What Does IBM’s Acquisition of SoftLayer Mean?

IBM softlayerFull disclosure:  I work at Rackspace, leading product marketing for compute cloud offerings.  Opinions expressed here mine and not my employer’s.

There was big news in the world of cloud M&A last week with IBM’s announcement that it intends to acquire SoftLayer at a price reported to be about $2 billion.  What does that acquisition mean to market participants and cloud buyers?  Here are three ideas to think about:

1)  Building and running public cloud IaaS is difficult – believe it or not, building and running a public cloud is actually a big deal.  Public cloud is very different from traditional hosting, or from slapping software on hardware and providing service over the Internet.  There are technology riddles to solve to keeping a cloud running, sales and go-to-market approaches to acquire customers in the cloud, and most of all service guarantees and support for the infrastructure at a large scale and much lower price than traditional IT.

None of the traditional software or hardware vendors like IBM or Oracle can claim to provide these at a level sufficient to attract cloud customers regardless of their forays.  IBM has come to that realization faster than any in their peer group of enterprise vendors (as they usually do, as seen with the divestiture of their PC business). A lot of industry analysts and old school strategists dismissed IaaS as an undifferentiated commodity.  The thinking is that the valuation of an IaaS service in its most simplistic sense is the value of the hardware in the datacenter and the operating expenses for the staff supporting it.  Unfortunately this valuation doesn’t capture the intrinsic value that service at scale provides and the service values the company holds.

IBM buying SoftLayer tells us why.  IaaS is actually a difficult thing to do.  Ask Dell, who recently withdrew from the public cloud market and VMware who is still figuring out how to offer IaaS.  The reason vendors like AWS or Rackspace have been successful in IaaS is because they were businesses that were started from scratch with years of technology and talent investment, and have a value differentiation that is aligned with providing a service at scale that thousands of customers can enjoy.

2)  Public Cloud IaaS is officially a mainstream enterprise market segment – IBM’s entry validates to the Fortune 500 IT buyer that public cloud IaaS market for the enterprise is very real – PRISM, security and SLAs notwithstanding.  But that is just the surface.  The market for it has been there all along for the leading cloud IaaS providers, while enterprise software and hardware vendors have been claiming that public cloud isn’t ready for primetime, or that OpenStack isn’t mature enough, etc. The reality is, IBM lacked a credible public IaaS to compete (SmartCloud wasn’t so smart after all), while its Fortune 500 customers were looking for public cloud alternatives. As they say, there are no atheists in foxholes.

3)  The real beneficiaries might not be who you think – Other than the investors at SoftLayer (acquired at approx. 5.5X revenue multiple), who else could potentially benefit from this acquisition?  IBM’s core customers are Fortune 500 firms.  SoftLayer has about 21,000 customers who are overwhelmingly small and mid-sized companies. Clearly, there are at least 20,500 non Fortune 500 customers in that mix.  Acquiring and servicing those customers is not something that traditional enterprise vendors are set up to do.  Consider the challenges that traditional license-based software vendors have when competing in the SMB market against subscription based SaaS providers selling the same type of application (ask Oracle, for instance).

IBM cannot offer its traditional white-glove service to 21,500 customers. The direct sales model can’t be supported by these customers at the low monthly price points. Therefore, the sales model will have to be different and the customer distribution map will necessarily span multiple segments. Few companies can successfully serve every segment of the market.  Great strategies are not only about what you do, but also about what you have the discipline not to do.

Will IBM position an IaaS offering to target its core customer base (Fortune 500) and leave all those SMB customers out? Or will it reduce the price and level of service it offers to its Fortune 500 customers to normalize its offerings across all IBM and SoftLayer customers?

The real beneficiaries of this acquisition could turn out to be AWS and Rackspace.

However this acquisition plays out, it shows that the public cloud market is an ever-expanding pie, which is great news for everyone serving — and eating — the pie.

Prabhakar Gopalan is a guest contributor to Leverhawk.

About Prabhakar Gopalan

Prabhakar Gopalan is a strategist with a diverse background in consulting, product design, product management, product marketing and corporate strategy. Prabhakar works at Rackspace. You can follow his tweets @PGopalan.

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