By SPENCER E. ANTE
International Business Machines Corp.'s vaunted software portfolio includes applications to help companies crunch huge amounts of data and manage their online storefronts. It also includes programs like Lotus Notes.
"I go to a party, and I almost immediately get insulted," says Eugen Tarnow, a director of the consultancy Avalon Business Systems, which sells the aging email software to businesses. "They say, 'Lotus Notes, that's still around?' It's no fun."
Remember Lotus? When IBM paid $3.5 billion for the email pioneer in 1995, the deal was seen as a game-changer that plunged the hardware company more deeply into the higher-margin software market.
Now, it's a symbol of the challenges facing new Chief Executive Virginia "Ginni" Rometty as she tries to spur growth in a software division that accounted for nearly a quarter of IBM's revenue and more than 43% of its pretax profit in 2011.
IBM has spent billions of dollars on dozens of software acquisitions in recent years, which have helped the company deliver a flow of steady earnings. Still, much of its software revenue flows from technologies like Lotus that it acquired or developed at least a decade ago. The company needs to modernize its portfolio for a new technology era by selling more software aimed at fast growing areas like social media, cloud computing and mobile.
Investors will be watching IBM's software results closely when the company reports earnings Tuesday.
IBM software revenue grew 1.4% in the first nine months of the year compared with a year earlier.
The company's chief rivals reported better results. In the fiscal year ended June 30, Microsoft Corp.'s software sales grew 5%, and Oracle' Corp.'s software sales grew 9% in the fiscal year that ended in May.
IBM'S third-quarter software revenue shrank 1% to $5.8 billion. The company says it didn't close a handful of deals it expected to finalize in September. Analysts are expecting the company to report about $29 billion in overall revenue for the fourth quarter, down about 1% from a year earlier.
For IBM, Lotus is too lucrative to ignore but very hard to grow. While the company doesn't break out how much revenue the Lotus franchise generates, tech-research firm IDC estimates the software accounted for about $1.2 billion of revenue in 2011, the most recently available number.
Meanwhile, that franchise is being eroded. The Federal Aviation Administration, which began using Lotus Notes as its main email program in 2001, announced in June a $91 million contract to switch its 60,000 FAA employees and contractors to a new Microsoft email and communications system that it says would allow it to work more efficiently.
Over the past few years, similar moves have been made by customers including J.P. Morgan Chase and the city and county of San Francisco, which dropped Lotus in favor of cheaper programs from Microsoft and Google Inc.
In the first nine months of 2012, Lotus's sales fell 6.4%, according to IBM filings. During the three previous years, Lotus was the weakest performer in IBM's software portfolio, which includes a range of software for forming the technology backbone of a business, such as database programs and software that runs computer servers and networks.
IBM's second slowest growing software business is based on Rational Software Corp., a software-tools company it bought in 2003 for $2.1 billion.
In the past, IBM has had some success in reviving these businesses by acquiring newer technologies and incorporating them into the older brands. Performance in its Websphere and DB2 database brands has been aided recently by the acquisition of companies such as Netezza, which speeds up data crunching; Coremetrics, which lets companies mine social media for customer feedback; and Unica Corp., which helps manage digital-marketing campaigns.
IBM is trying to do the same thing with Lotus by folding it in with social-media tools that address more current needs. Those tools, grouped under its Connections software, let companies create corporate versions of Facebook Inc., with user profiles, blogs and streams of news updates that co-workers can follow and learn from.
The challenge for IBM is that revenue from the business is puny compared with the revenue from Lotus. In the first half of 2012, IBM made $55 million selling social-business software, giving the company more than 11% of the market, according to IDC.
The market is also competitive, with rivals including startups Jive Software and Lithium Technologies Inc., as well as Yammer, which Microsoft bought last June for $1.2 billion in cash.
Over the next few years, though, IBM hopes that such software will become a billion-dollar business. IDC believes the market value will rise to $4.5 billion in 2016 from 2011's $767 million.
For now, the technology giant continues to milk its Lotus client base to win customers for its social-media software. For instance, the annual IBM Lotus conference to be held later this month was renamed Connect2013.
IBM also continues to update and sell the aging program. IBM General Manager Alistair Rennie says the company is absolutely committed to Lotus Notes and related programs and is preparing to release new versions of them in this year's first quarter.
The challenge, though, is finding new customers beyond those who previously bought Lotus.
"It is important to not think about Lotus as the master brand," Mr. Rennie says. "It is time to think about focusing on the new buyer."
Write to Spencer E. Ante at spencer.ante@wsj.com
A version of this article appeared January 22, 2013, on page B1 in the U.S. edition of The Wall Street Journal, with the headline: Lotus Notes? It Is Still A $1 Billion IBM Business.
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