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7/22/2011
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IBM's Unsexy Secret To Profits: Middleware

One telling statistic from IBM's big quarterly windfall: This unsung category drives 64% of the company's high-margin software revenue.

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Slideshow: 100 Years Of IBM: 25 Historic Milestones
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IBM took pains to highlight hot-button topics like cloud computing and big-data computing in its second-quarter earnings report this week. But behind the scenes, the backbone of IBM's software profit engine is middleware.

The world's second-largest technology company (after Hewlett-Packard) reported plenty of positive figures for the second quarter ended June 30. Revenue was up 12% over the same period last year to $26.7 billion, and profits grew 8% to $3.7 billion.

IBM also shared plenty of claims about sexy-sounding categories like Smarter Commerce and Business Analytics, but those categories don't show up in the SEC filings with financial figures attached. As an example, IBM said this week that its cloud computing revenue will double in 2011, but from what to what? You won't find a dollar figure in the quarterly report. As InformationWeek has reported, Amazon, Google, and Microsoft also have been coy about their cloud computing revenue.

Looking at the details that are available, software was one of IBM's bright spots, with revenue up 17% (10% adjusting for currency fluctuations) to $6.1 billion. More importantly, software gross margins were 88.4%, more than double the margins realized by IBM's Global Technology Services (outsourcing), Global Business Services (integration and consulting), and Systems and Technologies (hardware) businesses.

In fact, software has turned into IBM's profit engine. The segment's revenues have doubled in recent years, reaching $25.4 billion in 2010. That's only about a quarter of IBM's $106.8 billion in total revenue last year (and well shy of the $39.5 billion in revenue for Global Technology Services, IBM's largest segment). But software delivered more than $9 billion in profits for IBM last year, or about 44% of total company earnings.

It turns out that middleware, including WebSphere, Information Management, Lotus, Tivoli, and Rational products, accounts for 64% of software revenue, with the remainder coming from non-branded categories including operating system software. IBM does not break out product-by-product profitability, but it's easy to guess that branded products have higher margins than operating systems.

WebSphere was particularly strong in the second quarter, growing 55% year over year. But it just might surprise you all that's included in that category. Beyond the application server, the WebSphere portfolio includes everything in IBM's business process management and Smarter Commerce categories. That means 2010 acquisitions including Cast Iron, Coremetrics, Sterling Commerce, and Unica all contributed to that 55% second-quarter increase. And let's not forget the 2009 and early 2010 acquisitions of ILog and Lombardi, respectively, that also now figure in WebSphere sales.

In news on the core product, IBM announced the general availability of WebSphere Application Server Version 8.0 on Friday. The upgrade gives developers new frameworks and libraries that support latest-generation iOS (iPad and iPhone) and Android mobile devices. And throughput performance is said to have increased 29% over WebSphere 7.0, giving developers more scalability and capacity without having to change hardware.

IBM's key competitor in this category is Oracle, which offers the WebLogic Server. Oracle also has a vast middleware stack that's studded with acquisitions.

It's practically impossible to figure out just how much IBM and Oracle are growing organically. But make no mistake: software is the key to their profitability. And middleware--not mobile apps or cloud computing or big-data analysis--is foundation of revenue and, it goes without saying, enterprise customer expenditures.

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