Sun's New CEO Faces Tough Challenges

On the day he took the reins of legendary computer company Sun Microsystems, Jonathan Schwartz was asked how he's different from his mentor, Scott McNealy. "Haircut, sports preferences, he drinks Budweiser, I don't," quipped the 40-year-old, pony-tailed Schwartz, who was named Sun's new CEO last week. "We're different people, but we have the same values."

Whether a different person with the same values can put some of the magic back into Sun is the key question. The combative McNealy co-founded Sun in 1982 when he was 27, became CEO two years later, and has run the place ever since, participating in the decline of the mainframe, the shift to client-server computing, and the rise and fall of the dot-coms.

But Schwartz must deal with a new era in which computing power flows over the Web. Customers want Sun to deliver more performance for their dollars, and investors are clamoring for job cuts to help return the company to profitability. Will Schwartz chart a different path than McNealy, a man he called "a hero to us all" in his widely read blog? Based on his comments last week, he's looking a lot like McNealy II.

Yet, the challenges for Sun haven't changed. The company last week reported a loss of $217 million during its third quarter ended March 26, its third consecutive quarter in the red. However, revenue is growing again, up 21%, to $3.2 billion, thanks to growth from the acquisition of StorageTek and sales of x86 servers.

Few Changes Expected
But Sun's projected sales of $12.8 billion this year are well short of its 2001 apex of $18.25 billion. Sun's share of the $51.7 billion server market was down to 9.6% last year, as the company lost ground to IBM, Hewlett-Packard, and Dell, Gartner says. Wall Street analysts are calling for Sun to ax as much as a fifth of its 37,900-person workforce to give some buoyancy to its $5 stock price.Most of Sun's sales are tied to Solaris, its version of Unix, a platform in decline. Sun's strategy for growth hinges on selling more power-efficient and powerful systems that run on standard x86 chips and finding a way to turn its hardware and software expertise into a method for delivering computing as a service over the Net. Schwartz isn't promising any big changes, which means Sun's evolution is likely to be more incremental than drastic.

"They're going to hold pat," says Fred Killeen, interim chief systems and technology officer at General Motors, which spends a hunk of its $3 billion annual IT budget on Sun gear. Killeen is heading to Sun's Menlo Park, Calif., headquarters this month for meetings. McNealy handled the GM account, and "we don't expect a lot to change" with Schwartz, he says. Low-cost blade servers running Sun's Sparc chip have helped GM cut the cost of running purchasing and logistics systems, and Sun's Java software stack is integral to the automaker's Web apps. Still, there's room for improvement--Sun's pitch for utility computing hasn't won GM's interest; there are too many unanswered questions about data security and integration with on-site machines. "We haven't seen the right fit," Killeen says.

During his first three months, Schwartz plans a soup-to-nuts review of Sun's technology, finances, and sales group, and he wants to shift resources from small, money-losing accounts to big customers like Bank of America, eBay, Salesforce.com, and Wells Fargo. "We're not focused on dentists or flower stores and shopping malls," he said.

"Taking a whack to head count" isn't in his plans, he said, though he hasn't dismissed a shake-up ahead of the fiscal year that starts in July. Schwartz said Sun's major brands--Java, Sparc, and Solaris--can deliver more value, and he has Greg Papadopoulos, newly promoted to executive VP of research and development, reviewing every engineering project. Sun spends about $2 billion a year on R&D, and while there will be changes, execs say intellectual property is a pillar of Sun's strategy at a time when competitors are cutting back. "We've got a huge market opportunity ahead of us," McNealy told analysts and reporters in a conference call. He'll remain chairman and spend more time with customers. "We're going to be there for the long haul."

Schwartz's bet: Assuming the tech market keeps growing and Sun can keep costs in line, it will grow its gross margins--the price of a product minus the cost of producing it--which stood at 43% last quarter. Sun cut $500 million in costs in the past year, and it's aiming for more without the deep layoffs Wall Street analysts want. Keeping costs down will be key as Sun ramps up a plan to sell computing power over the Web, charging by the hour instead of selling hardware outright.Selling Services
But after winning major contracts in financial, telecom, and government markets with its high-performance, high-priced products in the '80s and '90s, Sun got caught from behind when businesses moved to low-cost computers running Windows and Linux on commodity processors from Intel and Advanced Micro Devices. "They keep missing the higher-value part of the industry--software and services," says Joshua Greenbaum, a principal at Enterprise Applications Consulting.Sun is making progress. In November, Virtual Compute, which runs high-performance computing jobs for customers in the oil industry, bought 1 million hours of Sun CPU time, which Sun sells for $1 per CPU hour. Sun's service fills short-term needs, CEO Ed Hayes says, but he doesn't plan to buy any more hardware from Sun or its major competitors. "It's too expensive," he says. "Computing is a commodity and getting cheaper and cheaper. I don't think people are interested in brand names."

Still, Sun has $4.4 billion in cash, and big Web services companies like Yahoo are buying Sun gear again. A priority for Schwartz is to figure out how to finally make some money from Java, perhaps by entering consumer markets where the software resides on millions of cell phones. Schwartz even suggested Sun will buy open source software companies to add middleware and perhaps a version of Linux to its software portfolio.

Schwartz has been on the fast track since joining Sun 10 years ago when it acquired his startup, and McNealy has been grooming him as his successor for at least the past two. Schwartz is equally facile with technology, operations, and finance, and he's known for his intelligence and smooth--even slick--public demeanor. And true to form as McNealy's protégé, he's shown he won't be a dry, by-the-book CEO in the mold of HP's Mark Hurd, called in last year to turn that troubled company around.

But it will take more than a quip or a slick ad campaign to turn around Sun's fortunes. The company always has been a technology leader and, until the tech bubble burst, was able to get top-shelf prices for its products. It can't anymore. Where to position Sun in an industry where few business customers are still willing to pay premium prices may be Schwartz's toughest challenge.

-- with Darrell Dunn0