(Editor’s note: End-customer purchasing shifts from licenses to subscriptions challenge IBM’s ability to grow software revenue, writes Technology Business Research Analyst Andrew Smith.)

HAMPTON, N.H. – End-customer purchasing shifts from licenses to subscriptions challenge IBM’s ability to grow software revenue.

IBM Software reported a 7% year-to-year decline in revenue to $7.6 billion during 4Q14. WebSphere, Information Management, Tivoli and Workforce Solutions all reported year-to-year revenue declines in the software segment, resulting in total middleware revenue declines of 6% from the year-ago quarter. Solutions in the total middleware segment accounted for 87% of IBM Software’s total revenue during the quarter. The declines in software come amid financial headwinds due to the loss of IBM’s System x business, combined with adverse workforce rebalancing charges sustained during the quarter. This difficult financial environment was felt throughout the IBM corporation in 4Q14, resulting in a 13% year-to-year revenue decline overall.

Despite a difficult financial environment in 4Q14, IBM’s strategic imperatives finished 2014 with relatively strong growth. Overall, revenue attributed to strategic imperatives increased 16% year-to-year, with Cloud revenue growing 60%, Mobile solutions growing over 200%, Analytics solutions growing 7% and Security solutions growing 19%. IBM had stated that 2014 would be a transition year, and the reality of the vendor’s evolution is reflected in its financial results, as core business units seek to better align with high-growth, strategic priority areas. However, TBR believes IBM’s resilient 4Q14 margin combined with the divestiture of more than $7 billion in revenues last quarter (which were yielding an annual half-billion dollar loss) illustrate the vendor’s desire to enter 2015 with a more streamlined portfolio of solutions to deliver to market.

IBM’s internal reorganization will help the vendor better disseminate software IP across its expansive portfolio

In 4Q14 IBM announced an internal reorganization that structures the company into specific units focused on combining technology, software assets and IP, and domain and vertical expertise for more agile delivery of IT in response to how its customers want to consume technology. As a result, the majority of IBM’s middleware, information and systems management software portfolio reside in the IBM Systems business unit run by Tom Rosamilia. The new unit will seek to combine IBM’s core infrastructure assets for buyers seeking to own and control their IT infrastructure. With this new, horizontally oriented unit, TBR believes IBM Systems will be better prepared to deliver high-performance infrastructure technology to businesses seeking flexible, scalable, hybrid IT solutions.

IBM continues to drive innovations in its cloud portfolio, better aligning with customer demand for application and workload portability and integration

IBM reported cloud revenues increased 60% during 2014. The vendor continues to make strides to bolster its cloud capabilities and drive adoption of innovative products for hybrid environments. One approach has been expanding geographic reach. The recent openings of SoftLayer data centers in Germany, Japan and Mexico enable IBM to tap into growing cloud opportunities in these markets while remaining in compliance with country-specific rules and regulations. IBM also gained access to nine Equinix data centers and its customers in Australia, France, Japan, Singapore, the Netherlands and the United States through a recent deal signing, providing SoftLayer integration on the Equinix Cloud Exchange. TBR believes expanding the reach and compatibility of SoftLayer data centers will help attract customers seeking hybrid cloud deployments for complex infrastructures, which require the integration and management of multiple cloud platforms.

IBM’s Middleware portfolio struggles to play catch-up to corporate imperatives of cloud, security and analytics

IBM reported 16% year-to-year growth among its strategic imperatives during 4Q14. However, year-to-year declines across almost every segment of the software portfolio point to continued cannibalization of traditional on premises licensing agreements due to subscription-based solution growth in new and existing cloud and hybrid cloud customer deployments. Revenue declines among WebSphere, Information Management and Tivoli portfolios in parallel with 16% year-to-year growth across strategic imperatives illustrate the zero-sum nature of IBM Software’s portfolio transition. Despite 7% year-to-year declines in the Software segment, gross margin remained strong at 90% and flat from the year-ago quarter. IBM will continue to manage and reduce costs associated with legacy software portfolios while it increases expenses necessary to drive high-opportunity products including Watson, SoftLayer and Bluemix and in support of key partnerships with vendors like Apple, Twitter, SAP and Tencent.

IBM’s middleware portfolio will seek tighter integration with emerging products such as Watson Analytics to drive revenue capture in higher-value deployments

IBM recognizes the opportunity to combine its software applications more effectively into end-to-end solutions, ultimately creating more customer stickiness and opportunity for cross-sales. To do so, TBR believes the vendor will develop more vertically aligned applications and platforms, which better facilitate integration of IBM’s extensive software IP, from Watson to WebSphere and Rational. IBM will continue to use Bluemix to spearhead this effort, increasing application portability and integration to meet the needs of LOB customers and developers who want to test, deploy and manage their applications within one ecosystem. Ultimately, the challenges will remain the same for IBM — and many of its software industry peers — during 2015. IBM must continue to invest in the transformation of its software business to align with new, end-user driven consumption models at a rate fast enough to offset declines in its license-based, legacy product lines. TBR believes IBM’s strategic approach to this transition seeks to generate a critical mass of subscription-based revenue to drive profitability and growth of software products and applications over the long term.

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