Good news for Intel and Dell - BAD NEWS for SUN !
"But at Merrill it is Dell and Microsoft, not Sun, that are winning the battle for new tech spending. The reason, McKinley says, is simple: Dell machines are so cheap that their total cost--hardware, software, and maintenance--is now 40% less than what it costs him to run Sun machines. Merrill's entire retail call center, handling tens of millions of customers a day, now runs on Dell machines, and Merrill is finding ways to use them on the trading floor too. "Traders are just like the rest of us,'' he says. "They'd rather use the same machine at work as they do at home." "
fortune.com
SUN MICROSYSTEMS
Sun on the Ropes
Server sales are down. IBM and Dell are punching hard. Can Scott McNealy pull off another miracle?
FORTUNE
Monday, January 7, 2002
By Fred Vogelstein
Say what you will about Scott McNealy, Sun Microsystems' co-founder and CEO, he's sure fun to watch. Give the man a mike, a stage, and an audience, then sit back and enjoy the show. Notes? Lecterns? PowerPoint slides? Those are for CEOs with nothing to say--and McNealy always has something to say.
Today, on a sunny fall morning in Silicon Valley, he's telling Sun shareholders at the annual meeting how the company is going to bounce back from the economic slump. He talks up the speed and versatility of Sun's new product line, lists the businesses Sun is getting into, and reminds his audience of all the cash--some $6 billion--his company has sitting in the bank.
But this is Scott McNealy, and the audience yearns for more. They want to hear him beat up on Microsoft and other competitors--and he doesn't disappoint. Using faux slips of the tongue, he refers to Microsoft's Web-services initiative as ".not" instead of ".Net," and IBM's latest server as "Regretta" instead of "Regatta." He calls the Microsoft antitrust settlement "garbage." He dismisses Dell as little more than a grocery store for Microsoft--"and everyone knows that the only value ever added to a banana in a grocery store is a bruise."
During his 15-year battle against Microsoft and assorted other foes, McNealy has had plenty of time to hone his zingers. But he is more than just Silicon Valley's answer to Don Rickles. McNealy's been pretty good at his day job too. Even after the past year's problems, shareholders have seen returns on average of 30% a year since Sun went public in 1986. Over that same span, he built one of the most dedicated work forces in corporate America.
McNealy's trademark swagger and combativeness pervade Sun. At other companies executives tend to be circumspect when they talk about competitors. At Sun officials attack rivals without any prompting. Question them closely about Sun's own strategy, and they assume the company's enemies put you up to it.
Their defensiveness is perhaps understandable. Practically since the company's inception, critics have said that Sun wouldn't survive long. It's been uplifting for employees to help McNealy make such predictions look silly time and time again. At Sun they almost enjoy being told they are going to fail. "It just gets us more energized,'' says President Ed Zander. "We love proving you guys wrong and proving the industry wrong."
But this time seems different. The past year wasn't just bad. It was the worst in company history. Revenues fell by nearly 50%; Sun lost money for the first time in a decade; it laid off employees for the first time ever; and its once lofty stock price fell a heart-stopping 73%.
Nor does there appear to be any quick fix. About 60% of Sun's revenue base--sales of servers to dot-coms, telecommunications firms, and financial services companies--has been pulverized in the past year. And Sun's problems extend beyond the vicious tech slump. The company is engaged in a two-front war in its main business: servers. On the high end of the market, IBM is gaining ground; on the low end, Microsoft's Windows 2000 operating system has enabled competitors--particularly Dell--to make inroads. In response, Sun has been forced to slash prices, which, as we'll see, is doing a number on profit margins.
The upshot is that Sun is going to have to reinvent itself, something it has never had to do before on such a scale. Not only does it need to broaden its server customer base, but it has to offer more products--things like storage and application server software, neither of which it has had any success with in the past. Put simply, Sun has to figure out what kind of company it's going to be when it grows up, and it's not clear McNealy & Co. have thought that through very carefully. Their continued cockiness in the face of mounting problems looks juvenile and worrisome to customers and shareholders. "Right now people understand [the hubris] comes with the territory,'' says Laura Conigliaro, hardware analyst at Goldman Sachs. "But if Sun can't resume its growth soon, it definitely won't play well.''
To understand how nasty things have gotten for Sun, just open a newspaper. Energy trader Enron, Internet service provider Excite@Home, and Web-hosting company Exodus all were big Sun customers. Zander likes to point out the good news in that: None of the business went to competitors. It just disappeared. But that hardly compensates for the fact that Sun must now attempt to replace all those sales at a time new customers want to spend only $1 million or $2 million instead of $30 million. Think about how many penny-pinching customers it will take simply to replace Enron, which two years ago agreed to buy $350 million in Sun gear by the end of 2004.
