Enterprise AI

IBM is Best Positioned to Lead the Enterprise AI Wave

Over the past thirty-five years, information technology consumers have experienced six game-changing medium-duration product innovation cycles, including the Lotus 123 large-memory spreadsheet, Microsoft Windows graphical operating system, Microsoft Office integrated suite of productivity applications, Microsoft Internet Explorer web browser, Apple iPod portable media player, Apple iPhone web-enabled smartphone, and Apple mobile suite of smart cloud-connected devices. The first three of these product cycles constituted a single long-duration technology wave, dominated by Microsoft and referred to as the PC technology cycle. The next three product cycles constituted a second long-duration technology wave, dominated by Apple and referred to as the post-PC technology cycle.

Over the next thirty-five years, information technology consumers will experience a number of game-changing medium-duration product innovation cycles, the first three of which will be the IBM Watson cognitive supercomputer, the IBM Watson cognitive cloud platform, and the IBM Watson cognitive suite of intelligent applications. These three product cycles constitute a single long-duration technology wave, dominated by IBM and referred to as the AI technology wave.

The optimal strategy used to capture the lion's share of industry profits during the PC wave was to establish early and clear positions of dominance in the platform and suite phases of the cycle, which Microsoft clearly achieved with its Windows operating system platform and its Office suite of productivity applications. Similarly, the best strategy to capture the vast majority of industry profits during the post-PC wave was to establish early and clear positions of dominance in the platform and suite phases of the cycle, which Apple clearly achieved with its iOS mobile operating system platform and its mobile suite of smart devices.

History will again repeat itself during the AI wave, wherein the firm that establishes early and clear positions of dominance in the platform and suite phases of the cycle will capture the bulk of its profits. IBM has moved quickly on both fronts. Its AI platform consists of IBM Watson cognitive services available through its IBM Blue Mix cloud platform hosted in IBM Softlayer facilities, as represented by the cognitive cloud service value chain system for IBM. The IBM AI platform is supported by IBM middleware, analytical, and management services hosted on IBM Power Systems or zEnterprise supercomputers running Linux or z/OS, as represented by the cognitive cloud infrastructure value chain system for IBM. The company's AI suites consists of IBM cognitive suites of domain-specific industry applications, including cognitive health, finance, commerce, security, education, energy, and transportation application suites, as represented by the cognitive cloud solutions diagram for IBM.

Lastly, IBM has recognized that the key to achieving and sustaining a position of competitive advantage over the duration of the AI cycle is to ensure that its AI platform and AI suites have direct access to three vast and exponentially accelerating stores of unstructured and structured data: consumer cloud data, things cloud data, and enterprise cloud data, as represented collectively by the cognitive cloud architecture diagram. However, with its cognitive value chain systems, cognitive solutions, and cognitive architecture clearly established to capitalize on the AI wave, the next great wave in modern computing, why is IBM stock still going down?

IBM Stock Down to 2009 Levels: Time to Buy or Get Out?

As of this writing in mid-January of 2016, global equity markets are experiencing unprecedented declines, with stocks of many leading technology companies plummeting ten to twenty percent during the first two weeks of the year. IBM was clearly among the decliners. While beating expectations for top and bottom line performance, the company issued substantially weaker earnings guidance than analysts expected, sending its shares below $120 for the first time since the fourth quarter of 2009. We believe that the mass exodus from IBM shares over the past two and one-half years by discouraged investors represents one of the best large-capitalization buying opportunities since Apple in mid-2013 and Google in early 2015, and we shall articulate the reasons for our view in the next several sections.

Defining the Cognitive Cloud Stack for IBM

IBM is in the process of a massive shift in its business model. Over the past two years, the firm has jettisoned under-performing hardware and semiconductor business units, retooled its business and technology services divisions, and rewritten and extended its middleware software to leverage emerging trends in cloud and big data analytics. Why is IBM radically reshaping all of its core business divisions? The simple answer is that the firm is strategically repositioning itself to become a dominant force in the next great wave of modern computing, the cognitive things era. Given this bold goal, the three key questions are:

1. What will the "New IBM" ultimately look like?
2. How will the company make the transition?
3. When will the market ultimately recognize it?

Cyclefund Research has constructed the following model to reflect the ideal structure of IBM following its transition from a traditional enterprise information technology company to a modern cognitive cloud service company, as illustrated for the first time in the diagram below.

