Compaq's Challenge

Compaq dumps Alpha and looks to IT services for profits.
A month ago, Nasdaq chief technology architect Jim Richmann was adamant that Windows-based servers using Intel's newly introduced 64-bit Itanium chip wouldn't be reliable enough to handle the billions of dollars in trades that go through the exchange each day. Richmann was planning to stick with Compaq servers built with chips designed by Mips Technologies Inc. and use the Itanium boxes only as simple Web servers.

Time for plan B. In a surprise move, Compaq last week said it's ditching Mips and its own Alpha chips and will instead put Intel processors inside all its high-end servers. The shift is part of a larger restructuring by the struggling computer vendor, which lost $82 million in its PC business in the first quarter. Compaq wants to decrease its dependence on low-margin hardware and grab a bigger share of the lucrative IT services and software markets. But competition will be fierce: Compaq will be engaging entrenched players such as IBM and Hewlett-Packard.

Richmann says he's not concerned about Compaq's move because he never had a problem with the Itanium chips. The trouble, he says, is that the Windows operating system used on most Intel-based machines lacks high-performance clustering and fault-tolerance capabilities. Compaq's NonStop Kernel operating system is what makes the vendor's servers fit for the high-stakes world of electronic trading, Richmann says.

That's the reaction Intel and Compaq are hoping for. Compaq executives say operating-system and systems-management software that enable advanced functions are what will distinguish high-end servers as more vendors move to Itanium. "We'll differentiate ourselves with superior systems engineering, memory management, caching, and all the technical services that surround that," says Compaq CEO Michael Capellas.

Compaq is eyeing IBM's transformation from being a hardware maker to a services provider as its model, CEO Capellas says.
Compaq maintains that porting all its operating systems to the Intel platform will make it easier for customers to run the best operating system for a given task. "When you think about the future of the Web, you'll have to manage different platforms," Capellas says. "You'll have very large data stores, high-performance simulation capabilities, application servers, edge-of-the-Net servers. Having a single architecture underneath makes all the sense in the world."

Under terms of a deal with Intel, Compaq will offer Itanium-based servers that run its Tru64 Unix, OpenVMS, and NonStop Kernel operating systems by 2004. Until then, Compaq promises to deliver one more generation of Alpha technology and will continue to enhance its Mips platforms. And Alpha technology won't disappear: The agreement calls for Intel to incorporate Alpha compilers and other technology into Itanium under license from Compaq for an undisclosed sum.

The decision represents a tacit admission by Compaq that its Alpha and Mips platforms, which accounted for $3.2 billion in sales last year, have limited growth potential. "Most high-end systems that Compaq is going to ship over the next few years are going to be based on Intel. It's not like Alpha has been a dominant architecture," says Merrill Lynch analyst Joe Osha.

That may be, but over the years Compaq has sold thousands of Alpha-and Mips-based systems, and many customers are less sanguine about the change than Nasdaq's Richmann. "I nearly fell off my chair when I heard they were going to do this," says Robert Ceculski, a systems analyst at Instantwhip Foods Inc. in Columbus, Ohio. The food distributor runs OpenVMS on 40 Alpha servers, and Ceculski says he doesn't know whether the operating system will run well on Itanium. "The kick in the face is that Compaq has been touting Alpha as far superior to Itanium," he says.

Intel designed Itanium from the ground up to support 64-bit operating systems, but the chip, launched in May, has yet to prove itself in the field. Also, Itanium's EPIC architecture differs considerably from Alpha's and Mips' RISC design, leading some to believe the transition may not be smooth. At the least, Compaq Tru64 users will have to recompile applications to run on Itanium, says Nathan Brookwood, an analyst at research firm Insight 64. "You're going to need the source code," he says.

That could be a problem if the software developer is no longer in business.

IBM officials cite such concerns as one reason the company is committed to its PowerPC RISC chip architecture. They also argue that Itanium, designed to run multiple operating systems, is a jack of all trades but master of none. "If you have a team that not only designs your chip, but also designs your software, you end up with much tighter integration, and that's crucial in markets where performance and availability are paramount," says Joel Tendler, IBM's program director for development of the RISC chip.

HP is making a move similar to Compaq's, but its customers may not have the same concerns. HP will move its 64-bit HP-UX systems onto Itan-ium from its PA RISC chip. But HP co-designed Itanium, ensuring that applications built for HP-UX will run on Itanium without recompilation.

