Microsoft and IBM Woo Customers With Free Trials and Price Cuts
Jan. 22 (Bloomberg) -- In October, Richard Steel, information technology
chief of the 250,000-resident borough of Newham in London's East End,
hired a consultant to see whether Linux software would save him money.
Within a week, he says, Microsoft Corp. offered to pay Cap Gemini SA,
Europe's biggest computer-services firm, to evaluate Newham's needs. Steel
took advantage of the offer and canceled a free Linux trial from
International Business Machines Corp.
``You don't look a gift horse in the mouth, do you?'' says Steel, who
decided on Microsoft after the Redmond, Washington- based company cut
prices and pledged to give his 80-person staff free training. Steel
declined to disclose further details.
>From town halls to corporate campuses, the two biggest software makers are
escalating their fight for domination of the world's computers. Microsoft
is set to report fiscal second- quarter earnings today and has said sales
from long-term contracts have declined. Linux and security flaws in
Microsoft's Windows software are to blame for the slowdown, says Tony
Ursillo, an analyst at Loomis Sayles & Co., which holds 3.5 million
Microsoft shares among the $55 billion it manages.
Analysts polled by Thomson Financial forecast Microsoft's profit excluding
some stock-option costs rose to about $3.22 billion, or 30 cents a share,
from $2.55 billion, or 27 cents, a year earlier. Sales probably increased
14 percent to $9.74 billion, the biggest percentage gain in 5 quarters.
To challenge IBM, Microsoft has dispatched almost 20 salespeople and
consultants to Miami-Dade County, Florida, where IBM runs the computer
network that helps police retrieve criminal records and residents pay
parking tickets.
`Battle Becomes a War'
In New York, IBM and Microsoft are vying to update the Web sites of Major
League Baseball and its 30 teams, which attract 750 million viewers a
year. Clear Technologies Inc., a Coppell, Texas-based seller of software
and computers to small businesses, says Microsoft calls or e-mails as many
as seven times a day to promote its products; IBM keeps in touch at least
once daily.
``What was a battle has become a war,'' says Heather O'Loughlin, an
analyst at Boston-based State Street Global Advisors, which is one of the
top five holders of IBM and Microsoft shares.
The winner will command a larger share of the software that runs computer
networks and the programs that manage information and run Web sites.
Corporations and governments spent $172 billion on such software in 2003,
according to Framingham, Massachusetts-based market research firm IDC.
Companies need the Windows operating system to run Microsoft's database
and e-mail programs. With Linux, IBM can steer customers to its Internet
and database software, server computers and technicians to maintain the
systems.
`Biggest and Baddest'
``One of the reasons I own both stocks is that one of them will probably
win,'' says Michael Holland, a money manager for 30 years who helps
oversee $500 million at Holland & Co. in New York. ``They are the biggest,
baddest and best at what they do, and they understand that they need to
focus on each other.''
The operating system battle has its roots in the 1980s, when IBM hired
Microsoft founder Bill Gates and his fledgling software company to build
the program that would run IBM's first personal computer.
In the 1990s, Windows muscled aside IBM's OS/2 operating system and went
on to dominate a $10-billion-a-year market, turning Microsoft into the
world's biggest software maker, with revenue of $32.2 billion in fiscal
2003. Armonk, New York-based IBM cemented its title as the No. 1 computer
maker, with $89.1 billion of revenue in 2003.
Now, Microsoft Chief Executive Officer Steve Ballmer, 47, and IBM CEO Sam
Palmisano, 52, are clashing over whether Windows or Linux will underpin
computer networks.
Linux Rising
Windows accounted for 55 percent of all server operating systems shipped
in 2002; Linux made up 23 percent. A third system, Unix, made up 11
percent, according to IDC. Linux shipments will rise an average 17 percent
annually until 2007, and Windows will increase an average 11 percent
annually, IDC says.
Palmisano saw the potential for Linux in 1999. When he headed IBM's server
business, he persuaded IBM to embrace the free, publicly shared operating
system that Finnish programmer Linus Torvalds had created in 1991.
Palmisano concluded Linux had become so popular with programmers and Web
site managers who could modify it to suit their needs that IBM was better
off supporting Linux than fighting it, John Patrick, then vice president
of Internet technology, told Bloomberg News in 2002.