The diagram above is called the Complete Cognitive Cloud Service Stack for IBM for 2016 and Beyond. It is a multidimensional diagram organized as a stack with four primary layers and a total of eight sub-layers. Reading from bottom to top, the primary layers are infrastructure services, platform services, cognitive services, and consulting services. Within each primary layer there are two key sub-layers, or eight sub-layers in total. Reading from top to bottom, the 8 sub-layers of the cognitive cloud service stack for IBM are:

1. Business Services
2. Technology Services
3. Cognitive Apps
4. Watson Services
5. Orchestration Services
6. Middleware Services
7. Compute Services
8. Hosting Services

IBM business services provide customers with business outsourcing, application management, business integration and transformation, and business maintenance services. IBM technology services provide customers with technology outsourcing, platform and system management, technology integration and transformation, and technology maintenance services. IBM cognitive apps and Watson cognitive services provide intelligent domain-specific software applications and cloud services to customers across a wide variety of industries, including healthcare, finance, retail, security, oil & gas, utilities, food & beverage, mining, entertainment, weather, and transportation. IBM orchestration and middleware platform services provide customers, third-party software developers, and strategic partners with a foundation for developing new cognitive applications and services, integrating cognitive and non-cognitive apps and services, and delivering cloud-based cognitive solutions worldwide at scale. IBM compute and hosting infrastructure services provide customers with off-premises private cloud, public cloud, and hybrid cloud compute, storage, virtualization, networking, and facilities services.

IBM Enterprise Stack for 2014

With our view of the new structure of IBM clearly defined by the complete cognitive cloud service stack presented in the previous section, we have answered our first question and are ready to tackle the second question regarding IBM's transition path. To gain insight into how IBM is transitioning from a tradition enterprise information technology company to a modern cognitive solutions company, we turn the clock back two years and examine IBM's business structure circa 2014, as presented in the diagram below.

The diagram above is called the Enterprise Information Technology Stack for IBM in 2014. It organized as a stack with four primary layers. Reading from top to bottom, the layers are business services, technology services, platform software, and hardware systems. In 2014, these layers had profitability profiles that ranged from high margins to low margins as depicted by the green and red box borders, respectively.

IBM Enterprise Stack Transition from 2014 to 2016

Between 2014 and 2016, IBM radically altered the internal structure of its enterprise stack by selling its x86-based server business to Lenovo and its commercial semiconductor fabrication business to GlobalFoundries, eliminating low-margin outsourcing contracts, retooling its consulting workforce, extending its middleware software, and introducing an entirely new business unit dedicated to Watson cognitive solutions. The central reason behind this massive undertaking was, and still is, to become the very first truly cognitive enterprise, with the ultimate goal of sharing its first-hand knowledge about making cognitive transitions with its most valuable customers. As a result of IBM's efforts, the company was able to markedly improve the profitability profile of two of its key business units, as shown in the diagram below.

The diagram above is called the Transition of the Enterprise Information Technology Stack for IBM from 2014 to 2016. It depicts IBM's enterprise stack in 2014 on the left and its enterprise stack in 2016 on the right. Each stack comprises IBM business units. Reading either stack from top to bottom, the business units are business services, technology services, platform middleware software, and hardware systems. In 2014, IBM business units had profitability profiles that ranged from high margins to low margins as depicted by the green and red box borders, respectively. In 2016, business units had profitability profiles that ranged from high margins to medium margins as depicted by the green and yellow box borders, respectively. Green arrows between the two stacks indicate business units with improved profitability profiles and grey arrows indicate business units with unchanged profiles.

Specifically, by jettisoning its commodity server business and offloading its semiconductor business, IBM was able to improve the profitability profile of its hardware systems unit and by eliminating low-margin outsourcing contracts and modernizing the skills of its technology consultants. It also improved the profitability profile of its technology services unit.

The Seismic Shift: IBM Transitions to Cognitive Cloud Services

By late 2015 and early 2016 it had become clear that IBM's transition from a traditional enterprise hardware, software, and services vendor to a modern cognitive solutions company had become unnecessarily complex and convoluted from a financial reporting perspective. For the fourth quarter of 2015, IBM reported strong top line growth of 26% for its strategic initiatives in cloud, analytics, security, mobile, and social, which at 35% had become an increasingly large portion of IBM's overall revenue, while at the same time it reported continued year over year declines in its traditional lines of business in global technology services (down 9.7%), global business services (down 12.0%), software (down 9.8%), and systems hardware (down 24.2%). Factoring the impact of a strong dollar and the divestiture of business assets, year over year results for IBM were: global technology services (up 1%), global business services (down 4%), software (down 6%), and systems hardware (up 3%).

