SUN/ORACLE
Can the Brash Brothers Bounce Back?
No matter what they say, Sun's Scott McNealy and Oracle's Larry Ellison can't get their customers to buy more. That makes for rough times ahead.
FORTUNE
Monday, June 10, 2002
By David Kirkpatrick
What a horrid time to be a technology company! The economy stinks. Corporate customers don't have money to spend, and even if they did, why would they? They're swimming in hardware and software they bought willy-nilly in the frenzied days of dot-coms and Y2K. That's bad news for any tech outfit, but Oracle and Sun Microsystems are feeling special pain: a tough run of bad publicity, embarrassing financial results, and stock prices that are at less than 20% of their peak and show no signs of recovering soon. Never mind that Oracle has been enmeshed in a minor political scandal involving a big sale to the state of California. More important, a widely publicized research study suggests that the longtime market leader in databases has fallen behind IBM for the first time. Meanwhile Sun, which aspires to be as well managed as GE, seems to be hemorrhaging executives; five senior managers have announced their departure, including President Ed Zander.
Each company is led by a smart, determined, brash founder with a mouth and an abiding conviction that future success is inevitable. "Oracle is far and away the largest supplier of information-management technology at what is still the dawn of the Information Age," trumpets CEO Larry Ellison. Sun CEO Scott McNealy also rebuts recent criticism: "Everybody wants to put a label on this company. But it's a very well-run, very thoughtful group of people focused on the very tough challenge of providing network computing to the world." Says a tech executive who knows both men: "They're the bad boys of enterprise computing, like two frat brothers who've gone awry." The question now is simple: Can the brash brothers battle back?
Sun and Oracle have more than just trash-talking CEOs in common. Customers often buy their products in tandem: Oracle's heavy-duty database software running on Sun's supercharged computers. Both technologies are considered topnotch and ultra-reliable. And the companies have followed a similar recent trajectory. Both soared in the dot-com era, when it seemed that just about everyone needed their components. Then both crashed. Now their products are seen as expensive at a time when rapidly commoditizing technology is inexorably driving prices lower.
Ellison and McNealy also both hate Microsoft. As that company's lower-priced software gets more reliable, it is slowly but steadily creeping up from below on both Oracle's database and Sun's computer operating system. Paul Flessner, the Microsoft executive responsible for enterprise server software, is happy to explain that dynamic from his perspective: "Sun and Oracle have very similar business models--they charge a premium price for what they paint as very special and enterprisey, when the reality is that the industry has caught up with them on both hardware and software." Then there's IBM, which seems ever more competitor than partner. IBM now operates a formal war room devoted to planning attacks on Oracle with its DB2 database and another devoted to stealing market share from Sun's computers. It's scary to be caught between the richest technology company and the biggest.
For all the parallels, Sun and Oracle will lean on different strengths as they try to fight their way out. Sun is a well-managed, disciplined operation that can take high-level departures in stride. Zander left because he was 55 years old and had made hundreds of millions of dollars in Sun stock, and because McNealy, the 46-year-old CEO, wasn't going anywhere. Like all the other Sun executives who have quit, Zander will phase out gradually. In fact, the company has a succession strategy in place for all key execs in the organization's top three tiers. And Sun has used the recent pain--last year it fired 3,900 in its first layoffs ever--to reorganize and to make itself more disciplined. Says Marissa Peterson, who heads manufacturing and supply-chain operations: "In the last year and a half we've matured tremendously."
By contrast, $10 billion-a-year Oracle is an autocratic kingdom. Even Ellison's chief financial officer, Jeff Henley, describes him as "mercurial." Ellison lost one potential successor, President Ray Lane, two years ago. Lane is now a venture capitalist. The man who followed him into the No. 2 spot, Gary Bloom, bolted five months later to become CEO of rapidly growing storage-software firm Veritas. Bloom says he and Ellison discussed the possibility of his eventually becoming CEO, but that Ellison became reengaged at the height of the dot-com bubble. Around then Oracle launched a group of Internet-oriented business applications. Explains Bloom: "At the time when Oracle's market cap briefly exceeded IBM's, Larry thought Oracle had the opportunity not only to be the most powerful software company in the world but to be the most powerful company in the world. He believed the e-business suite could fundamentally change the way corporations operate." Now there's no heir apparent, and several other senior sales executives have left in the past two years. "All those executives at Sun are still there working to help transition the company," says Bloom. "But all the Oracle departures were immediate." When Bloom speaks about life inside Oracle, the term he often turns to is "turmoil." (As if to underscore the organizational contrasts, a hot Silicon Valley rumor has McNealy talking to Lane about taking Zander's old job. Lane says the rumor is groundless.)
The disarray at Oracle is readily apparent. For instance, when pressed on the pricing of its database, Ellison claims that the notion that Oracle is more expensive than Microsoft is incorrect: "We believe in the Microsoft model of low-cost, high-volume software, and we've been moving that way radically," he says. But in an interview a day earlier, CFO Henley said, "I don't think we're moving toward a higher-volume, lower-cost approach." Nothing like that would ever happen at Sun, where disciplined executives spout the company line. (Besides, nobody but Ellison thinks Oracle's databases are cheaper overall than those from Microsoft or IBM.)
The company may be dysfunctional, but its products are what help keep corporate America functioning, and that's why Oracle has financially weathered the dot-com crash better than others. Sales over the past three quarters are down by 10% from a year ago, but Oracle's net pretax profit margin has actually risen and is now a remarkable 35%. Brags Ellison: "We're more profitable than all other enterprise-software companies combined." (He's omitting Microsoft, which is far more profitable.) Ellison loves to point out that Oracle is the only one of the "four horsemen of the Internet"--Cisco, EMC, Oracle, and Sun--that hasn't lost money recently. The others are now "on foot," he quips.
