Oracle and Sun: The death of hardware?

Has a software company ever purchased a multi-billion dollar hardware company? Isn’t it supposed to be the other way around? On one level, the news of Oracle’s purchase of Sun Microsystems is historical and surprising. A press release on Oracle’s web site itemizes the following benefits of this unique merger:   

  • Combining best-in-class enterprise software and mission-critical computing systems
  • Customers will benefit as their systems integration costs go down while system performance, reliability and security go up
  • Long-term strategic customer advantages to Oracle owning two key Sun software assets: Java and Solaris.
  • With the acquisition of Sun, Oracle can optimize the Oracle database for some of the unique, high-end features of Solaris.

These are all interesting points about the potential value this merger will create for customers. However, I am much more taken aback by two harsh realities this merger drives home regarding the enterprise technology marketplace.

Services as Margin Dollar King

First of all, the merger of Oracle and Sun brings together two very different companies that, believe it or not, landed on the same square regarding economic health. As the database and computer server markets matured in tandem, both Oracle and Sun became immensely dependent on services revenues and services margins to fund their business models. To give you a sense of how critical services will be to the combined company, we can look at the quarterly revenues of each individual company that were analyzed in our last Service 50 snapshot. The numbers are below:

Oracle and Sun Qrtly Revenues

Oracle and Sun Qrtly Revenues

Smashing these numbers together, services will roughly represent 61% of total revenues for the combined company. More importantly, services will potentially generate 61% of the margin dollars used to fund investments and throw off profits.   Oracle has generated fantastic profits over the past two years by buying up aging software companies that had little incremental license growth, but a lucrative services install base. In this respect, is Sun any different as an acquisition target?

 

Hardware Irrelevance

As I have commented before, Sun’s dependence on services was not by design or desire, but the result of commoditizing hardware. The fact that a software company has bought a multi-billion dollar hardware company places an exclamation point on this cold reality: hardware is commoditizing. The second bankruptcy of my alma mater SGI and the purchase of Sun Microsystems prove that the high end server market is no longer what it once was. Storage providers such as EMC and Brocade have clearly experienced margin pressure. In fact, a majority of the hardware companies we track in the Service 50 have experienced a downward trend in both product margins and operating incomes over the past two years:

The Service 50: Hardware Company Trends

The Service 50: Hardware Company Trends

The poor global economy is not helping, but does anyone believe makers of computer servers, storage, PCs, or telecommunication switches will be able to hold the line on price and margin over the next three years? In fact, I believe the data points to overall irrelevance of hardware. Customers will pay for software and services that enable business capabilities. They are less willing to simply pay for physical piece of hardware—especially if it lives in a technology cloud somewhere and they never see it or touch it.  Just look at the incredible transformation legacy telecommunications providers such as Alcatel-Lucent and Avaya are experiencing. Right before their eyes, the business has gone from providing large, black box hardware solutions to delivering complex software on commoditized, open source hardware.

Oracle bought Sun! I declare this the day differentiated hardware died. It may take a decade for the body to grow cold, but trust me, stiffness is setting in for any enterprise technology company that believes they can survive solely on the back of high margin iron.

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