Intel doesn't seem worried. The chipmaker says design breakthroughs make Itanium faster than competitive chips-such as Sun's UltraSparc III-at a given clock speed. Intel officials also are confident they can win the battle for the high end by turning the company's vast, economy-of-scale-driven manufacturing to the production of high-performance, low-cost 64-bit chips-in turn, allowing its customers to beat rivals on price.

Compaq officials are basing their strategy on that cost advantage. "We'll be giving our customers a clear path to what will be proven to be the most robust, performance-oriented processor platform, plus the lowest cost," says Mike Winkler, Compaq's executive VP for global business units.

That strategy doesn't have all IT managers convinced. "It's difficult to evaluate how our systems are going to perform on a different chip architecture because right now we don't have anything to evaluate," says Joe Pollizzi, deputy head of the engineering software services division at the Space Telescope Science Institute in Baltimore, which operates NASA's Hubble telescope. The organization uses clusters of Alpha systems running Tru64 Unix to crunch data the telescope captures. Intel has a poor record of meeting production schedules, Pollizzi says, noting that the vendor missed its target date for Itanium by almost two years. "If I'd bet on Itanium a couple of years ago, I'd have been in big trouble."

As it backs out of the costly chip business, Compaq is increasing its emphasis on software and IT services. That strategy underpinned IBM's transformation from a money-losing computer maker to a highly profitable solutions provider. "We're definitely looking at the IBM model," Capellas says.

Compaq will soon unveil a major push into so-called IT-as-utility services. As defined by Compaq, that includes everything from usage-based pricing to full life-cycle management. "This is going to be a core component of our outsourcing strategy," says Jeff Lynn, VP and general manager of Compaq Global Services.

Compaq also plans to grow its services revenue by buying into highly profitable vertical markets. Already a strong player in the telecom industry, Compaq wants to acquire leading services firms in life sciences, retail, media and entertainment, health care, and government. It will make four to six acquisitions in the next two to three years, with the first coming before year's end, Lynn says.

Compaq has about 38,000 services employees, and the acquisitions should boost that by 5% to 10%. Still, the number pales next to IBM Global Services' 150,000 employees. Compaq officials say they don't plan to compete with IBM in managing big mainframe data-center environments, but will focus on narrower areas such as help-desk and call-center management.

Compaq knows that buying into services is easier said than done. It acquired Digital Equipment Corp. in 1998 largely to tap that company's formidable services arm, but interdepartmental bickering soon dashed any hopes of a quick return. "We learned a lot from that experience," Winkler says. "We left that business running on its own and never really fed it properly in terms of resources. Maybe our hardware heritage got in the way."

Now, Compaq executives promise that services and hardware teams will work hand in hand, with services leading the way. Specialized services teams will target specific industries, and hardware teams will fulfill the resulting infrastructure recommendations.

What IT managers expect from Compaq is the ability to support a broad range of technology. DirecTV Inc.'s relationship with Compaq dates back to the satellite television provider's origins in 1992. That's when DirecTV, now a $5 billion company, was setting up its business in El Segundo, Calif. It contracted with Digital to provide network and systems-integration services and 64-bit Alpha servers. DirecTV now outsources its subscriber transaction-management system to Compaq Global Services, which handles about 10 million bills per month for the fast-growing company. In recent years, Compaq has extended its support to cover DirecTV's Sun and HP servers. "Compaq is realizing that to become a player in the outsourcing business, it needs to support and know about systems in addition to its own," says Mark Schubert, VP of enterprise strategies and architecture for DirecTV.

Compaq is also looking to grab a bigger chunk of the enterprise-software market. The company is already a leading developer of software for the telecom industry; it now wants to develop specialized programs for other markets. Winkler hints that Compaq also will push harder into the lucrative middleware market, developing everything from application servers to Web services that power next-generation E-business infrastructures.

It all sounds great. But Capellas concedes that Compaq will have a tough time entering new markets if it can't fix its ailing PC business, which continues to provide most of the company's revenue but is again awash in red ink. "We absolutely have to improve the efficiency and profitability of the PC operation. It's still a $20 billion business for us," he says.

That makes three highly diverse businesses-services, software, and an ailing hardware unit-that Capellas has to juggle. It's an ambitious strategy, but Capellas' choice of Itanium indicates he's willing to make controversial decisions.