me have been clamoring for since the mid-1990s, the data center door has opened a crack, and the i5, with its sophisticated partitioning and multiple operating system support, has a decent chance of actually compelling CIOs and VPDPs not only to open the door but also to bring in partners to pitch the machine to solve their problems.

IBM has always understood that the box count for the iSeries had to remain high if the OS/400 ecosystem was to not only survive, but to thrive. And the price cuts are key to IBM’s plan to boost the box count coming out of the iSeries factories in Rochester, Minnesota, and in Dublin, Ireland.

Of course, with such big price cuts for servers, memory, disk, and other core components, this begs the question of how IBM can maintain iSeries hardware revenue, much less increase it. I have argued for years that the OS/400 server market is more elastic than IBM’s marketing model suggested. IBM had its reasons for charging high-prices–it needed the margins because its manufacturing costs were high, and to help pay for its very aggressive battle against Sun and HP in the Unix market, where it is arguable that IBM may not have broken even as it uses pricing as a way of gaining market share.

Now that IBM has huge credibility with the Power-AIX servers, and Sun and HP have backed off a bit on price cuts, IBM has a little more room. (I said a little.) IBM also has a little bit more room since the iSeries and i5 machines sold in Asia/Pacific are now being built in Ireland, where labor is cheaper and shipping costs to Asia are lower. (The pSeries manufacturing for Asia/Pacific customers also has been moved to Ireland, and IBM also has a bulk deal with United Parcel Service to ship from Ireland to Asia. This, combined with hundreds of tiny changes in the supply chain of parts that go into the iSeries, and in how the product is manufactured and delivered, has enabled IBM to get iSeries prices lower.

IBM cares a lot about revenue growth, but it has always cared more about profit growth. So with prices on the iSeries essentially cut by 40 percent with the i5 launch, can IBM grow revenues and maintain profits?

The answer seems to be yes. Zollar says that IBM’s plan is to sell more boxes, which is obvious enough, but that he also expects IBM and its partners to be able to sell richer configurations of the boxes. My guess is that the average selling price of a box is not as low as you might think, because the mindset shift from spending as little as possible to do the bare minimum of work on an iSeries to spending about the same amount of money or slightly more to do a lot more things with an i5. This is the bet I would make, and it is clearly the bet IBM is now making. (Heaven help us all. And I wish IBM had done it five years ago.) “I think there is a huge pent up demand for memory and disk storage,” says Zollar.

Marrese says that the Green Streak promotions in late 2000, which eventually led to the revamping of the iSeries line in January 2001, were the first step in the transformation of the OS/400 server into a competitive box. But a beta test in March of this year for the Model 520 and OS/400 Express packaging that debuted in early May seems to have been what pushed IBM over the edge to start cutting prices. Italy, Marrese explained, has a labyrinth of tax laws that make it painful to run a large business, and that is one of the reasons why the country is teeming with small businesses. Many of those small businesses, it turns out, have acquired AS/400 Model 150 and Model 170 servers. And they just keep using them and don’t upgrade as much as IBM would like. In the beta program, IBM took an iSeries Model 800, packaged it like the Model 520 Express machine (low price, lots of software, ready to run out of the box), and found out that if it cut the price of this configuration in half, compared with the cost of building it with regular iSeries Model 800 pricing, it sold twice as many boxes.

Another area that Zollar says he is focusing the iSeries division on is one of the standard drivers of the product line: high availability. “Because of the historically high reliability of the AS/400 and iSeries, our customers are very under-invested in high availability and resiliency.” While high availability and system clustering software have been the biggest drivers of AS/400 and iSeries sales in the past decade, my guess is that only about 10,000 of the 215,000 OS/400 shops in the world have implemented high availability solutions. With cheaper and easier-to-use high availability software, and much cheaper i5 boxes, IBM should be able to make it up in volume.

Zollar says he has implemented a few other changes to help boost sales. For one thing, he said that the company is reaching out to the legion of small iSeries partners with only a few dozen accounts to try to get them back into the game. IBM is giving decent discounts to partners that buy Model 520 Express configurations in blocks of 10 or 20, and the company will not sell the new i5 machines direct in competition with its channel, which accounted for about 85 percent of iSeries revenue in 2003, according to Zollar. While iSeries sales growth in 2003 was in the “healthy double digits” for midrange and high-end iSeries machines (Zollar said the number “began with a two” when I pressed him to nail it down somewhere between 10 and 99 percent, and my guess is around 25 percent revenue growth), it is the low volumes of entry machines that has been a drag on both iSeries shipments and iSeries revenue. Shipments were flat and sales were up 7 percent in 2003 across the iSeries line. Clearly, getting partners excited about selling the i5 Model 520 Express configurations is a key to the new strategy.

But it is not the only opportunity IBM is looking at. Marrese says that IBM booked around $100 million in Linux-related iSeries server sales in 2003, a factor of six larger than Linux sales on the box in 2002. She says sales to support traditional green-screen applications was flat or down, and that Domino, high availability, Windows integration, and WebSphere are key drivers. But what has Marrese smiling is the coming support for native AIX within logical partitions on the i5 machines. As it turns out, nearly 40,000 OS/400 customers also have Unix servers in their shops, of which the vast majority are running HP-UX applications. Getting even a percentage of these customers to port their HP-UX applications to AIX and move them onto the i5 supporting both their OS/400 and AIX workloads will go a long way toward boosting overall iSeries sales.

Perhaps more than anything else, the timing of the i5 announcement with a recovery in the worldwide economy is auspicious. Marrese says that, in 2003, iSeries sales in Italy, German, and France picked up, that North America started off strong, and that Asia/Pacific countries like China are exploding (albeit from a very small installed base). “Customers have been buying to do the bare minimum,” she says, “but now they are getting the green light to spend again.”