Sun salesmen also face the unenviable task of trying to sell new equipment in a market flooded with almost-new equipment. Most of Sun's dot-com customers and a few big telecom clients didn't just file for bankruptcy reorganization. They liquidated, putting hundreds of millions of dollars of Sun servers on the auction block, typically for less than 50 cents on the dollar. It's been a boon to CIOs like Sheila Beauchesne at Martha Stewart Living Omnimedia. She upgraded her entire back end with used Sun gear this summer, paying as little as 10% of what it would have cost to buy new. It's not just that Sun won't see a penny of Martha Stewart's cash today. It also means her company won't be in the market for new gear for two or three more years. "I really like Sun gear," Beauchesne says, "but they have to figure out a way to be more price-competitive."
All this is happening while Sun is having a harder time making its tried-and-true sales pitch--the one in which it says, We're smarter than everyone else, and our gear is better. Being able to outthink and out-innovate its competitors is what enabled Sun to become the top workstation company in the 1980s and the leading server company in the 1990s. Its success during the Internet bubble is particularly instructive here. Back then CIOs were interested in just two things: that a vendor understood the Internet and that it sold fast, reliable equipment. Sun, which invented Java, a major Internet programming language, was the obvious first choice on many lists. Any company that could come up with an invention powerful enough to make Microsoft sweat must be smart, the thinking went. "It got us in a lot of doors," a former employee recalls. "The gear pretty much sold itself."
What happened? For starters, the buzz surrounding the company has waned. Java continues to attract developers and grow in importance, but it's been around for five years and CIOs aren't as wowed. Some CIOs, like Kodak's Mark Gulling, don't even associate it with Sun anymore, because Sun in effect gave Java away to promote it. "When I see Java, I see an open language, not a picture of Sun," he says. CIOs have different priorities too. Two years ago they wanted the best gear and they wanted it fast. Now, with budgets under pressure, they have to make a different calculation--get the best gear for the least money.
Most important, while Sun was distracted by all the money it was making from dot-coms, rivals caught up. IBM, which until 18 months ago was viewed as competitive only in older mainframe technology, has released a new line of high-end Internet-style servers, including a $1.8 million machine known as Regatta that many say is as fast as Sun's top-of-the-line product. Meanwhile, Microsoft, with its Windows 2000 operating system, finally has been able to make low-end Dell and Compaq servers reliable enough to handle important corporate tasks.
Sun refuses to acknowledge the validity of any of those issues. It says CIOs still think Sun is the smartest guy on the block, that Java is as powerful a selling point as ever, and that Sun's machines continue to be far superior to competitors', and a good buy to boot.
But that's pretty easy to disprove. For starters, the huge premium Sun once commanded over rivals has shriveled, according to IDC, the Boston market research company. Indeed, a price war has driven prices down for all servers by more than 10% on average and by as much as 50% in some cases. As a result, profit margins at Sun have fallen 17 percentage points since 2000. Meanwhile, in the third quarter Sun's market share fell four percentage points, while both Dell and IBM saw slight gains. It's still unclear whether rivals are stealing customers or whether Sun simply had more clients go out of business. But the trend isn't inspiring confidence in Sun's ability to return to even pre-dot-com-bubble growth patterns--roughly 20% a year--anytime soon.
A visit with John McKinley, CIO at Merrill Lynch, highlights the problem. Merrill is one of Sun's best customers. Sun uses Merrill in advertisements and encourages the firm to talk to the media about their relationship. And McKinley certainly doesn't mince words when talking about Sun's technology: "They still make the best high-end server on the planet." But at Merrill it is Dell and Microsoft, not Sun, that are winning the battle for new tech spending. The reason, McKinley says, is simple: Dell machines are so cheap that their total cost--hardware, software, and maintenance--is now 40% less than what it costs him to run Sun machines. Merrill's entire retail call center, handling tens of millions of customers a day, now runs on Dell machines, and Merrill is finding ways to use them on the trading floor too. "Traders are just like the rest of us,'' he says. "They'd rather use the same machine at work as they do at home."
