Sunny, With Dull Patches

So Oracle has bid $9.50 a share for Sun Microsystems, valuing the US hardware fallen giant at $7.4bn. It's a far cry from what Sun might have been worth a few years ago but it currently is worth a 42% premium over Friday's closing stock price for Sun - how the mighty have fallen.

IBM had tried to secure a deal with Sun last month but nothing came of it. To be frank, it may have been a more natural fit in some ways - two hardware vendors with software and services interests combining to plug the gaps in each others' portfolios. But the recent past has seen the once mighty Compaq get severe indigestion when it took over the lumbering has-been Digital only to see the failed combination being bought by HP under Carly Fiorini.

The fact is, Oracle is a software giant and although threatened by the likes of IBM, in reality the two models are poles apart. The computer industry has always segmented the business models of software and hardware. Many hardware companies had software interests but they never really came to the fore and dominated any specific space. Similarly, some software companies have had some hardware interests but again, none that ever really dominated a sector.

The plain facts are that software is a gross margin rich business model with development costs underpinning it. Hardware has seen its gross margins eroded, made worse as each vendor has attempted to service major supply agreements as Prime Contractors and therefore had to buy other hardware vendor products in at reseller type margins, often securing long term supply at single digit margins on other vendor equipment and so dissipating its true gross margin on deals. It has been the nature of the beast in getting revenue growth at the cost of profit. Dell, in particular, has felt the pinch using this tactic.

So what would happen when you combine the two models, particularly of two giants of their specific sectors? I have to say, that the jury is out for me. Sun made a walloping $1.9bn loss last year on £13bn of sales but Scott McNealy, the colourful Chairman behind Sun, reckons that Sun will contribute $1.5bn of profits this year and $2bn next year to the new group.

Industry Speak

Industry analysts reckon that Sun's customer list will give Oracle access to those customers who are not currently using their database products. How often have we heard that kind of speak before? The fact is that hardware vendors rarely 'own' their customers in the way that a software company does unless they have a major stake in their applications or infrastructure. The chances of Sun dictating what database it customers use are pretty slim to say the least. Moreover, it is not as if Oracle is not known in the corporate world so that Sun customers will not have heard of them - all in all it's a silly argument and would be similar to Microsoft buying Apple to force their operating system and products down the throats of Apple customers.

The best way to make such a combination work is to produce database-engine boxes which were tuned in performance to run Oracle applications - 'Appliances' if you like. The storage industry has a number of such products and giants in this sector like EMC and NetApp have acquired strongly tuned software products to work specifically with their hardware.

But such an avenue is fraught with danger, as EMC has seen in acquiring VMware. As great an acquisition as that was (EMC got its money back by floating just 10% of VMware stock), the issue was always that VMware had to remain independent of its parent in order to remain the credible market leader, particularly with Microsoft gearing up to get on the attack. If VMware were to favour its parent by tuning performance or showing preference, long term it could ruin its position with the likes of HP, IBM, Dell and others and so allow Microsoft in as the 'independent vendor' who was hardware agnostic.

This is the danger for Sun-Oracle. If Oracle tries to leverage its new hardware purchase by tuning the performance to the hardware or showing preference in development, then the vast array of hardware vendors will slowly but surely get jaundiced and it allows a gap for an independent supplier with good brains and products to win their hearts as there is no vested interest. Right now, HP or IBM executives who have a strong relationship with Oracle, are probably thinking that all their Oracle installations are potential Sun Microsystems targets.

Long term that may not be proven to be the wisest of choices. If you are going to buy a hardware vendor as a leading software supplier, make sure you buy the biggest as your first step, not the cheapest, as you may just have bought yourself not just a chump but a liability that will lose you a lot of friends.

What may have started as a plan to strengthen Oracle's position against IBM may be the first gong of the death knell of a giant of the software industry. If there is one watchword in this industry that determines success it is FOCUS.