A Jolt of Java
Sun Microsystems' boy wonder grows up and even makes peace with Microsoft
Scott McNealy doesn't try to sugarcoat his company's past. "People thought we were nowhere three years ago," says the longtime CEO and cofounder of Sun Microsystems, one of Silicon Valley's biggest producers of computer hardware and software. Worse, he admits, they weren't entirely wrong.
The dot-com bubble was as good to Sun as it was to anyone in high tech. The company prospered step for step with bubble-era start-ups by selling many of the servers--high-speed computers used to store application and data files--and much of the software that powered the Internet boom. In 1996, more than a third of World Wide Web servers were Sun computers. The company's market cap jumped from $15 billion in 1997 to $121 billion two years later. At its peak, Sun salespeople found they didn't even have to sell; they could just sit by the phone and take orders. The business model was simple: Roll out expensive hardware--including some servers starting at $500,000--and watch the billions roll in. "We were all drinking the Kool-Aid," McNealy says.
Then, of course, the music stopped. The dot coms disappeared, and the bottom fell out of the market for high-end servers: 50 percent of Sun's sales vanished almost overnight. By the end of 2002, the company had shed $111 billion in value. Lower-priced servers from Dell and Hewlett-Packard flooded the market, and Sun's business suddenly looked dangerously obsolete. Round after round of layoffs came and went. There was talk of a buyout. In 2003, one Wall Street analyst took the unusual step of writing an open letter to the company's board questioning McNealy's leadership. Sun's stock had tumbled from a high of $65 to closer to $4, where it has been flatlining ever since.
But McNealy, a fast-talking, joke-cracking, former hockey player from outside Detroit, whose 21-year tenure as the head of Sun is the second-longest run of a CEO in Silicon Valley behind Oracle's Larry Ellison, did not resign. And three years after his company seemed dead in the water, Sun's CEO is starting to whistle a merry tune once again. His business may not be sexy--buried, as it is, in the dark corners of corporate data centers. But his company is finally back on offense, rolling out a series of next-generation chips and servers, forming new alliances, and, controversially, open-sourcing much of its enterprise software--that is, offering access to its products free of charge. "Our image is moving from clam-digger to Armani suit,"blusters McNealy in his usual folksy fashion. As Internet use climbs and Silicon Valley darlings like Google, eBay, and Yahoo! continue to buy up the company's products, some analysts are starting to wonder if there may be light at the end of the tunnel for Sun and McNealy--and, perhaps, early signs of renaissance for one of high tech's still-battered markets.
That McNealy would be in the vanguard of a tech comeback may come as no surprise. He has, after all, been one of the industry's most innovative--and boisterous--characters ever since he was named CEO, at 29, of his fledgling start-up in 1984. Though he had almost no prior experience in computers (he took a night course in basic electronics so he could understand his cofounders), with McNealy at the helm, Sun became the fastest-growing company in the United States between 1985 and 1989, dominating the workstation boom and going head to head with Microsoft and Apple in the race for computing's future. Sun's servers were among the most reliable and powerful on the market. And while McNealy earned a reputation for his sharp tongue, he also seemed to put his money where his mouth was: He and his wife named their first of four children Maverick and their dog Network. In 1995, when Sun engineers rolled out Java, a universal computer language that enabled all networked computers to communicate with one another and share applications, McNealy hitched his company's fortunes to the Internet. His long-held mantra--"the network is the computer"--seemed to anticipate the Web's interconnected computing environment. And many industry watchers, during the boom at least, hung on his every word.
Computing power. He of the silver tongue has a grand title for today's new Web-based business climate--"The Participation Age." Three million new users worldwide jump on the Web each week, using services that allow them not only to absorb new information--so last century--but to actively participate in the way content is created, from podcasting to blogging to voice-over-IP. "Three hundred thousand folks have a professional career eBay-ing," says McNealy. "Who'd have thunk?" As that network continues to expand, he maintains, there has never been a better time to be in the business of building out Web infrastructure. "The bigger the network, the more we sell," he wrote recently. If Yahoo! wants to compete with Google by, say, increasing the amount of storage space on its E-mail system, it will need more computing power to do so.
Which, in theory anyway, is where Sun comes in. The problem, though, is that the company has been losing ground of late in all three of its major businesses: in servers, to rivals HP, IBM,and Dell, which have offered cheaper products; in microprocessors, to Intel and Advanced Micro Devices, whose chips have been more popular; and in operating systems, to Linux, which companies have been able to download free. Sun hasn't made a profit since 2001. Last quarter, the company brought in $2.7 billion in revenues but still posted a net loss of $123 million.
McNealy, though, thinks he's found a way out of the quagmire. Ignoring his critics, he has stubbornly kept his research-and-development budget at its bubble-era level--and may be starting, finally, to see the payoff. In December, Sun unveiled an entirely new line of servers, the T1000 and T2000, which Sun executives say are five times as powerful, one-fourth the size, and consume one-fifth the power of competing machines--and, just as important, cost less, too. They are powered by a new chip called the UltraSPARC T1, which the company hails as "the world's first eco-responsible processor," and which runs on a mind-boggling 70 watts of electricity--about as much as a light bulb. Good news, says McNealy, for big Web companies like Google and Yahoo! whose second-largest operating expense--after paying their employees--is often electricity. Customers are already raving about the new hardware. "It was great to see them roll that thing out,"says Larry Lozon, vice president of data center services at Electronic Data Systems, a global IT services firm. EDS beta-tested the new Sun servers a year ago, and Lozon insists the technology is legit: His old servers required 5,000 watts to operate, whereas the new Sun boxes use only 800. Still, "from everything we could see, the performance is maintained, if not increased," he says. Multiply electrical-bill savings alone over the 80,000-some servers EDS has in data centers across the world, and "the power implications on those kinds of numbers are really, really big."