Beneath all the bravado, there are in fact changes taking place at Sun. It has laid off 9% of its work force--or 4,300 employees. And it is broadening its sales efforts to include the health-care, retailing, manufacturing, and government sectors. These are customers it previously has not called on. McNealy says such organizations are less cyclical, and at the moment have a lot more money to spend on technology than do Sun's traditional clients. Since Sept. 11, the company has also emphasized its security business, pushing Java smart cards--credit cards with a computer chip. Although the market is not big yet, Sun is betting that security-conscious people around the world will begin using smart cards as identity cards, and that Sun servers will be the ones that authenticate them.
Sun also put one of its top executives, Mark Canepa, in charge of the storage business last summer, and in the fall he teamed up with Hitachi to offer customers something Sun had previously lacked, a high-end storage product. Last summer Sun bought back control of its IPlanet software business, deciding that its three year partnership with AOL Time Warner (owner of FORTUNE's publisher) was not working out. And through the so-called Liberty Alliance and McNealy's relentless stumping, Sun is aggressively promoting Sun One, its counter to Microsoft's .Net Web services platform.
Zander talks about these moves as part of a single shift in tactics. In the past, he says, companies wanted two things from Sun: top-of-the-line hardware and stable operating-system software. Now they want three more things: storage, middleware (software that runs specialized servers), and Web services. So the company is doing what it's always done--following its customers. He says Sun retrained its entire sales force last summer to drive home this point: that it is "not just producing a bunch of products but infrastructure that helps customers solve problems."
What's not changing at Sun, Zander and McNealy say, is its business strategy--and its attitude. It still believes that the Internet is the most important business development of the last half-century and that being the "Internet infrastructure company," as it likes to say, is a winning business strategy. Success, according to Zander, is just a matter of execution now. "We know what we have to do,'' he says. "We just have to go do it."
If only it were so simple. In the coming years, hardly anyone in IT is going to be able to grow as fast as it did in the past decade. Bull markets will return, but the huge increase in IT spending created by telecom deregulation in 1996 and by the Internet bubble are gone for good. Sure, diversifying into new markets to sell servers is a good idea for Sun, but they aren't exactly high-growth businesses.
Besides, even if it were just a matter of execution, as Zander says, Sun's record on that front has been less than stellar. Take web services. McNealy says that Sun invented the idea and that the only thing Microsoft has done better is market it. But since when is being outmarketed something to be proud of--particularly when you invented the thing?
The company's record in the storage and application server market is even worse. Although Sun invented some of the technology EMC now uses to dominate the storage market, it never saw the benefits: Sun concluded--incorrectly--that customers wanted small storage devices that worked with networks rather than a big centralized system. After partnering with AOL in 1998, Sun also controlled the No. 1 and No. 2 software application servers (Sun's own plus the one AOL inherited when it bought Netscape), but Sun fought internally over which technology to use, resulting in long delays. Now EMC tops the storage business with a 21% share, compared with Sun's 6%; BEA and IBM dominate the application server business, with a combined 35% share, vs. just 8% for Sun. "They should have owned those businesses,'' says Ashok Kumar, an analyst at Piper Jaffray in Menlo Park, Calif. "The fact that they do not means a significant opportunity has been lost."
Ultimately, for Sun to succeed, a radical change in the way its employees think is in order, and right now it doesn't look as if McNealy and his team are even close to pulling that off. The trouble is that even though McNealy has instilled great loyalty in his work force, Sun's various divisions don't have a good reputation among customers for working well together. Now they will have to start. And it won't be easy. Sun took a whack at the problem in 1998, creating divisions that attempted to operate under a single corporate umbrella, but the effort hasn't gone far enough. One big customer reports that as recently as last summer, Sun's legal department was threatening him on a copyright issue on the same day that a top Sun sales rep was visiting his company to discuss a pending offer. The matter took months to resolve.
Sun's decentralized structure didn't happen by accident. It's been at the heart of Sun's ability to innovate and make fast decisions. Coordinate too much, the thinking went, and you slow decision-making too much. Insiders still like to call Sun the biggest little startup in Silicon Valley. Now McNealy & Co. must try to persuade everyone to forgo that divisional efficiency for the greater good.
There's another thing that probably has to go--McNealy's obsession with Microsoft. It's no longer clear that customers, even Sun's best, want to hear how evil Bill Gates is. Top officials at Sun seem to understand that. "The thing you have to watch is that customers have invested in Microsoft whether you like it or not,'' says Zander. "So you really have to walk the fine line and make sure you're not out there personally attacking them to the point where you can't tell your own story. The worst thing you can do is be known as the company that's against another company, as opposed to the company that delivers blank." In other words, the key to Sun's future is not McNealy's delivery of Microsoft wisecracks, but Sun's ability to deliver great products at good prices.
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