With strong results in strategic initiatives and reasonable performance (after adjustments) in global technology services and systems hardware, why was IBM's stock cratering in early 2016 to levels not seen since late 2009? To answer this question, we have created the following diagram which depicts IBM's breakthrough shift to cognitive cloud services.

The diagram above is called The Seismic Shift: Transition of the Enterprise Information Technology Stack to the Cognitive Cloud Service Stack for IBM from 2016 and Beyond. It depicts IBM's enterprise hardware, software, and services stack in early 2016 on the left and its cognitive cloud service stack for 2016 on the right. Each stack comprises IBM strategic business units. Reading the current stack from top to bottom, the business units are business services, technology services, platform software, and hardware systems. Reading the future stack from top to bottom, the business units are business services, technology services, cognitive services, platform services, and infrastructure services.

In 2016, IBM current business units have profitability profiles that range from high margins to medium margins as depicted by the green and yellow box borders, respectively. In 2016 and beyond, IBM future business units are expected to have profitability profiles that range from very high margins to medium margins as depicted by the dark green and yellow box borders, respectively. Dark green arrows between the two stacks indicate business units with significantly improved profitability profiles, green arrows indicate improved profiles, grey arrows indicate unchanged profiles, and yellow arrows indicate diminished profiles.

Comparing the two stacks, it is clear that IBM is making a seismic shift in its operational structure by moving from hardware systems to infrastructure services, from platform software to platform services, and most importantly by introducing an entirely new and critical layer into its business model for the future: cognitive services.

Why is IBM Stock Still Going Down?

It is the current massive shift in IBM's business model that is causing investor uncertainty regarding the company's financial performance and its stock to continue to decline. To see the impact of this remarkable shift more clearly, we have combined the IBM seismic shift diagram and cognitive cloud service stack diagram into a single unified visual image, as shown below.

Referring to the unified diagram above and reading from bottom to top and left to right, the shift from hardware systems to infrastructure services is clearly positive from a profitability profile perspective, the shift from platform software to platform services is mixed, the introduction of an entirely new set of cognitive services is strongly positive, and the continuation of technology and business services is net positive. As IBM completes its transition to the cognitive cloud service stack, we expect strong margin and revenue performance from IBM Softlayer infrastructure service, IBM Websphere platform service, and IBM Cognitive Apps. We also expect improved margin and revenue performance from IBM technology and business services, as customers become increasingly aware of the value of becoming a cognitive business and look to IBM professionals to lead the way.

Most importantly, we expect outstanding revenue and margin performance from IBM Watson cognitive services, as a large number of executives running global companies across a wide range of industries begin to see the inherent competitive advantages that accrue to bold firms who equip every knowledge worker with one or more domain-specific cognitive assistants. By adopting cognitive technologies for their workforce, these visionary executives will usher in a new era of augmented human intelligence and forever, and perhaps irreversibly, shift the performance curve of the individual, the team, the group, and the organization.

IBM Competitors within the Cognitive Cloud Service Stack

Given its unique vision to pair knowledge workers with cognitive assistants across a wide variety of industries coupled with the fact that IBM Research and IBM Solutions groups have been developing core cognitive technologies, deep learning algorithms, and domain-specific solutions for nearly a decade, the company is well ahead of prospective competitors on the learning curve and exceptionally well positioned to defend, lead, and perhaps dominate all four of the core layers of the cognitive cloud service stack.

To visualize breadth and depth of competition faced by IBM across all layers of the cloud service stack, we have extended the IBM cloud service diagram presented previously to include direct competitors, as shown in the diagram below.

We call this diagram The Top-Twelve IBM Competitors across the Four Core Layers of the Cognitive Cloud Service Stack. It is a multidimensional diagram organized as a stack with four primary layers and sixteen competitive positions. Reading from top to bottom, the primary layers are professional services, cognitive services, platform services, infrastructure services. Within each primary layer there are four competitive positions listed in rank order reading from left to right.

The diagram can be analyzed horizontally to answer the following key questions:

• Who are IBM's top competitors in infrastructure services?
• Who are IBM's top competitors in platform services?
• Who are IBM's top competitors in cognitive services?
• Who are IBM's top competitors in professional services?

The diagram can also be analyzed vertically across all layers to answer the most important question:

• Who are IBM's top competitors overall?

We answer these five critical questions regarding IBM competitors in the sections below.

