Long term doubts for Microsoft and IBM

Software giant Microsoft was hit hard by the global recession, but the failure of its Vista operating system, launched in 2006, to mirror the success of earlier versions was arguably more damaging for the company.

While its tentacular grasp on almost every software market did not win the company many friends, until Vista’s release Microsoft still had a reputation as a highly effective operator. It was a flop, however, and the company’s continued dominance of the desktop operating system sector looked less certain than it had done.

But with Vista’s successor, Windows 7, Microsoft has reaffirmed its desktop dominion, and sales of the operating system have propped up its recent financial figures. The trend continued during the three months ending 30 September 2010, when revenues from the operating system soared 66% year-on-year to $4.79 billion.

The company also enjoyed renewed spending by businesses. Sales by its Business division, which sells the Office desktop productivity suite and the Dynamics range of applications, increased 14% to $5.13 billion. Its server and tools division also began to show signs of recovery, as sales rose 12% to $3.96 billion. Total revenues at Microsoft were up 25% to $16.2 billion, while net income gained 51% to $5.1 billion. The company said it was benefiting from hardware refreshes previously delayed by the economic climate.

Still, the damage to Microsoft’s reputation for invincibility has been done. Looking to the future, analysts questioned whether Microsoft’s new operating system for mobile phones, Windows Phone 7, is enough to compensate the company’s market-trailing performance in that space.

“Gone are the days when Microsoft could be late to the market but, through immense resources, catch up and be relevant,” wrote David Hilal of investment bank FBR Capital Markets. “The vendors it is catching up today are much stronger, and the adoption curves are much greater, thereby exacerbating the problem of being late to market.”

Then again, many commentators wrote Microsoft off after Vista. Clearly, the software giant is not a spent force yet.
One company that has been written off as a vestige of technologies past on more than one occasion is IBM. In recent years, though, it has put paid to that perception, and its systems-plus- services business model is now emulated by all the enterprise IT giants.

That said, IBM’s recent performance has been underwhelming. In the three months ending 30 September 2010, the company reported a year-on- year revenue increase of just 3% to $24.3 billion.

Sales at IBM’s technology services unit, by far its largest, were modest, rising just 0.7% year-on- year to $9.5 billion. IBM’s software division also posted a 0.7% rise to $5.2 billion. Net income rose more convincingly, by 12% to $3.6 billion.

The company’s hardware division saw the strongest revenue growth. Its 10% sales increase to $4.3 billion was driven by a surge in demand for System z and MIPS mainframe technologies.

Most troubling for IBM’s investors was a drop in new business, which of course spells trouble for future performance. The issue was raised during a conference call with investment analysts. “For your last three quarters worth of signings, year- over-year you are down 7%,” Toni Sacconaghi of investment research firm Sanford C. Bernstein told executives. “You have missed your signings estimate effectively for three straight quarters.”

However, CFO Mark Loughridge insisted that the decline was caused by a delay in signing a major outsourcing services contract, which would have pushed new bookings up 14% had it been completed in time.

Inorganic growth

In its third quarter, Europe’s largest software business, Germany’s SAP, continued to recover from a recession so damaging that it cost former CEO Léo Apotheker his job. Apotheker now holds the top job at Hewlett-Packard.

The applications vendor chalked up a 20% annual sales upswing to 2.32 billion, along with a 12% increase in profit to 501 million. Much of this growth resulted from the company’s acquisition of database and mobile systems vendor Sybase in May 2010, but there were signs of organic growth in all locations and for all sizes of company.

A legal dispute with arch-rival Oracle may take the shine off this recent return to form. Oracle claims that Apotheker was directly involved in the alleged theft of its intellectual property by now- defunct SAP subsidiary TomorrowNow. SAP had previously set aside $100 million as a potential settlement for the Oracle suit, but increased this to $160 million in the current quarter.

Document management giant Xerox posted comprehensive increases in both quarterly sales and net income. However, the company expressed serious concerns over the long-term sustainability of this growth, so much so that it announced plans to cut 2,500 of its global workforce over the next year. Xerox announced a near identical number of cuts in January 2010.

During its third quarter, the company recorded a 48% ballooning in revenue to $5.43 billion alongside a more than doubling in its profits to $250 million. Like SAP, Xerox’s growth was largely driven by acquisition: it bought IT services provider ACS for $6.4 billion in September 2009. “I am not confident enough yet to say this ‘better’ will stay forever,” said CEO Ursula Burns.

Peter Done

Peter Done is managing director of Peninsula Business Services, the personnel and employment law consultancy he set up having already built a successful betting shop business.

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