Software Will Make A Quarter Of Dell’s Profits – Swainson

Eighteen months ago Dell didn’t have a software division. In a few years’ time it will deliver a quarter of the tech firm’s profits. That’s the goal of John Swainson, who joined Dell in 2012 to head up the new unit.

It’s even more ambitious than it sounds, because Swainson’s fledgling division is currently making a loss on about $1.5 billion of revenue –  out of Dell’s total turnover of around $60 billion. He’s got to grow – but  any expansion has to avoid treading on the toes of some pretty powerful partners with a big stake in the software industry, such as Microsoft and Oracle.

He’s written off the idea of being a public cloud provider.  And to add to his troubles, most people TechWeekEurope speaks to are  still unaware that Dell does any software at all – apart from some admittedly-well-liked remote management tools.

Is he serious? We met him in London to find out.

Don’t compete with your customers

“To be relevant within Dell we really should have $5 billion turnover,” Swainson told TechWeekEurope:  “That’s a modest percentage of Dell’s overall revenue, but a much more sizeable percentage of Dell’s gross margin.”

Software is a major part of Michael Dell’s plan to revive the hardware manufacturer that bears his name, because software comes with big margins, and doesn’t face what Swainson describes as the “immediate challenge” of the PC business.

Alongside PCs (or “end user computing”) Dell has two other divisions: Enterprise (servers, storage and networks) and Services (much of which is based around acquisition Perot Systems). Long term, Swainson expects PCs to turn round, and the enterprise business to grow, as Dell has strong market share. Services is more dependent on labour, so can only grow slowly.

“The software business can grow at double digits organically,” he said, “and we will grow it faster than that, through acquisition.” He’s hoping to be eight percent of the turnover (which would be a fair bit more than $5 billion).

He’s also reckoning on a big profit margin, which would take his contribution to Dell’s profits up to that 25 percent he is aiming for. Software can have a 20 percent profit margin, but at the moment is still loss-making: “Today my division loses money because of the accounting associated with acquisitions.”

Waiting for Dell to go private?

Michael Dell wants software because he wants Dell to move away from its traditional hardware base. He has already finalised some big acquisitions, including Quest Software, as well as security specialist SonicWall and data centre recovery firm AppAssure (all in 2012).

Software acquisitions have slowed down since then, for a period of consolidation – but also because software acquisitions are not Wall Street’s favourite thing.  That’s one reason why Dell wants to take the company private, line up more investment, and end the necessity to turn a profit every quarter.  “Michael has identified five areas that he wants to do to grow the business that he thinks Wall Street is going to hate in the short term,” says Swainson.

One of those is buying software firms.

“In a public company the accounting rules associated with acquisitions are quite onerous,” explained Swainson. “You have to take a lot of write-offs upfront, and basically take a haircut on deferred income like maintenance revenue, which is the mother’s milk of the software business. That makes it very difficult for a software business acquisition to look profitable in the short term.”

Dell’s move off the stock-market is hitting snags, but Swainson is adamant that software acquisitions are not “on hold”, pointing out that Dell recently bought cloud specialist Enstratius (formerly Enstratus).

What sort of software?

Swainson’s group sells any software that isn’t bundled as part of a system, or delivered as part of another service. That’s a slightly fuzzy definition, but as he says “any organisational structure only fits the real world for a brief moment.”

The software group has three areas of interest. Systems management is an obvious one, that builds on Dell’s experience: “There are a lot of opportunities in things like cloud management,  which are strategic and where we want to make sure we have a substantial presence”. Swainson is also building up Windows management, performance management, storage management, and virtualisation management portfolios.

Security is another target, based around the SonicWall company and extending to cover “everything at the edge of the network”, including identity and access management: “The strategy is hooking these together to get more context awareness at the edge of the network.”

Finally, Swainson wants to stake out some business in information management: “It’s the smallest area – but the largest total available market.” There’s lots of opportunity to offer tools around databases and Big Data systems, to help administrators move their data (and their skills) to newer systems and opportunities:  ” We are not going to buy a relational database, but we have a number of tools that go around the edges. We have a nice sized business around Oracle’s relational database, for instance.”

