Yves here. When Edward Snowden began revealing the true scope of the surveillance state and the degree to which major American tech and communications companies were partners, Ed Harrison almost immediately recognized how damaging the news was to the cloud computing model. Yours truly, among others, wondered how quickly some countries would try to regain control of their Internet architecture, at least to keep the NSA from snooping on strictly domestic communications. That trend would also favor non-US service and equipment providers. For instance, a book I’m reading now, Spies for Hire by Tim Shorrock, mentions in passing that the NSA wanted to restrict US companies developing stronger forms of encryption because if they got too good, the NSA would not be able to crack it either. The Americans were very unhappy, and argued that that restriction would enable Europeans and the Japanese to take the lead in that field. The solution? The NSA let our domestic players go ahead as long as they got secret decryption keys. Mind you, this tidbit was public knowledge before the Snowden exposes, but remember also that aside from websites that needed encryption to allow for Internet commerce, most people didn’t give encryption a passing thought. These sort of security/privacy issues have gone mainstream, to the detriment of some US players.
By Wolf Richter, a San Francisco based executive, entrepreneur, start up specialist, and author, with extensive international work experience. Cross posted from Testosterone Pit.
The first shot was fired on Monday. Teradata, which sells analytics tools for Big Data, warned that quarterly revenues plunged 21% in Asia and 19% in the Middle East and Africa. Wednesday evening, it was IBM’s turn to confess that its hardware sales in China had simply collapsed. Every word was colored by Edward Snowden’s revelations about the NSA’s hand-in-glove collaboration with American tech companies, from startups to mastodons like IBM.
But the fiasco was tucked away under the lesser debacle of IBM’s overall revenues, which fell 4.1% from prior year, the sixth straight quarter of declines in a row. Software revenue inched up 1%, service revenue skidded 3%. At the hardware unit, Systems and Technology, revenue plunged 17%. Within that, sales of UNIX and Linux Power System servers plummeted a dizzying 38%. Governmental and corporate IT departments had just about stopped buying these machines.
IBM quickly pointed out that there were some pockets of growth in its lineup: business analytics sales rose 8%, Smarter Planet 20%, and Cloud, that new Nirvana for tech, jumped 70%. But in the overall scheme of things, they didn’t amount to enough to make a big difference.
All regions were crummy. Revenues in Europe/Middle East/Africa ticked up 1%. In the Americas, they ticked down 1% – “The improvement came equally from the US and Canada and once again, we had strong performance in Latin America,” is how CFO Mark Loughridge spun the situation during the earnings call because it was less bad than last quarter.
But there was nothing to spin in Asia-Pacific, where revenues plunged 15%. Revenues in IBM’s “growth markets” dropped 9%. They include the BRIC countries – Brazil, Russia, India, and China – where revenues sagged 15%. In China, which accounts for 5% of IBM’s total revenues, sales dropped 22%, with hardware sales, nearly half of IBM’s business there, falling off a cliff: down 40%.
Mr. Loughridge, in his prepared statement, tried to come up with a logical-sounding panic-free explanation:
We were impacted by the process surrounding China’s development of a broad based economic reform plan, which will be available mid-November. In the meantime, demand from state-owned enterprises and the public sector has slowed significantly as decision-making and procurement cycles lengthened.
So, would that unprecedented collapse of demand for hardware in China end after mid-November? Nope. These “changes will take time to implement,” he warned. In fact, he did not expect demand to pick up “until after the first quarter of next year.” Not anytime soon.
No one believed that rigmarole.
When an analyst needled him, Mr. Loughridge began to deviate from the scrip: “The hardware business across those elements of the product line accepting zSeries performance (IBM mainframe computers), it was down substantially. We were talking 40%, 50%. Enormous reductions on a year-to-year basis in a geography where we intended to see growth rates.”
They’d intended to see double digit growth rates. He referred to last year, when sales in China were up 19%, “driven heavily by really strong performance in hardware base,” he said. But suddenly, hardware sales collapsed “40%, 50%” from last year. IBM didn’t even have time to come up with a credible excuse. He was struggling to make sense of it, grasping at flimsy straws and the same economic reform plan theory that no had believed earlier, but this time, it got all tangled up:
And you got to look at that and say, what significantly accounts for that. And I would say, quite honestly, if you look at the elements in China and we have worked with the team in China that simply has been a substantial impact as the process surrounding China’s development of broad based economic reform plan takes shape. And that is going to be announced and available, we think in November and probably it will take some time to implement. So I think we are looking at a couple of quarters, but once that economic plan is announced, it adds clarity to market, we should see, I think and fairly within our team, a recovery in the demand pattern for state-owned enterprise public sector.
The explanation is more obvious. In mid-August, an anonymous source told the Shanghai Securities News, a branch of the state-owned Xinhua News Agency, which reports directly to the Propaganda and Public Information Departments of the Communist Party, that IBM, along with Oracle and EMC, have become targets of the Ministry of Public Security and the cabinet-level Development Research Centre due to the Snowden revelations.
“At present, thanks to their technological superiority, many of our core information technology systems are basically dominated by foreign hardware and software firms, but the Prism scandal implies security problems,” the source said, according to Reuters. So the government would launch an investigation into these security problems, the source said.
Absolute stonewalling ensued. IBM told Reuters that it was unable to comment. Oracle and EMC weren’t available for comment. The Ministry of Public Security refused to comment. The Development Research Centre knew nothing of any such investigation. The Ministry of Industry and Information Technology “could not confirm anything because of the matter’s sensitivity.”
I’d warned about its impact at the time [read.... US Tech Companies Raked Over The Coals In China]. Snowden’s revelations started hitting in May. Not much later, the Chinese security apparatus must have alerted IT buyers in government agencies, state-owned enterprises, and major independent corporations to turn off the order pipeline for sensitive products until this is sorted out. As Mr. Loughridge’s efforts have shown, it’s hard to explain any other way that hardware sales suddenly collapsed by “40%, 50%” in China, where they’d boomed until then.
This is the first quantitative indication of the price Corporate America has to pay for gorging at the big trough of the US Intelligence Community, and particularly the NSA with its endlessly ballooning budget. For once, there is a price to be paid, if only temporarily, for helping build a perfect, seamless, borderless surveillance society. The companies will deny it. At the same time, they’ll be looking for solutions. China, Russia, and Brazil are too important to just get kicked out of – and other countries might follow suit.