Can Sun Microsystems be Profitable?

Implications: Sun has tied its future to open source, but seems clueless on how to monetize open source.  Worse yet, they don’t seem to care!  Meanwhile their core revenue stream continues to dwindle.  Future prospects don’t look good.

Analysis: Sun Microsystems in its heyday had a business model rather similar to the one Google enjoys today.  One major revenue stream, with high margins, funded a multitude of ancillary activities.  In Google’s case the revenue stream is advertising, and it is so profitable Google can afford to indulge in a wide variety of non- or marginally-profitable activities.  In Sun’s case the revenue stream was enterprise servers.  Sun’s enterprise servers, circa 2000, were ubiquitous and carried high margins.  They funded a variety of non- or marginally-profitable activities at Sun.

The advent of multi-core chips is seriously eroding Sun’s enterprise server market share and forcing them to cut margins dramatically to retain the share they still have.  Whereas once it was necessary to spend from $25K to $250K for an enterprise server, today a server with similar power is available as a commodity item for $7K to $20K.  Sun has a successful range of products in this market space, along with retaining their legacy Sparc-based large server products.  However, margins are much lower in the commodity server space, competition is more fierce, and thus the margins are no longer sufficient to fund other activities.  This picture is not likely to get better for Sun.  On the contrary, commodity processors from Intel and AMD continue to grow in power and cores, further encroaching on Sun’s Sparc-based server market.  The recent introductions of the T1 and T2 product line furthers the Sparc architecture, but still competes in the commodity server market.

Sun has storage products, but here they face increasing competition from Network Appliance, Hitachi and EMC.  They are not a leader in the storage market, which means this too becomes a relatively low-margin business as they struggle to survive.

Sun has tied their future to the open source world.  They claim, probably rightly, to be the world’s largest open source vendor.  Swartz is on record repeatedly espousing the view that having the Sun brand widely distributed through open source is critical to Sun’s future.  His philosophy is to seed students, developers and startups with the Sun brand at no charge, with the idea they’ll eventually become paying customers in the enterprise world.  That strategy was used very successfully by IBM in the Sixties and Seventies with their mainframes.  They provided mainframes at reduced prices (or free) to colleges to get students hooked.

The flaw in Swartz’ reasoning, and where the IBM comparison breaks down, is that the products IBM was providing were the same as they sold to enterprises at high margins.  Once the students were hooked on IBM mainframes and moved into enterprises, they paid through the nose to buy more mainframes.  Sun doesn’t have a comparable high-margin product to follow on to their open source offering.  All they have is a subscription service to support those open source products in the enterprise.  That will bring in “some” revenue, but the margins are much lower than in the mainframe and server markets, so Sun as currently constituted will not be able to survive in that model.  Further, there are a lot of choices in the market, and once customers start paying they may no longer use Java or MySQL.  Today’s free MySQL users may become tomorrow’s Oracle users.

Sun’s business model continues to depend on high-margin server business, which is shrinking.  What they’re left with is low-margin commodity servers and open source support, neither of which can support Sun’s current investment in R&D and other activities.  Sun supporters may feel good to know their brand is everywhere, but their future is one of steady decline unless they can either find a high-margin business or re-structure around a low-margin business model.