Still, Oracle does face a big product problem, as highlighted in an April survey of 502 Oracle customers conducted by Morgan Stanley and a user group. Some 87% of its customers say that Oracle has the best database technology. But they don't need much more of it, and they worry that it's too expensive. Only 6% plan to buy more in the near term, and 43% would consider a cheaper supplier.
Oracle would love to count on growth from that suite of e-business applications that so excited Ellison. But the suite has had quality problems and isn't selling well. Adds ex-Oracle executive Tom Siebel, CEO of Siebel Systems: "Oracle says you'll buy all your software from them. But that strategy puts them in competition with every IT company in the world. It's failed. It's crazy." Siebel predicts that Oracle will retrench, focus its research on its database products, and again excel. For now, though, Ellison remains deeply committed to his e-business applications.
The product story at $13 billion-a-year Sun is worse. By some measures, Sun has been losing share in its core market--Internet servers--to Dell, IBM, and HP. Sun is vertically integrated: Sun machines use Sun microprocessor designs and Sun's own operating system software. For almost everybody else in computing, Intel is the computer maker. Intel devotes all its attention to chips, and spreads its costs over 100 million a year, while Sun sells only computers containing about a million of its Sparc microprocessors annually. While Intel spent $3.8 billion last year on R&D, Sun spent about $2 billion, much of it for things other than chips. Intel machines now best Sun's in raw performance. Says John Parkinson, chief technologist in the U.S. for consultants Cap Gemini Ernst & Young: "Sun is in worse shape than Oracle because it's so dependent on hardware. Staying competitive at the silicon level is really hard when you don't have much volume."
McNealy insists that Sun's computers are not losing share, remain technologically superior, and cost less to operate. He points out that Sun's top machine manages 72 microprocessors in tandem, with consummate reliability and almost no loss of performance, something no Intel-based machine can approximate. Paul Otellini, Intel's chief operating officer, doesn't dispute that, but calmly responds, "There's nothing hard about this stuff. At the end of the day it just takes engineering resources and time." Intel has more of both and works with every major enterprise-software company to ensure that its products run well on Intel-based computers.
Intel is driving a move to Linux, the open-source computer operating system that is, like Sun's Solaris software, a variant of the Unix operating system. Just about every big computer company is marketing "Lintel" systems--Linux on Intel-based computers. IBM has invested well over $1 billion to build robust versions of Linux for enterprises. Even McNealy's big ally, Larry Ellison, likes the stuff. "With Linux you deliver better performance and better reliability, and of course, much lower cost," he says. "That's why we're so interested in Intel all of a sudden." This can put a lot of pressure on Sun's high-margins systems business, since it is not terribly difficult for customers to move their software applications from Solaris to Linux. Driven by its customers' demands, Sun is starting to offer its own Linux box as well--but that's a low-margin product that won't do much to cover Sun's massive R&D costs.
Sun has been in tough spots before, and it has always sold and marketed and invented its way out. The strategy this time is to make life easier for customers by integrating a variety of components into complete systems. Says McNealy: "What we're trying to do in our R&D shop now is put all the scalable systems, the operating systems, the storage, and the network together in what I call a big friggin' Webtone switch, and then turn it over to the customer." That should appeal to CIOs, but if Sun integrates too much, it faces the same risk as Oracle: alienating longtime partners.
McNealy holds that there's another reason customers will continue to rally around: Sun isn't IBM or Microsoft. Says he: "IBM goes in there and gives away the services for a year or two until your brains are atrophied and then tries to help you get well later. We go in instead and help you build a strategy so you can execute. That requires a little more up-front investment, though in today's market IBM's approach seems a little more attractive. Microsoft does it a different way: The first hit of heroin is not free--they actually pay you for it. Look at their equity investments into customers like AT&T." An article of faith at Sun is that customers in industries like media, telecommunications, and personal financial services will resist Microsoft technology because they fear the company. Says Sun's newly appointed software boss, Jonathan Schwartz: "We're there to help our customers run their businesses. One of their priorities has become competing with Microsoft. To which we reply, 'Welcome to the club.' " The battle between Sun and Microsoft is also being fought over the nascent world of web services. Both companies have a set of technologies to enable any software application to talk to any other. Sun hopes that the huge success of its Java software and its J2EE variant can pull in hardware sales as companies resist Microsoft's ".net" approach.
McNealy can't just sit back and count on his core customers, however. John McKinley, who runs technology and services at Merrill Lynch, is a huge Sun customer who has become entranced by Linux: "I want Sun to survive and thrive, because it gives me choice. But I won't necessarily pay a huge premium to maintain that choice." Cutting prices sharply would be really tough on Sun, which as a hardware maker has considerable capital costs. Oracle has greater flexibility to cut prices, something that should come in handy now, during what Oracle CFO Henley calls the worst IT spending recession since 1973-74.
For all their woes, neither Sun nor Oracle is in serious near-term danger. Sun has $6 billion in the bank, and its machines are the reliable hardware that drives corporate infotech. Oracle has $5.6 billion in cash, and its database software holds and organizes the information at the heart of the information economy. These guys aren't going anywhere. But you can forget about a return to the growth spurts of yesteryear anytime soon. To cherry-pick from the words of that longtime Sun customer, John McKinley, these days the story at Sun and Oracle is a lot more about "survive" than "thrive."
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