IBM Once Again Looking To Software For Growth

When Lou Gerstner reshaped IBM in the 1990s, the former chairman and CEO transformed a company that relied on hardware for most of its sales and profits into a services powerhouse.

The shift rippled through the IT industry, with IBM Global Services (IGS) becoming the model many vendors emulated as they, too, recast their products as drivers for an expanding services business. But now, IBM is in the midst of another seismic shift: Software, not services, is the company's new growth engine.

The quiet shift drew a spotlight in recent weeks as IBM set off on a buying tear. Big Blue followed one pricey acquisition, its $1.6 billion FileNet buy, with a second, its $1.4 billion Internet Security Systems deal, and mixed in smaller purchases of MRO Software and Webify Solutions. Swallowing four companies in a month is unusually aggressive for IBM, but the company for years has been a voracious acquirer—particularly in the software market, where it bought two dozen companies in the past two years.

The billions IBM is spending to expand its software portfolio make sense when you look at its bottom line: IBM's software division generates more profit than any other, including the much-larger IGS. While IGS accounted for $47.4 billion in sales last year, operating costs pulled its gross profit to $12.3 billion. IBM Software, headed by 32-year IBM veteran Steve Mills, has a stratospheric 87.5 percent profit margin. It posted a profit of $13.8 billion on sales of $15.8 billion last year.

IBM is betting big on Mills' unit. Three of the five largest acquisitions in IBM's history have been for its software group: FileNet, Rational (bought in 2003 for $2.1 billion) and Lotus (acquired in 1995 for $3.5 billion). Other billion-dollar purchases include Informix in 2001 and Ascential last year.

Splashy as the big buys are, IBM's software success stems from hundreds of smaller deals and decisions made over the past few years. After its troubled Lotus takeover, IBM swore off applications. Mills staunchly maintains that IBM will never do a big applications acquisition on his watch. That strategy—if it stands—will allow IBM to stay out of the tough ERP market—where dwindling revenue and margins drained the life out of onetime leaders PeopleSoft and Siebel Systems—and instead profit from selling the middleware and services applications customers need to integrate their systems.