Big Blue software bigwig Steve Mills discusses future profits, IBM's acquisition strategy, and the importance of an open format
Steve Mills joined IBM in 1974 as a sales trainee in New York City, rose into management by the mid-1980s, and became the executive in charge of IBM's software business in 2000. That business generated more than $18 billion in 2006 sales—about one-fifth of IBM's total—and contributed 40% of the company's profits. By 2010, IBM (IBM) expects half of its profit to come from software.
Mills' software group has been involved in nearly 50 buyouts since 2000. So far this year, the 56-year-old Mills has made five software acquisitions. Big Blue tends to wring growth from the companies it buys by selling customers of its popular WebSphere middleware (software for connecting applications), its DB2 database, and other widely used products on the benefits of new technologies.
But competitors are angling for pieces of IBM's market share. They include hyper-acquisitive Oracle (ORCL); a Hewlett-Packard (HPQ) that's putting more focus on software; and Microsoft (MSFT), which continues to push for a bigger share of corporate computing budgets.
At a Sept. 27 conference on partnerships with venture capital-backed companies at IBM's Almaden Research Center in Silicon Valley, Mills, a senior vice-president and group executive at IBM, spoke with BusinessWeek.com technology writer Aaron Ricadela about IBM's software growth plans, the acquisition landscape, and competition with Microsoft and Oracle. An edited excerpt follows.
A year ago you said you hope to increase the size of IBM's software business by 6% to 9% a year, with new acquisitions contributing 2% to 3% of that. Is that still your goal?
Six [percent] to 9% growth had been the bandwidth we shared with the investment community in the spring. Looking out to 2010, we expect the model to in fact lift from 6% to 9%, to 7% to 10% on the revenue side. We're tracking within that bandwidth—we did 7% last year. The percentage of our software that comes from some of the faster growing parts of the portfolio continues to get larger, and that provides some lift to the overall growth rate. Inside of those numbers in any given time period, two to three points of growth will be attributed to acquisitions.
What areas of the market are you focusing on to help achieve those goals?
We always start with a market view. If we don't drive the organic growth of our business, we're not going to create the company we want purely through acquisitions. With a $20 billion software business, you're obviously not going to be able to buy enough things in any given time to propel growth purely by acquisition. Furthermore, from a customer's perspective, what they're looking for is things that fit together. We've always been very focused on acquiring things that fit well with the technologies we have. The revenues of the companies [we buy] actually increase—often double—compared with what they had been on a standalone basis. We drive for reasonably rapid payback. We want to mitigate purchase-accounting effects, and demonstrate how these things are accretive to the shareholder within a relatively short period of time. Our track record's been quite good. We've been driving a roughly two-year accretive full GAAP accounting; our competitors tend to not talk about it in GAAP terms.
Then the question is always, "What companies are you going to buy, Steve?" Everybody asks me that question and naturally I can't give the answer. But the past is prologue to the future insofar as the kinds of acquisitions we've done have for the most part been midsize to small. We certainly acquired our share of venture-funded companies that haven't yet gone public. This works for us because we have this very large portfolio—the largest software portfolio in the industry. Our focus has been concentrated on middleware technologies—all the things that are necessary for a company to tie its processes together and enable the development of new applications Every single acquisition we do fits into one of the major categories of middleware that makes up our portfolio. And because these things fit, we get a natural lift. I have a more than 15,000-person field [sales] organization because these things we acquire fit well with what we're already selling—it enhances the value proposition. The reps love it. Now the rep is given another arrow in the quiver.
You claim IBM has kept development functions intact at the companies you acquire, but some of your competitors have been slashing essential operations such as developers when they acquire companies to get a quicker return on their investment. Is Oracle cutting development for the acquisitions it makes?
Yes, very heavily. All companies look at streamlining general and administrative expenses, because you don't always need as many accountants and treasury people. You get some modest efficiencies from that. But what Oracle has done is taken out developers, marketing people, sales reps. So they've diminished the [acquired] company's capacity to innovate and go out and serve customers. Now given that software is a very sticky technology because you build your business processes around it, customers don't remove the software and you can keep on collecting. Charles Wang perfected that model—[Computer Associates] (CA) ran its business for decades this way. And Oracle is executing a strategy which is very much like the old Computer Associates strategy. We're running a very different play. It's a very challenging play because it demands growth in order to deliver returns. But the customers like it, and it permits us to go back to the customer again and again and again.
IBM recently made a new version of its Lotus Symphony collaboration software available for free. Why are you taking on the challenge of gaining market share from Microsoft Office? Why is that strategically important to IBM?
This really starts with open standards. Documents are incredibly important to the way that businesses and governments run. We have a situation in the IT industry today where you have one company delivering its own unique formats, and therefore the only provider of an editor that adhere to those formats. Now you as a business or government are now tied to those editors in order to manipulate those formats. Why not an open format that anyone can build an editor for? Documents get ingested by different types of applications. So the need for an Open Document Format (the new version of Symphony supports this format) and open editing capability jumps out at you whenever you engage in a lot of complex business-process flows and business-operations scenarios that we get involved in.
We find Microsoft Office, particularly the Microsoft Word phenomenon, as essentially impeding some of the strategies that we're trying to drive in the marketplace. It's not because the editor's a bad editor, it's because the formats are not open. To store and retrieve the documents and maintain their fidelity, I need Microsoft products. If I want to do more things with those documents, the next thing I have to do is buy more Microsoft technology. Then when the documents need to be shared, everybody needs to have more Microsoft technology. It's not that Microsoft is doing something you wouldn't expect a company to do—of course they want everybody to buy more Microsoft technology. From our perspective, we'd like to see an open-standard approach in which customers can create documents in Microsoft Word but share them with other products, pull them into other editors, manage, store, retrieve, and modify them, and not necessarily have to buy a full suite of Microsoft technology to do that. That's the issue.