$1 Billion Investment
IBM invested $1 billion to make its hardware and software work with Linux,
says Mike Darcy, a company spokesman. Today, IBM sells computers, programs
and services that rely on Linux, and it sells Linux-based systems that it
tailors to customers' requests -- adapting the software for electronic
commerce, for example, or adding a security feature as required.
IBM doesn't break out its profit from Linux. In the fourth quarter of
2003, IBM's total software sales rose 12 percent to $4.3 billion.
So far, neither IBM nor Microsoft has persuaded Mark Herskovitz, manager
of the Dreyfus Premier Technology Growth Fund, that it has the edge.
Shares of IBM gained 20 percent in 2003, placing it last among the seven
companies in the Standard & Poor's 500 Computer Hardware Index, which
gained 26 percent.
Microsoft fared worse. Its shares edged up 5.9 percent in 2003 to trail
the S&P 500 Systems Software Index's 16 percent rise. Computer Associates
International Inc., Dell Inc., Hewlett- Packard Co., Oracle Corp., SAP AG
and even unprofitable Sun Microsystems Inc. were better investments last
year.
`Mature Company'
IBM shares have gained 5.4 percent to $97.70 so far this year. Microsoft
shares have increased 3.4 percent to $28.30 as of yesterday.
``I own Microsoft and IBM, but I'm not enthusiastic about either,''
Herskovitz says. ``Microsoft has become a mature company in a mature
business. IBM is similar in terms of being mature.''
Finding ways to expand is more critical since a 3 percent drop in
worldwide technology spending during 2001 and 2002 caused Microsoft to
report the two slowest years of revenue growth in its 17-year history as a
public company: a 10 percent increase to $25.3 billion in the fiscal year
that ended on June 30, 2001, and a 12 percent increase to $28.4 billion
the next year.
In July, Chief Financial Officer John Connors told investors that revenue
in fiscal 2004 would rise less than 10 percent for the first time.
IBM Sales Drop
At IBM, sales dropped 6 percent to $83.1 billion in 2001 -- the first
annual decline since 1993. They fell a further 2.3 percent in 2002. Sales
of computer hardware plunged 27 percent during that time. In 2003, sales
gained 9.8 percent.
Marty Shagrin, who helps manage $50 billion, including about 2.9 million
IBM shares, at Victory Capital Management Inc. in Cleveland, says he's
concerned that IBM's gross profit margin from computer services -- its
biggest business -- narrowed to 25 percent in the third quarter from 27
percent a year earlier.
Software, by comparison, is three times more profitable. IBM reports a
profit margin of 86 percent for its software division, according to an IBM
press release.
``Linux is a good business,'' Palmisano told analysts in May. ``It's a big
opportunity for us.'' Palmisano and Ballmer declined to comment for this
story.
Microsoft's research supports Palmisano's statement. Connors estimates
shipments of Linux-based servers rose 23 percent in the 12 months ended on
June 30; Windows server shipments rose 7.7 percent. Connors didn't provide
dollar amounts.
``We feel more competitive pressure from IBM and Linux,'' Ballmer told
Bloomberg News in October 2002 at the Gartner Symposium/ITxpo conference
in Orlando, Florida.
Rivals Eliminated
Throughout the 1990s, Ballmer, a 23-year Microsoft veteran who took over
as CEO from Gates in 2000, referred to Microsoft's rivals as Noise:
Netscape Communications Corp., Oracle, IBM, Sun and everyone else.
That's changed. The Netscape Web browser has 3 percent market share
compared with 96 percent for Microsoft's Internet Explorer. Sun, whose
Linux and Unix servers compete with Windows- based machines, lost $3.43
billion in its fiscal year ended in June. At Oracle, the world's
third-biggest software maker, annual sales have dropped in each of the
past two years.
That leaves IBM. In 2002, IBM beat Oracle to take the title of the largest
database software seller, according to Stamford, Connecticut-based
research firm Gartner Inc. IBM shipped 31 percent of all servers in the
third quarter of 2003, the most of any computer maker, according to IDC.
