Does Sun have a new enemy number one?

Buyout of Digital creates juggernaut to challenge Sun in enterprise, workstations, and storage markets

By Rick Cook

SunWorld
February  1998
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Abstract
Maybe the worst news for Sun about Compaq's DEC acquisition is the fact that it won't be so easy to pick on Digital anymore. Compaq is now the second-largest computer company and, whether Sun likes it or not, it's going to represent some new competition for our friends in Mountain View. We tell you what Compaq has bought and give you a hint at what kind of company ComDEC could become, and where it will affect Sun. (2,700 words)


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Compaq's acquisition of Digital Equipment Corp. creates not only the world's second-biggest computer company (after IBM), but also a monumental headache for Sun Microsystems. The new Compaq will be a $37 billion company with a product line that ranges from sub-$1,000 PCs to enterprise servers using multiple 64-bit processors, and a worldwide service and support organization.

In other words, "ComDEC," as it has been dubbed in some circles, has the potential to threaten Sun in all its markets, especially at the high end where Sun wants to be and in the departmental server and workstation markets which are Sun's bread and butter.

"Sun was competing head to head with Digital, and to a certain extent with Compaq," says Jerry Sheridan, director and principal analyst in the computer systems and servers program at Dataquest, a San Jose, CA, market researcher. "Now the combined company is a larger competitor with features that make it more formidable to Sun."

Needless to say, Sun doesn't see it that way, at least not publicly. Sun sees the merger, and the period of confusion that will follow as the two companies try to combine product lines, as an opportunity to steal sales from both Digital and Compaq. "Compaq now faces the unenviable task of trying to get disparate technologies (from Tandem NonStop to DEC Unix/VMS to Compaq NT) to work together," Sun said in a prepared statement released after the merger was announced.

While Sun's statement has a certain air of whistling in the graveyard it also contains a lot of truth. Certainly the acquisition represents one of the biggest challenges Compaq has ever faced. Getting synergy out of the deal is not going to be easy, and the new company will undoubtedly stumble along the way. Industry observers generally see the merging of the two companies as the biggest potential obstacle.

However, the potential benefits are huge as well. Most analysts are optimistic about Compaq's chances of digesting DEC -- eventually. They point out that Compaq has moved quickly and effectively to integrate its other major recent acquisition, Tandem Computers. They think the company can do the same thing with the much larger DEC.


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Servers, workstations and the future of Unix
The new Compaq's most immediate threat to Sun is in the workstation and departmental server market. Both Compaq and DEC are NT powerhouses, and the combination is going to be even more powerful. Compaq is a Windows company and DEC is known for its high-end NT solutions. DEC has also forged close links with Microsoft over the last few years and shifted more of its focus to NT. The merger creates an NT powerhouse, complete with a direct sales force and more Microsoft-certified engineers than any other company in the world.

All of which should help increase sales of NT servers and workstations. And because Sun is the dominant player in the Unix workstation market, much of that increase will come out of Sun's hide.

According to International Data Corp., a Framingham, MA-based research firm, Sun sold about 43 percent of the 660,000 Unix workstations sold last year. Compaq by itself had just over 15 percent of the market for NT workstations, which was roughly twice the size of the Unix market.

This is an area where Sun is already coming under strong pressure from companies selling NT systems. In the last three years NT has gone from nothing in the workstation/server market to a major presence. "NT is going to cause major problems for the traditional workstation players, including Sun," says David Vellante, a senior VP at IDC. "The bottom line is that NT really puts pressure on the workstation market. It makes that business a low growth business for Sun and underscores the imperative of moving Sun into the enterprise."

In the short term, the increased emphasis on NT at the expense of Unix may help Sun win business from Digital customers who want to stay with Unix and are unsure of Compaq's commitment to DEC Unix. Some analysts point out that Sun followed this strategy effectively when Hewlett-Packard announced its line of NT products. Of course HP's workstations and servers had been strictly Unix-based while Digital has been increasing its commitment to NT for years, so the pickings may be slimmer this time around.

Although both DEC and Tandem had versions of Unix, one common assumption is that the new Compaq will move out of the various flavors of Unix to concentrate on NT. However, this isn't a done deal. In discussing the merger, Compaq officials have been careful to keep their options open in regards to operating systems.

This isn't just a matter of reassuring nervous Unix customers. For one thing it would be hard to replace Unix across the board in Digital's product line. DEC's high-end multiprocessor systems with 16 or 32 processors run Digital Unix. There is nothing equivalent on NT, although Digital is working with Microsoft to develop 16- and 32-processor versions of NT.