Analysts have tried not to be swept away by the hype. "They're learning their lesson: Entry-level prices--that was what was killing them," says Yankee Group's Laura DiDio. Indeed, at just under $3,000, the Sun Fire T1000 is actually cheaper than the competition, an obvious nod to Sun's shrinking market share. (Sun now has around 30 percent of the revenue in the Unix server market, slightly less than both IBM and HP.) But while no one seems to doubt that McNealy's new eco-friendly angle will have legs, most analysts refuse to be baited by what they say is, in the end, still just a product announcement. "Certainly, the initial numbers are impressive," says Gordon Haff, an analyst at Illuminata. Before declaring Sun resurgent, though, "we need to see eBay buying thousands of these; we need to see Google buying thousands of these."(Neither company wanted to comment on its purchasing plans. Sun, meanwhile, says more than 100 customers, including EDS, have already agreed to buy the servers.)
Cash on hand. McNealy's comeback strategy isn't limited to the research lab, of course--he has been working boardrooms, too. Last week, Sun and Oracle announced a 10-year agreement to continue using each other's products. That follows a splashy press conference this fall in which Sun and Google, whose CEO, Eric Schmidt, was the chief technology officer at Sun until 1997, promised to collaborate on unnamed, future projects. Along with a handful of smaller acquisitions this year, Sun purchased StorageTek, a data-storage company, for $4.1 billion. The combined companies are now the fourth-largest data storage entity in the world--and, as McNealy is quick to point out, demonstrate that while Sun's bottom line has sagged, the company still has about $4.5 billion in cash on hand. "Sun is making all the right moves in a very aggressive fashion," says DiDio. "They've got some very good alliances here. If you've got a friend in Google, that's pretty good."
McNealy has made friends in some unlikely places, as well. In 2004, after two decades of mortal combat, Sun and Microsoft announced that they had signed a 10-year interoperability agreement that allows the companies to cross-license their products. For McNealy, who spent much of the '90s referring to Bill Gates as "Billy Big Bucks"and actively supporting the Justice Department's antitrust investigation of his rival, this was a stunning reversal. As part of the deal, Microsoft agreed to pay Sun $1.6 billion, and both companies put their antitrust struggles behind them. Experts see this as just more evidence of how dark Sun's prospects have been of late. "They were in a really bad way coming out of the dot-com era--they were losing billions and billions of dollars," says John Rymer, an analyst at Forrester Research. This, in other words, may have been the only way to stop the bleeding. In a rare, tight-lipped moment, McNealy demurs on the Microsoft question. "We're strong and respectful competitors--always have been,"he says, "but the food fight is over."
Freebie. Its new hardware and high-visibility partnerships notwithstanding, there is still one reason most analysts haven't put "buy" ratings on Sun. In the past year, Sun has moved toward open-sourcing for most of its enterprise software--meaning it will offer free access to the Java Enterprise System and Solaris 10 operating system that make its servers run. McNealy, for his part, argues that this is simply a return to Sun's roots--that the company, from its first workstations to its advancement of Java, has always supported nonproprietary, shared technology. He also says the products will eventually generate service revenue and expand the pool of developers who use Sun software. And, to be fair, there may be something to this: Since it was open-sourced in February, Solaris 10, the most recent version of Sun's operating system, has been downloaded 3
But industry analysts are still scratching their heads. "We're as perplexed as anybody else," says Richard Gardner, a research analyst at Citigroup. There is little doubt about why Sun is moving in this direction. "Linux has played Pac-Man with Sun's market share,"says DiDio. More and more of the company's servers are being shipped with Linux on them, and Sun is desperate to make its software stack as attractive as the competition's. Still, giving away an entire line of proprietary software is uncharted territory: "I just don't see how open-sourcing ultimately creates a wildly profitable business model for them," says Gardner.
McNealy insists that skeptics are missing the business proposition inherent in open source. "People don't understand 'free,' do they?" he says. "Look at Google. When was the last time you paid for a Google search? It's free. You build a large community, you can monetize a large community. You don't have a large community, it's very tough to monetize."
But, for once, there is some caution in McNealy's voice. He acknowledges that he doesn't have the same gold-plated reputation that he did in the '90s. "I've been a chump and a hero and a chump and a hero 40 times over in my career," he says. And while his new strategy of rolling out eco-friendly servers and open-source software to build out the Internet's infrastructure may ultimately be vindicated, for now, he understands that his sights need to be set slightly lower. "We've got to grow and make money. We do that, all is forgiven," he says. The loser stamp of the past few years will be erased. "We'll be cool again--we'll have the right alligator or horsey on our shirt instead of the big L. "After the body blows of the past few years, he seems to relish the thought. So, too, would Sun investors.
AT A GLANCE
Founded:In 1982 by Stanford M.B.A.'s Scott McNealy and Vinod Khosla and computer scientists Andy Bechtolsheim and Bill Joy
Net Loss: $11 million on revenue of $11 billion in 2005
Employees: 38,600
Business: Global supplier of network computing systems, servers, software, and storage
This story appears in the January 23, 2006 print edition of U.S. News & World Report.