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IBM Needs to Get Its Head in the Cloud

Katie Benner is a Bloomberg View columnist who writes about technology, innovation, and the cult and culture of Silicon Valley. She lives in San Francisco.
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When IBM talks about building out a great cloud computing business, it's telling shareholders exactly what they want to hear.

Cloud computing is one of the most important technological trends of the last decade and it's a business that IBM should be trying to dominate. The cloud lets companies rent the sorts of products and software that they used to buy (like their own big server farms, for example) -- allowing them to be more lithe and mobile in how they manage information technology and their own businesses.

In short, the cloud simplifies and streamlines things for corporate customers and it's become clear that they prefer this new business model -- and will quickly abandon other, legacy models for it.

It makes sense, then, that IBM is extolling life in the cloud. But the reality is that consulting remains at the heart of IBM's product mix and culture, in part because that's the business that has saved the company from obsolescence in the past.

Lou Gerstner engineered a highly-praised turnaround at IBM in the 1990s by tacking a consulting firm onto the company's personal computer business (which Microsoft and a host of more nimble competitors were trouncing). Sam Palmisano doubled down on the strategy when he acquired PricewaterhouseCoopers' consulting arm and jettisoned the PC business altogether.

IBM's current chief executive officer, Ginni Rometty, has been with the company since the 1980s and was groomed to succeed Palmisano by Palmisano himself. She has been dutifully following the Gerstner-Palmisano playbook ever since she became CEO in 2012. She's trying to slim down one of the world's marquee corporate behemoths (Big Blue!) and has sold off its chip-making business, as well other units that make low-end servers -- all in order to focus on consulting and software.

This decades-long march into consulting -- and the abandonment of low-end products in the name of high-end products and high-end services -- means, however, that it will be really hard for Big Blue to become a true player in the cloud.

IBM derives as much revenue from high-priced consulting fees as it does from software sales. IBM's so-called "solutions business" model looks something like this: Tell us what you want to do and then we'll pick the right products you need and charge you dearly to install, monitor and maintain them.

By contrast, the cloud's menu of on-demand software, databases, computer storage and computing power appeal to customers from Dropbox to the CIA because it's a combination of fast, cheap and easy to use. Many of these offerings are freemium products, so companies can try them before they shell out a single dime. The products are also routinely updated, seamlessly in the background.

No more armies of consultants are necessary to choose and install products that used to cost a company millions of dollars in licenses and fees.

The best and most competitive cloud computing companies see their relationships with customers as built upon a suite of products that are constantly updated and that generate a stream of fees harvested over a long period of time. They aren't selling an expensive, high-margin enterprise package. In other words, they don't do business the way that IBM does business.

"Companies that want to be in the cloud have to make a cultural shift," says Mark Russinovich, the chief technology officer at Microsoft's cloud business, called Azure. While Russinovich is hardly an objective observer -- Azure is fighting to be the biggest name in cloud computing -- he's right to point out that simply offering some cloud products does not a cloud player make. Of IBM's nearly $100 billion in revenue last year, its cloud businesses accounted for only $4.4 billion of that figure.

Cloud leaders like Amazon Web Services and, increasingly, Azure have created an entire stack of budget-friendly, software-for-rent that's built around foundational services like storage, data centers and computing. They also make higher margin add-ons, and partner with an array of other companies for added security and data analytics products.

A company can use AWS or Azure as cheap, one-stop shops that meet their needs, even if those needs change. Customers comfortable in this world doubt that IBM can respond as quickly to their needs. The CIA, for example, rejected IBM's bid for a cloud services contract, citing fears that the company couldn't accommodate usage spikes.

If consulting continues to be IBM's primary business, then software, including cloud software, will remain a secondary offering. It's not unlike what happened to financial advisers when they became part of banks. Advisers were once focused on helping investors make smart choices. Once they were part of the Merrill Lynches and Citigroups of the world, they became another pipeline for the banks' investment products and smart advice often came second to that function.

IBM recently announced a terrible third quarter. A savvy Bloomberg Businessweek investigation earlier this year by my colleague Nick Summers shows that investors shouldn't have been surprised at all by that news, for the company has long massaged its earnings and used financial engineering to mask the fact that it missed the cloud computing trend and couldn't figure out how to catch up.

An apologetic Rometty signaled to investors this week that the days of IBM monkeying around in the cloud are over. She promised to focus more on products and less on maneuvers that allowed it to continually boost IBM's stock price.

"We have got to reinvent ourselves like we have done in prior generations," Rometty said on a conference call with investors.

This is typically when the hero in our movie lays the groundwork for a fantastic turnaround. Like Rocky Balboa, IBM is supposed to buckle up, get some discipline, shed fat and then run and punch its way to victory. The message to investors is that the current growing pains will give birth to a new, valiant montage of executive moves, with Rometty in boxing gloves training for the championship.

Companies that cope with abrupt changes in their industries do this, of course. They learn to innovate and adapt in fresh directions when they've overlooked innovations that already surrounded them.

But IBM and Rometty won't knock out the competition in the cloud by following the Gerstner-Palmisano playbook: trimming low-end products and emphasizing high-end consulting services. That's not what the cloud is, and if Rometty can't wean IBM off of its current model she'll spend the rest of her tenure shadow boxing, with real opponents dancing around her in the ring.

(Corrects sixth paragraph to remove reference to sale of IBM's low-end mainframe business. IBM has only sold high-end mainframes, and still operates that business. It is only the low-end server business that it has exited.)

This column does not necessarily reflect the opinion of Bloomberg View's editorial board or Bloomberg LP, its owners and investors.

To contact the editor on this story:
Timothy L O'Brien at tobrien46@bloomberg.net