The decision to stop application development and strengthen its focus elsewhere has opened up new markets and has led to the software group becoming one of IBM's success stories

Mr Steve Mills is not as well known as Bill Gates of Microsoft or Larry Ellison of Oracle, yet as head of IBM's $13 billion (€14 billion) software group he runs a software business that is second only to Microsoft.

It is one of the success stories at IBM, the world's largest computer company, and increasingly important as Big Blue struggles to raise earnings and revenues in the face of a steep decline in global information technology spending.

As pricing competition hurts hardware sales and companies cut back on IT services, the software group and its healthy margins are pivotal in helping IBM regain revenue and earnings momentum.

In its most recent quarter, IBM missed Wall Street revenue targets by about 10 per cent. All of its business groups suffered declines but software suffered the least. Revenues declined 1 per cent to $2.9 billion. In the prior quarter, software was the only group to show any growth, increasing revenues by 6 per cent.

This is impressive given that other software companies have reported much steeper revenue declines. This, analysts agree, is largely due to Mr Mills implanting a change in strategy; a strategy that is different to that of rivals.

"Two years ago we decided to drop application development and focus on middleware," Mr Mills says.

Middleware is a broad term that covers software used to run e-business applications. It consists of application server software, which companies use to connect their e-business applications and database software that stores mountains of crucial data on customers, suppliers and business transactions.

Before Big Blue decided to quit the applications business, it was spending $1 billion a year on development and marketing costs, and doing badly, holding a small share of the market.

In addition, it discovered it was increasingly competing with many of the larger software companies whose support it needed for its middleware business. This is because e-business software companies had to produce versions that ran on IBM middleware.

Mr Mills's focus on middleware was astute. And it came at a time when Oracle, the leader in database software, had decided to build aggressively its e-business application business and, therefore, compete with enterprise software companies such as Siebel Systems, PeopleSoft and other software vendors.

The result was that the enterprise software companies began to focus on offering support for IBM middleware, rather than Oracle, which had now become a direct competitor.

"Because we don't compete in applications, it means all the large enterprise software companies partner with us for databases and application software, and this has the added benefit that their sales forces also promote our products," says Mr Mills.

IBM's database and application server business has been growing rapidly. In the most recent report from Gartner Dataquest, a leading US market research company, IBM squeaked past Oracle for the top spot in databases.

Although a significant part of that gain was due to the $1 billion acquisition of Informix's database business last year, its core DB2 database product did show gains.

"Years ago we used to lead Oracle by 30 points of market share but then lost market leadership to them, so it feels very good to regain the lead," says Ms Janet Perna, head of IBM's database group.

The question now is if Big Blue's strategy can continue to be effective as other giant software companies increasingly target the middleware market. SAP, for example, a leading enterprise software company, is developing its own application server software and it has a massive installed base within large companies around the world.

"We do not consider SAP a competitor - the market is consolidating around two industry leaders, and that is us and BEA Systems," says Mr Mills.

Oracle and Sun Microsystems are distant competitors, say analysts.

Mr John Kiger, director of product marketing at BEA, maintains that, although narrow, it still has the lead over IBM in application server software - a $2.2 billion market. "We have won some key customer accounts that used to be IBM's because our product is easier to use and has a lower cost of ownership," he claims.

Within these tough times of lower IT spending, convincing customers to choose software based on lower cost of ownership is critical.

Last year Oracle was forced to cut prices and restructure its licensing agreements, partly because of pricing pressure from IBM.

Although middleware is vital for e-business, IBM's software group has tapped into another growing trend: integration. Companies around the world are trying to unify their computer systems so they can have a single view across their business.

IBM's middleware has been beefed up with features that help that process.