Lock on PCs
The trouble for Ballmer is that Microsoft can't expand much in the
personal computer market. Windows already runs about 93 percent of all
PCs, and PC shipments were forecast to have risen 11 percent in 2003 --
less than the 18 percent average annual increase during the 1990s,
according to IDC.
By contrast, Connors estimates, sales of Microsoft server software will
rise as much as 14 percent during the 12 months ending on June 30 compared
with an increase of 8 percent or 9 percent for Windows for PCs. That's why
persuading customers to choose Windows rather than Linux is important.
``We have told our sales force to really understand that this is the
job-one issue,'' Ballmer said in Orlando in 2002.
In July, Ballmer turned up the heat on IBM by appointing Microsoft's
director of business strategy, Martin Taylor, to head the company's
anti-Linux effort. Taylor is attacking two factors customers consider most
when buying software: cost and security. He wants to convince buyers that
Microsoft beats Linux in both.
Windows Evangelist
The son of a Baptist minister, Taylor, 34, is a regular at Ballmer's
Wednesday morning weekly basketball game at a health club near Microsoft's
200-acre campus. He manages a team of about 10 people from a third-floor
office decorated with pictures of his three-year-old twins.
Taylor says he spends more than half of his time on the road meeting
customers, whom he declines to name. If the sales force finds someone
who's considering Linux, Taylor says, ``Send me on the first plane.''
Kevin Johnson, Microsoft group vice president of worldwide sales,
marketing and services, says that if a customer says it can save money
with Linux, Microsoft sends in consultants to show otherwise. To persuade
supermarket chain Safeway Inc. to use Windows rather than Linux, Microsoft
ran a free two-day course. In 2003, Safeway switched 1,800 servers to
Windows.
Every quarter, Johnson awards cash prizes equal to 5 percent of the salary
of members of sales teams selected for the best wins over competitors.
``Winning against IBM and Linux is especially rewarding,'' Johnson says.
Converting Converts
To Johnson, no Linux convert is a lost cause. Since 1999, Mike Prince,
chief information officer at Burlington Coat Factory Warehouse Corp., has
used Linux-based computers at the retailer's 335 stores. He says a
Microsoft representative whom he won't identify called him in September to
talk about moving to Windows.
Prince, who has touted Burlington's use of Linux at LinuxWorld
conferences, hadn't heard from Microsoft's sales team in about two years.
``For economic and security reasons, Windows doesn't resonate with me,''
he says.
Prince says Microsoft called him again in December. ``I left the door
open,'' he says.
Microsoft and IBM disagree on whose software is cheaper. Linux server
software for running an e-mail system for 5,000 or more people costs
$1,300 per server per year compared with $1,675 for Windows, estimates
Chad Robinson, an analyst at Robert Frances Group Inc., a consulting firm
in Westport, Connecticut. Software for securing company networks costs
$900 per server for a Linux version and $2,300 for Windows, he says.
Microsoft disputes Robinson's conclusion and cites data from a Forrester
Research Inc. report that Microsoft commissioned. The report shows that it
costs less to build and run a Windows network over several years in some
cases.
`Work It'
Ballmer doesn't dispute that Microsoft is losing to Linux in some
instances. ``The truth is, there are some things where they're better than
we are,'' he told an audience at New York's 92nd Street Y in November.
For one thing, changing to Linux from Unix can be less complicated than
moving to Windows from Unix, Ballmer said.
On Jan. 15, Microsoft began offering a free software tool that lets
customers use both Unix and Windows in a server network, hoping to guide
longtime Unix users along a path toward Windows. Microsoft engineers have
to ``work it, work it, work it, work it, work it,'' he said, slapping his
hands for emphasis.
Ballmer's team may find itself working overtime. IBM has 7,500 employees
selling, marketing and researching Linux, up from less than a few hundred
in 1999, IBM spokesman Darcy says.
6,000 Customers
IBM says 6,000 customers are using Linux -- a number that surprises even
Palmisano. In 2001, he says, he begged for four customers to act as
references in a speech he was preparing on Linux. He got five. Since then,
E*Trade Financial Corp., Lehman Brothers Holdings Inc., Lockheed Martin
Corp. and Waste Management Inc. have switched some of their networks to
Linux.
``I never imagined the takeup would be what it is today,'' Palmisano said
in May.