Top IBM Competitors in Infrastructure Services

The top IBM competitors in cloud infrastructure services are:

1. Amazon
2. Microsoft
3. Oracle
4. Google

While we expect IBM to face strong competition from Amazon and Microsoft in storage, compute, virtualization, and networking services, we also expect IBM to partner with both of these firms when customers already have preexisting commitments to these key infrastructure service providers. Despite this competition, we expect IBM to command premium pricing for its Softlayer private and hybrid cloud infrastructure services, especially for customers who require the highest levels of security, real-time in-transaction analytics, or supercomputer-class data throughput and computing power.

Top IBM Competitors in Platform Services

The top IBM competitors in cloud platform services are:

1. Microsoft
2. Salesforce
3. Oracle
4. SAP

While we expect IBM to face strong competition from Microsoft, Salesforce, and Oracle in database, application server, integration, and business intelligence services, we also expect IBM to partner or cooperate with all three of these firms when customers already have preexisting commitments to these key platform service providers. Despite this competition, we expect IBM to command premium pricing for its branded middlleware platform services, especially for customers who require integration, business intelligence, and systems monitoring services across complex on-premises and off-premises private and hybrid clouds.

Top IBM Competitors in Cognitive Services

The top IBM competitors in cognitive intelligence services are:

1. Google
2. Microsoft
3. Apple
4. Baidu

While we expect IBM to face some degree of competition from Google and Microsoft in cognitive services over time, we fundamentally see IBM's cognitive strategy as being largely orthogonal to those it its nearest competitors in the near to mid-term. Specifically, Google and Microsoft are currently focusing on and best equipped to dominate horizontal cognitive intelligence use cases, whereas, in stark contrast, IBM is relentless focused on and uniquely equipped to lead and perhaps dominate vertical cognitive intelligence use cases. We refer to cognitive use cases as vertical if they are specific to a particular domain or industry and vertical if they are general in nature across domains or industries. For example, IBM Watson Health is a domain specific cognitive solution for the healthcare industry, where as Microsoft Cortana and Google Now are general intelligent personal digital assistants for the general population, applicable across domains and industries, but without the depth of a domain-specific solution.

Top IBM Competitors in Professional Services

The top IBM competitors in professional consulting services are:

1. Tata Consultancy
2. Accenture
3. Cognizant
4. Infosys

While we expect IBM to continue to face competition from Tata, Accenture, Cognizant, and Infosys in professional services, we view IBM's seismic shift to cognitive cloud solutions as a game-changing move in the professional services industry, one that will place all four of the leading professional services firms in a position of competitive disadvantage for many years into the future. Specifically, once visionary executives of leading firms across a wide variety of industries make the commitment to transform their traditional businesses into cognitive business, they will seek the best professional advice, the best business solutions, and the best technology solutions as they design, select, implement, deliver, scale, and maintain their domain-specific cognitive cloud solutions.

Their basic options will be: A) Piece together a complex cognitive solution at scale by calling on, for example, Amazon for infrastructure support and services, Microsoft for platform support and services, Google for intelligence services, and Accenture for consulting services or B) Pick up the phone and call IBM for the whole stack of cognitive cloud services from a single vendor already a cognitive enterprise itself. Most senior executives, including CEOs, CIOs, and newly minted Chief Data Officers (CDOs), entrusted with leading the cognitive transformation at large, public, well-established global firms will simply not take the former risk. They will pick up the phone and with very high probability place the first, and for many visionary executives the only, call to IBM.

Top IBM Competitors Overall

The top IBM competitors over all primary layers of the cognitive cloud service stack are:

1. Microsoft
2. Oracle
3. Google

While we expect IBM to increasingly face overall competition from Microsoft, Oracle, and Google, we believe that these competitors are not ideally positioned to lead the enterprise AI wave at this stage of its evolution because they are simply too far behind IBM in domain-specific cognitive solutions.

The New IBM is All About Apps: Cognitive Apps

In the past, IBM has traditionally avoided developing enterprise software applications in order to remain unbiased while consulting with executive decision makers and to avoid conflict of interest with many of its strategic partners, such as SAP, Oracle, Salesforce, Microsoft, and Workday, who provide packaged software application suites, including enterprise resource planning (ERP), customer relationship management (CRM), and human capital management (HCM) application suites for large, medium, and small enterprises. Going forward, however, IBM clearly intends to break with the past and offer a number of complete and comprehensive cognitive application suites, including cognitive health, finance, commerce, education, energy, and transportation suites.

