The short-sighted missteps of the server companies

Apologists for Capitalism are wont to wax eloquent about the creative destruction they see in the tech industry. They see the vertiginous rise and fall of tech companies in the Silicon Valley as a beautiful system that weeds out the laggards who aren’t nimble enough to keep adapting, while rewarding the creative innovators with huge pay offs.

Frankly, I see the skyrocketing stocks and crashing failures of the tech industry as a condemnation of how modern Capitalism functions. The erratic fortunes of the tech companies generates a tremendous amount of stress in the lives of the people who work in these companies. The directors of tech companies often make decisions which are based on short-term profit margins, raising the stock prices or cashing out those stocks, rather than producing a quality product or service and working toward long-term goals that will help the company grow in the future and provide stable employment for the employees.

We can see this destructive dynamic playing out currently in the server business. Fifteen years ago, IBM was the undisputed leader in the server business. It had a long tradition of offering quality servers, which were pricey, but its engineers were known for the high quality of their support and services around servers. IBM was also renowned for for offering the best line of PCs for enterprise, which came with excellent support and long-term warranties. IBM’s Thinkpad and Thinkcentre lines were highly sought after PCs, due to their engineering excellence and sturdy construction. The Thinkpad laptops generated a special kind of brand loyalty among engineers and geeks, who took exceptional pride in owning the coveted boxy, black devices. Unfortunately, PCs were turning into mass market devices with slim profit margins under 3%, so IBM’s PC business was nearning the company very much.

Still, as the inventor of the PC and a long tradition of quality engineering and reliability, IBM’s PCs added a certain cachet to the reputation of the company. IBMers knew that HP and Dell might move more PCs, but they could take pride in the fact that they offered quality PCs and people trusted them to provide the best support in the industry. More importantly, IBM’s PC business gave the company an entry way into businesses to sell them more lucrative contracts in other areas. The support contracts for the PCs were a vehicle for Big Blue to talk to companies about their other IT services where IBM did earn large profit margins. Having a PC business allowed IBM to offer comprehensive IT services for companies and helped keep its competitors HP and Dell away from its clients.

Rather than think about PCs as an essential piece that helped enable their servers and software businesses, the directors of IBM fixated on the fact that PCs were being commoditized with low-profit margins. They decided that IBM should only focus on areas with high profit margins, so in 2004/5 they sold their PC business to Lenovo, a Chinese original design manufacturer who had been building their Thinkpads since 2002.

IBM essentially shot itself in the foot, although it would take a while for that fact to become evident, so the managers at IBM would pat themselves on the back for increasing their profit margins and getting rid of many costly employees in North America and Europe who they passed to Lenovo. In addition, they gained entry to the growing Chinese market, because Lenovo promised to direct their Chinese customers toward IBM’s server business. It looked like a great decision on paper, but in the long term, divesting from the PC business helped to undermine IBM’s profitable server business. Not only did IBM help establish Lenovo as a major provider of PCs to enterprise, but it also gave Lenovo a vehicle to start offering their own servers to many clients of IBM and become a major competitor which undercut IBM in the x86 server market. By no longer providing PCs, IBM lost contact with many potential new clients for its server business and it gave its existing clients to start talking to HP, Dell and its new competitor Lenovo for their IT services, since IBM could no longer offer a comprehensive IT solution for businesses.

After selling its PC devision to Lenovo, IBM gradually lost market share in its server business, especially among x86 servers, where all the growth in the industry was occurring. IBM’s biggest profit margins lay in mainframes and in AIX on the POWER architecture, but the market share of both mainframes and UNIX servers was already in long-term decline and that decline further accelerated after the economic crisis of 2008/9, as many companies sought to reduce their IT budgets by switching to cheaper x86 servers running Linux or Windows, reducing the number of servers through virtualization and by outsourcing their servers to third-party clouds.

While IBM maintained its formidable advantages on big iron, only a select number of companies and governments now needed mainframes. Much of the computation formerly conducted on mainframes moved to distributed networks of low-end x86 servers. High performance computing is increasingly moving to the cloud, where IBM certainly competes, but cloud computing is a cut-throat business dominated by Amazon, Google or Microsoft. The advent of the Moreover, many of the new mainframes were now located in China, where the government was eager to promote national companies shifdistributed computing on  found fewer and fewer reasons to use old-style mainframes

 

shrank, while the low-end servers based on the x86 architecture grew to take over most of the market. Since IBM was no longer a first tier eventually became new provider of In the long term, however, IBM opened up their rid of a business with low-profit margin

 

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