For another, NT has some significant drawbacks in the enterprise environment. Microsoft Scalability Day notwithstanding, the current versions of NT do not scale well across the enterprise. As the combined Compaq/DEC moves further into enterprise territory the weaknesses of NT will become more apparent.

One important piece of the puzzle will be a 64-bit version of Windows NT. A beta version of this code is supposed to be in the hands of developers around the time NT 5.0 ships (scheduled for this summer, according to Microsoft), and Microsoft is swearing up and down that by the time Merced arrives, there will be a 64-bit version of their OS available. This software is expected to fix some, but not all, of NT's deficiencies and will make it a stronger competitor against Unix.

Compaq the RISC vendor
A related question involves the future of Digital's Alpha RISC microprocessor, which has never lived up to its promise in the market. While the processor itself is screamingly fast, Alpha's sales have been slow. There is speculation -- denied by both parties -- that Compaq will drop the Alpha line entirely in a couple of years. Here again, one critical question is the success of a new potential competitor, in this case Intel's 64-bit Merced processor, due to ship next year.

"I believe both Digital Unix and the Alpha processor will go forward, at least through the introduction of the Merced," says Dataquest's Sheridan. "Then I believe there will be a period of stability and integration for both Merced and NT 5.0, and when all of this gets ironed out, then I believe it will be an issue of price-performance, installed base, applications ported, and channels of distribution which will determine which one -- or both -- of these survives."

A new game in the enterprise
Say "DEC" and most IT professionals immediately think of VAX minicomputers and the company's glory days as an industry monolith. Although the glory days are behind it, Digital Equipment Corp. has a significant presence in the glass house -- the world of enterprisewide computing that is so important in Sun's future.

Sun and DEC have been competing in the enterprise market for some time, but Sun's stronger financial position and general upward momentum had given Sun major advantages. Indeed, the competitor Sun's sales force worries about most in the enterprise isn't DEC. It is Hewlett-Packard, or occasionally IBM. Compaq has moved up from the desktop to the departmental and LAN server market to a presence in the enterprise, but it hasn't been as important.

In buying Digital, Compaq has sped up its development from a desktop and departmental server company into an enterprise computer company. "Compaq reasoned, correctly in my opinion, that in order to keep its momentum going it had to attack the enterprise," says Vellante. "They had two choices. They could have made deep, prolonged investments in infrastructure, technology, and partnering over the next three to five years, or they could buy DEC."

"Digital was exactly what Compaq needed to be more efficient in the large corporate market. Compaq without Digital was a PC company trying to play with the big boys," says Vellante. "With Digital it's a PC company that can play with the big boys."

Sales and service: Digital's experience with Compaq's aggressiveness
One of the main reasons Compaq can do this is because of Digital's service and support organization. Last year DEC got 45 percent of its revenues ($5.8 billion out of $13 billion total) from service. DEC's service business is worldwide and generally recognized as world class.

"I think Digital's service business was paramount to Compaq in the buyout," says Dataquest's Sheridan. "One of the needs Compaq needed to satisfy as it moved toward its goal of becoming a $40 billion enterprise server company, one of the gaping holes, was the need for a world-class service and support entity. By purchasing Digital, they acquire that capacity."

Digital's service and direct sales force experience combined with Compaq's aggressiveness creates a potent competitor that will undoubtedly take enterprise business away from other companies. Since Sun is a leader in enterprise computing, albeit a relatively new one, Sun is likely to be the number one victim.


"By itself Digital was easily defeated by Sun," says Sheridan. Sun could point to DEC's lackluster market performance and its continuing financial losses, raising questions about the company's long-term viability, he notes. "Sun could compete against Compaq by saying it didn't have a robust service and support organization." The combined company is both financially healthy and has a service and support organization which can match Sun's.

Storage
Vellante also cites DEC's storage array business as a place where the combined company can hurt Sun. Although Digital sold off its disk drive manufacturing business to Quantum, it kept the business of making and selling storage subsystems. "Digital is a major storage subsystems company, and I think that the combined company will be the largest storage subsystems vendor in the world. That's interesting because it's a big market -- $30 or $40 billion annually -- and Compaq had a big chunk of it growing nicely already."

But in large account sales Compaq was hampered by its reliance on resellers for most of its sales. Sun, by contrast, has sold storage through its own sales force for years. "If Sun sales reps can't outsell a reseller on a big server deal, they shouldn't have their job," says Vellante. "Now they have to go up against a PC model company with a direct sales force." This is a much tougher proposition, Vellante says, and it is likely to hurt Sun.