In short, the IBM of the past left software applications, or apps, to its partners. In stark contrast, the IBM of the future is all about apps, and not just traditional apps but cognitive apps for virtually every critical domain across every key industry.

The indisputable fact that IBM has made a seismic shift in its core business model in order to become a dominant force in the applications business is not yet fully appreciated by global investors and therefore serves as a substantial catalyst to future stock appreciation, assuming global macro conditions do not markedly deteriorate. Once investors realize the upside potential of IBM's cognitive business and its synergistic power to drive and accelerate sales within its infrastructure, platform, and professional services businesses, we expect the company's stock to quickly, and surprisingly to most, appreciate to reflect the realization of IBM's vision to change the interaction paradigm between man and machine and definitively shift the performance curve of the cognitive enterprise.

Why IBM is Best Positioned to Dominate the AI Wave

Less than a decade ago, Watson was just a vision in the minds of a handful of scientists working in IBM's Watson Research Lab who had a dream to build a computer system smart enough to go head to head with the best and brightest Jeopardy contestants on national television. In a few short years, the researchers' vision was realized and Watson achieved victory in 2011 by defeating the show's reigning champions. At that time, the IBM Power System supercomputers powering Watson occupied a small room. However, less than five years later, IBM had reduced Watson down to the size of three large pizza boxes while improving its cognitive intelligence performance by over 2,000 percent (source: Watson Computer article from Wikipedia.org).

With first-hand knowledge of the power of its new cognitive invention, IBM reached out to its most trusted and valuable customers to forge partnerships to develop domain-specific cognitive solutions based on Watson. Working together with these strategic customers over the past five years, IBM has been able to clearly identify critical business challenges ripe for combining human and machine intelligence to produce decisions and outcomes markedly better than would be produced by either human or machine alone. The full power of Watson can be leveraged to structure cognitive solutions which address these challenges across myriad industries.

Having misjudged the transition to touch-based mobile devices in 2007, Microsoft has been busy transforming its traditional consumer and enterprise software businesses to operate seamlessly across all leading mobile operating systems, including iOS, Android, and Windows. In addition, having properly recognized the power of the cloud in 2008, Microsoft has recently demonstrated that it has successfully transitioned its traditional consumer and enterprise software business to the cloud, including Office, Windows Server, and SQL Server which have be successfully transformed to Office 365 and Azure infrastructure and platform services.

Having misjudged the transition to the enterprise cloud in 2010, Oracle has been busy transforming its traditional enterprise database, application server, business intelligence server, and business application suite to the cloud, including Oracle RDBMS, Oracle WebLogic, Oracle BI, and Oracle eBusiness Suite which are currently in the process of being transformed to the Oracle Data Management Cloud, Analytics Cloud, Customer Experience (CX) Cloud, Human Capital Management (HCM) Cloud, Enterprise Resource Planning (ERP) Cloud, Supply Chain Management (SCM) Cloud, and Enterprise Performance Management (EPM) Cloud.

By leading the way in voice-controlled intelligent virtual personal digital assistants, Google has established a very strong position relative to Apple Siri and Microsoft Cortana with its Google Now artificial intelligence (AI) agent powered by the cloud. Properly realizing that the success of its current AI agent cannot be limited to horizontal general-domain use cases, but must expand, and expand quickly, to include vertical domain-specific use cases, Google has been moving quickly to cement its position in enterprise AI. Unfortunately, the vehicle, Google Glass, that Google has chosen to explore the vast opportunities of enterprise AI has been tarnished in the minds of consumers due to its premature launch as a developer product in early 2013, beta-level consumer product in mid-2014, and a discontinued product in early 2015. While we strongly believe that Google will bring life back into this game-changing product, it will take time to alter consumer perceptions about the highly innovative device.

In short, Microsoft is spread across consumer and enterprise cloud and non-cloud services, software, and devices. Oracle is engaged in fierce competition on multiple fronts with traditional enterprise software vendors as well as new and emerging cloud service software providers. Google is just beginning its foray into enterprise AI, albeit from a strong foundation in consumer AI. In contrast, IBM, has finally become laser focused on enterprise AI underpinned by Watson, a breakthrough cognitive system that itself has been quickly and quietly learning how to work intimately with the best and brightest minds in the world on the most difficult business challenges of our day. Therefore, for the moment and somewhat ironically, it is IBM that stands alone, uniquely and eminently positioned to fully capture the preponderance of profits of the emerging enterprise cloud AI wave, much as Microsoft did with the PC wave and Apple did with the post-PC wave.