One hurdle that may slow IBM's Linux push is a lawsuit that was filed by
SCO Group Inc. last March in Utah state court. SCO claims that IBM
misappropriated trade secrets when it developed its Linux-based offerings.
The suit centers on SCO's licenses for Unix. SCO charges that IBM
transferred Unix code into its Linux products, thereby breaching its
contract to license Unix from SCO. Darcy says the suit is without merit.
`Cloud Over IBM Linux'
SCO is seeking as much as $50 billion in damages from IBM. It has sent
hundreds of letters to IBM customers warning them they may need to either
change their Linux software to remove infringing computer code or pay SCO
a licensing fee.
The offensive is spooking some IBM clients, says Rob Enderle, principal
analyst at Enderle Group in San Jose, California. ``There is a cloud over
IBM Linux,'' he says.
Ballmer warns that IBM won't protect its Linux customers from SCO's suit.
``People say, `Now, Linux is like an IBM product,''' he told analysts at a
July meeting at Microsoft's headquarters, his voice rising. ``To which I
say, `Really? Will IBM tell you the road map for Linux? Can they respond
to your request for a new feature? No. They don't control Linux.'''
IBM has declined to insure customers against losses from Linux-related
lawsuits. In January, it agreed to contribute to a Linux-case defense
fund.
Some Microsoft customers took a hit on Aug. 11. That day, a hacker
released a computer worm called Blaster on the Internet, where it searched
for Windows computers with a security flaw.
The incident snarled networks at TeliaSonera AB, the largest Nordic
telephone company; J.C. Penney Co., the No. 2 U.S. department store
company; and the Federal Reserve Bank of Atlanta. A week later, a second
worm, called Sobig, spread to Windows machines via e-mail.
Targeting Hackers
For Bridget O'Connor, chief technology officer at New York- based Lehman
Brothers, the threat to her Windows computers prompted a switch to Linux
for the trading system at the fourth- largest U.S. securities firm.
O'Connor paid IBM $3.5 million for 700 Linux servers after she'd spent the
summer keeping viruses off 18,000 PCs and 5,000 servers on three
continents.
``Do people want to bet their jobs on things outside their control?'' asks
O'Connor from her 14th-floor office in New York. ``No.''
In November, Microsoft said it would offer $5 million in rewards for the
capture of hackers like those responsible for Blaster and Sobig. It plans
a free update to Windows this year that's intended to do a better job of
blocking viruses.
`Money and Persistence'
Some investors say it's foolish to underestimate Microsoft. In April 2003,
the software maker won over the London Stock Exchange, which chose Windows
rather than Linux and other programs from IBM for its network that
collects market data to sell to investors and news outlets. The service
accounts for about 40 percent of the exchange's $400 million of annual
revenue.
Ian Homan, head of technology at the exchange, says he'd been ``pretty
cynical'' about whether Windows could run a powerful system. The London
Stock Exchange set up a trial in half of the time and at half of the cost
he'd forecast. The final product has never crashed, and the exchange will
probably move its trading system to Windows, Homan says.
Money manager Holland says Microsoft's resolve in promoting Windows and
its $51.6 billion in cash can take it far in winning more customers like
Homan. ``They've got the money and the persistence,'' he says.
Jab at Windows
One thing investors can count on is more head butting. In September,
Microsoft and IBM gathered reporters in the Fontainebleau Room of New
York's St. Regis Hotel to show off standards they'd developed jointly for
Internet software.
Gates, Microsoft's chairman, and Steve Mills, head of IBM's software
group, stood onstage in a display of cooperation. It was the first time in
more than a decade that top Microsoft and IBM executives had appeared
together in public, the companies said.
While Gates looked on, Mills used Linux -- not Windows -- to run his
demonstration, turning the venue into a dig at Microsoft by promoting its
biggest rival, Enderle says.
``Yesterday, we were onstage together shaking hands,'' Charles Fitzgerald,
Microsoft's general manager of business strategy said the next day.
``Today, we are back beating each other over the head in the
marketplace.''
With billions of dollars in software sales and dominance of the world's
computers as the prize, IBM and Microsoft have more to gain -- and to lose
-- as they clash this time around.
Last Updated: January 22, 2004 00:05 EST
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