Making it work
The purchase of DEC isn't an unalloyed win for Compaq. As Vellante points out, in purchasing Digital, Compaq got "a great channel presence, a good service organization, and pretty good technology," but Compaq also got some things it didn't want. "The bad news is they got a lot of DNA as well," he says.

That DNA includes a corporate culture that evolved in the closed systems minicomputer business and never really developed the aggressive marketing skills needed to compete in the open systems world of today. Over the last few years DEC has grown sluggishly when it has grown at all. "Compaq had great momentum without a service organization," says Vellante. "Digital had a great service organization without momentum."

"Compaq bought a non-momentum company. It's not common to buy a non-momentum company and give it momentum," says Vellante. "There are isolated examples of that happening, but with DEC it's going to be a challenge."

Momentum is critical because it has been one of Sun's major advantages over Digital in the enterprisewide market. "Sun's big advantage over Digital was momentum," says Vellante. "Sun was the hot company. It had Java. It had business model advantages. It made its own processors, so it had higher gross margins. In my opinion what Compaq brings to Digital is heat, and you don't get much hotter than Compaq."

Concepts like heat and momentum aside, Compaq's business culture is ruthlessly focused on low-cost manufacturing and high-impact marketing. Compaq started out making IBM PC clones and has survived 20 years of increasingly brutal PC wars. It has a reputation as a tough, relentless competitor that innovates when it has to and keeps its focus on the bottom line.

The overlap
Not everyone expects the acquisition to be a match made in heaven. Compaq's competitors, such as Sun and Hewlett-Packard, see a lot of pitfalls and potential problems.

This acquisition is more difficult than the Tandem buyout, Sheridan says, because unlike Tandem, DEC and Compaq have significant overlaps in their product lines. For example, both Compaq and Digital have lines of departmental servers running NT, both have storage array businesses, and so on. "The advantage the Tandem/Compaq merger had was that because the companies had such disparate product lines it was fairly easy to fit Tandem into Compaq because there was very little overlap," says Sheridan. "With Digital there is a lot of overlap."

One result is a certain amount of nervousness among Compaq and Digital customers. Everyone expects that Compaq will rationalize the product lines of the merged company, but no one knows what products will be discontinued. That announcement will come in May.

Meanwhile Compaq is doing its best to calm fears, especially among Digital customers. After the merger was announced, Compaq officials met with press and analysts to assure everyone that they intended to continue to support existing systems. Compaq CEO Eckhard Pfeiffer called such support "an absolute must for customers' business."

Some observers wonder if Compaq hasn't taken its passion for growth too far. "Compaq seems to be obsessed with the notion that bigger is better," says Vellante skeptically. "If you're not a $10 billion company it's hard to get people's attention in the enterprise. But if you go from a $50 billion to a $70 billion company I'm not sure that gives you a lot of leverage."

Among other things, what Vellante calls the "Law of Large Numbers" comes into play. The bigger a company is, the harder it is to maintain a given annual growth rate.

In general, the longer it takes for ComDEC to get its act together, the better it will be for Sun. A prolonged period of digestion will give Sun a breathing spell and the opportunity to take customers away from the struggling company.

Opinions vary on how long it will take the new Compaq to get itself pulled together. Some observers, such as Hewlett-Packard's Emilo Ghilardi, manager of worldwide marketing, think it could be as long as four years, based on HP's experience with similar mergers. Others point to how quickly Compaq has moved to integrate Tandem and expect a much shorter period.

"One thing people keep asking is when Compaq can be this formidable competitor," says Sheridan. "It's not easy to answer that. There's a period of assimilation and integration that has to take place. Compaq has to bring together these three cultures [Compaq, DEC and Tandem]. How do you divest yourself of installed base or people and buildings? And how do you coalesce all the sales, service, and support people to present a cohesive face to the world?"

Sheridan noted that Compaq recently announced an initiative called E2000 that might be the model for bringing DEC into the Compaq fold. "The purpose of E2000 in my mind is to announce to the world that there is a unifying umbrella over the Compaq and Tandem product lines. The products will communicate with each other, enhance information, files, and computing resources for one another. It's to demonstrate to the world that there is a united front."

"What Compaq needs to do, sometime down the road when they have all their strategy ironed out, is to come out with a modified E2000 to show where all Digital's products and structure will fit into the new corporation," he says.

When that day comes, Digital customers will gain some degree of certainty, and Sun will better understand how the world's second largest computer company intends to go after its business.


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About the author
Rick Cook divides his time between writing about the Web, computers and high technology, and novels. His most recent stories for SunWorld are "Linux lines up for the enterprise" "IBM bets on Java" (December 1997), and "Sun turns its rays on big iron" (November 1997). Reach Rick at rick.cook@sunworld.com.

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