Financial Matters: IBM Pricing Strategies Fuel Used Processor Market

by Barry J. Graham
April 1, 2005

For some 30 years prior to the introduction of CMOS technology in the early ’90s, IBM mainframe processors had been increasing in capacity by 15 percent per annum, with the price declining at a similar rate. The correlation between the capacity increase and price decline was due to the economics of processor manufacturing, where any capacity increase delivers an identical cost reduction. Now, although this was a significant annual price decline, it didn’t allow users to “scrap” mainframe technology as early as was the case in the mini-computer and PC world. This resulted in users requiring upgrades to installed mainframe processors and even additional processors of the same type for some years after they were removed from IBM marketing. This created a healthy used market for IBM processors.

However, with the introduction of CMOS with its 40 percent per annum capacity increase and a 40 percent per annum price decline, the mainframe processor life was shortened and the value and demand for “used” systems was minimal. This was also driven by IBM’s clever marketing programs, which allowed for upgrades from one technology level to the next, restricting the availability of used processors and some manipulative maintenance pricing, that greatly increased the TCO of older processors.

Around 2000 this changed, and since then, the average annual price decline is closer to 10 percent—well below even the pre-CMOS level—and consequently, the second user market is once again growing as users are keeping their processors longer and, therefore, require upgrades and additional processors. This price decline slowdown is undoubtedly a result of the Plug Compatible Mainframe (PCM) suppliers exiting the market—leaving IBM with no competitive pressure to lower prices. In fact, IBM increased the price per MIPS slightly with the introduction of the z990—the first time in the history of the mainframe.  

The result of the slower price decline is that the price per MIPS is around 10 times higher today than the level that should have been achieved with CMOS technology, yet the performance of the top-end z990 is almost exactly on the technology curve.

To minimize the number of used systems (or upgrades) being purchased, IBM is today selling the older z900 at up to 25 percent higher prices per MIPS than the z990, is charging higher maintenance prices per MIPS, and is offering lower software pricing for most users on the z990.

The net result is that for any user requiring more than a very small z900 upgrade, the three-year TCO of a z990 solution from IBM will be around 10 to 15 percent less than the z900 from IBM.

While the slower price decline may sound like bad news, market forces always come into play when a monopoly attempts to exploit its domination; in this case, second user systems and third-party maintenance. These are both well-tried solutions from an earlier era and will grow in importance over the next few years.