IBM Finally Joins Cloud Pricing Wars: What it Really Means for Big Blue

IBM is among the last tech companies to join the cloud pricing wars that have been raging on this year. On June 10, IBM lowered the price of storage available through its SoftLayer cloud infrastructure service by 60% to just $0.04 per GB per month, bringing it within spitting distance of Amazon  AWS' $0.03 per GB per month, and Google (NASDAQ GOOGL) Drive's $0.026 per GB per month. IBM also promised to lower virtual server prices by up to 5%.

The funny thing is that IBM did not make a big splash about its price cuts, which was in stark contrast to its rivals, which unabashedly follow up on each other's cloud moves by announcing their own, often bigger, moves in a matter of days. So why did it take IBM so long to join the pricing wars, and why is it important?

Dominance of IaaS and hybrid cloud
Although IBM has plenty of enterprise credibility, the company has not had a strong developer or cloud history, until it recently acquired SoftLayer. In contrast, AWS enjoys mass mindshare with developers. IBM has been trying hard to avoid the cloud-as-a-commodity mind-set, championed by leading cloud providers, by differentiating its cloud offerings.

IBM, together with cloud players such as SAP, offers gilt-edged cloud services, with a price to match. In IBM's case, the major differentiator is its SoftLayer bare-metal capabilities. IBM has to walk a tightrope between remaining competitive as a cloud vendor and devaluing its core brand. That could be why the company took so long to announce its price cuts, and why the announcement was low-key.

IBM has been trying to parlay its niche cloud into enterprise deals. Although the company must have been hurt by the loss of the $600 million CIA deal to AWS last February, Big Blue has been wining elsewhere. The company signed a $600 million seven-year cloud outsourcing deal with energy provider NiSource that involves implementing a hybrid cloud using SoftLayer. IBM's SoftLayer has a strong focus on IaaS and hybrid clouds, which is a good thing since indications are that the future of the cloud is hybrid.

Gartner estimates that the cloud computing market was worth $131 billion in 2013. IaaS and PaaS are the most commonly referenced public cloud segments. IaaS has a 5.5% share of the cloud market, compared to 1% for PaaS. There are growing concerns that the PaaS market could be consolidating, with many IaaS and SaaS vendors already offering PaaS-like solutions. It appears, therefore, as if public clouds with a strong Iaas focus, such as SoftLayer, will be favored more by industry trends.

Revenue cliff
IBM has experienced a worrying revenue decline for the last eight consecutive quarters. The company reported revenue of $22.48 billion in the first quarter of fiscal 2014, the lowest quarterly revenue in five years, or a 3.9% year-over-year decline. Its net income fell a jaw-dropping 21.4% to $2.38 billion, while diluted GAAP EPS declined 15.4% to $2.29.

IBM's hardware business, including servers and systems storage, seems to be disintegrating. Revenue from the segment fell 23% to $2.4 billion. Practically all of the company's server segments fared badly -- System-Z revenue tumbled 40%, power systems revenue declined 21%, and System-X revenue fell 17%.

IBM's System-Z mainframe business still commands a strong market position. It is, unfortunately, in the final stages of its product cycle, hence the huge revenue decline. The power systems business serves high-end Unix and Linux computing customers who have been migrating to bladed white-box data center environments, impinging on the sector's growth. Meanwhile, performance of the low-end System-X business has been faltering with the planned sale of the x86 server business to Lenovo.

IBM is, however, betting big on the cloud to drive new growth for the company.

Betting big on the cloud
IBM's cloud business is, by far, the most promising of all its businesses. The company's cloud revenue expanded 80% in the first quarter, with the annual run rate of cloud-delivered-as-service growing 100% year over year to $2.3 billion. The revenue was almost as big as that from the company's server division.

Source: Synergy Research Group

A lot of growth in IBM's cloud service is inorganic (from acquisitions). The company spent $3.1 billion last year to acquire 10 cloud companies. But, the overall cloud market is also growing at a brisk pace, up 20% last year to $131 billion. IBM Market Intelligence estimates that the cloud market will reach $200 billion by 2020.

IBM's cloud business grew 69% in fiscal 2013 to $4.4 billion. Allowing for a more modest 25% growth through 2020, the business will reach annual revenue of $16.8 billion by 2020, or nearly 17% of its current annual revenue.

In the short term, it might take three years for growth in the sector to balance out declines in the company's overall revenue, assuming that it holds steady at the current rate of 50% per annum.

Foolish bottom line
IBM is betting big on its cloud to drive new growth. The company cut its cloud prices to remain competitive, and its gilt-edged cloud services should help differentiate it from rivals.

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Joseph Gacinga has no position in any stocks mentioned. The Motley Fool recommends and Google (C shares). The Motley Fool owns shares of, Google (C shares), and International Business Machines. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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