What do Oracle and Microsoft think?

Does this bother Oracle? Apparently not. A recent announcement anointed Dell as a preferred partner, presumably because Oracle isn’t getting on well with HP. “Dell will be Oracle’s preferred provider for x86 hardware, except Exadata,” says Swainson. “Dell will optimise its hardware and software for Oracle configurations.”

And what about Dell’s biggest partner, Microsoft? How does Redmond feel about Dell having a software division at all?

“I don’t know, but they certainly know we have one.” said Swainson, who is now part of Michael Dell’s annual meetings with Microsoft CEO Steve Ballmer.

“I think Microsoft understands why we have a software division, and they see it as generally complementary,” he said. “There are a few areas of overlap but not too many”. The most obvious of these is Microsoft’s System Center business: “those guys wish we didn’t exist, but the rest of the team are perfectly happy with our tools. They recognise there is a new and capable partner in the ecosystem.”

He is going to be careful around Microsoft though: “They are our largest single customer, and I’ve never liked the idea of competing with our customers. As a business model, that is hard to justify long term.”

What about the cloud?

Swainson has two cloud dilemmas: whether to offer cloud services, and how to use the cloud to deliver Dell’s own software.

Dell recently pulled the plug on its public cloud offering, preferring to offer cloud technology through partners. ” We are an arms supplier to cloud providers,” is Swainson’s description of that strategy. “We provide hardware and software if you want to build public and private clouds. We provide services. And we provide a hosting service if you want us to host them. The one thing we have decided is that we aren’t going to be ourselves a public cloud provider.”

Dell’s public cloud service was an “experiment”, he says, and the results were that “the economics of us being a public cloud provider were not favourable. And the optics [appearance] of us being a cloud provider when we are in turn the principal hardware and software provider to many of the public and private clouds we are competing with – that didn’t seem to make a great deal of sense either.”

What about the paying customers who took part in the “experiment”?  Swainson says “we are in the process of migrating existing customers to other partners, or they can run out their whole contract with us.”

In fact, Dell will still provide clouds: hosted private clouds for individual customers: “We still have the capability, we have the data centre room. We have decided not to offer public cloud as a service.”

He says the economics of private cloud services are better all round: “We do not know of a public cloud today which is returning the cost of capital. From our economic analysis it’s not clear if they ever will.”

So is he just arming cloud providers so they can shoot themselves? “No, there are people in this business for other reasons. They may have a lower cost of capital, or a different economic rationale. Amazon doesn’t publish the  financial details of its cloud services, so we don’t know what their economic model is”.

Dell’s’ major  partner Microsoft does cloud in a big way, but it also has its own economic model, including software as a service (SaaS) businesses such as Office365.

The SaaS dilemma

So how about SassS? Dell is buying up software providers, just when those companies face potential shift between on-premises software and cloud delivery. Does this add to his headaches?

“I wouldn’t be too quick to write off on-premises software,” he says. “IDC believes that SaaS will be ten percent of the market by 2015. Today it’s about five percent. I’m interested in that ten percent – but I don’t want to lose sight of the 90 percent.” On-premise software isn’t going away any time soon – and may never go away.

The PRISM revelations are a “wake up call”, he says, which may make some people think twice about moving applications to the cloud – by reminding them their data may be vulnerable: “You would be surprised at how much naivety there is around this subject. People are going back to their contracts and may be finding they either don’t have any rights or don’t have the rights they thought they had – or the rights get extinguished if the government asks for the data.”

As a former CEO of CA, and a senior executive at IBM, he’s got a long history, and knows how long lived systems are. He’s also in touch with the gradual shift towards open source: he was around when both Eclipse and Apache were founded, he tells us.

There are limits to what Dell can do in the software business. without alienating its big partners – and Swainson isn’t chasing any magic solutions like a move to the cloud. But within the limits he’s set himself, there’s a lot he can do.

The ultimate fate of Dell Software depends a lot on whether any restructuring can bring in the investment money it needs. But he makes a decent case for his $5 billion goal.

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