IBM’s Big Blues

IBM Tries to Adapt. Again.

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There’s no better case study than IBM when it comes to showing how a company can keep ahead of the ever-changing technology business. Big Blue brought computing to the corporate world with its mainframes in the 1960s and 1970s. Its desktop personal computer, introduced in 1981, set the standard for the machine that’s now almost ubiquitous in offices and homes. Up-and-coming computer makers pushed the company to the edge of bankruptcy in the 1990s before it adapted again, learning to sell services and software to help companies enter the Internet age. Now it faces new threats from cloud-services rivals and hasn’t figured out how to make much money from selling technical services to support the burgeoning corporate use of smartphones and tablets. Its shares fell 2.1 percent in 2013 versus a 26.2 percent gain for the S&P index of tech-company stocks, and plunged again in the fall of 2014. A new CEO is faced with trying to change IBM’s spots again.

The Situation

After 20 years of steady sales growth and envied profits, IBM has struggled. The company abandoned a 2015 earnings forecast in October after reporting that third-quarter adjusted earnings from continuing operations were $3.68 a share, down from $4.08 a year earlier. It’s push into services is no longer enough to mask problems with its hardware units. The company reported on Jan. 21 that sales of the services divisions fell 3 percent in 2013 — total revenue has hovered at about $100 billion a year since 2007. Many companies that used IBM’s consultants to help set up in-house computer systems have begun renting server space from Amazon.com and signing up for sales-tracking software from Salesforce.com with a few clicks of a mouse. And other than Watson, the Jeopardy-playing supercomputer, IBM’s once-overflowing cupboards of innovation are looking bare. Financial engineering techniques such as buybacks and dividend increases now power the stock, not technology innovations. IBM was the only stock in the Dow Jones Industrial Average to drop in 2013.

Source: Data compiled by Bloomberg
Source: Data compiled by Bloomberg

The Background

Under Thomas J. Watson and his son, Thomas Jr., IBM used sophisticated research and groundbreaking sales management to dominate the nascent computing industry. By the 1990s, though, the company seemed to have no answer when rivals such as Digital Equipment and Compaq came up with cheaper alternatives to its profitable mainframes and other computers. Enter Louis V. Gerstner. The former McKinsey consultant and RJR Nabisco chief slashed more than 100,000 jobs and created a Global Services division that became the pre-eminent e-business consultant guiding companies struggling to deal with the rise of the Internet. Gerstner’s successor, Sam Palmisano, a career IBM salesman, took the helm in 2002 and kept profit high by selling the PC unit to Beijing-based Lenovo and building and buying software companies. (Palmisano has advised Bloomberg News’s parent company on privacy and data standards and serves on the board of Bloomberg Philanthropies.) Ginni Rometty became the first woman to lead IBM, in January 2012. An honors graduate in computer science, she’s talked of using Watson and other artificial intelligence technologies to help companies make sense of the torrent of data they collect. The stock fell to $187.57 at the end of 2013 after peaking at $215.80 in March. Since then she’s made a move right out of the Palmisano playbook, selling IBM’s low-margin PC server unit to Lenovo on Jan. 23 for $2.3 billion. Then on July 15 she announced a partnership with Apple to boost sales of software and consulting services to companies using iPhones and iPads. A day later the shares closed at $192.43, up 2 percent.

The Argument

IBM fans — notably Warren Buffett, the company’s largest investor — loved Palmisano’s promise, made in 2010, to boost earnings per share from $11.52 to $20 by 2015, but Rometty backed away from that pledge after weaker-than-expected software sales and lower productivity in services in the third quarter of 2014. Rather than strategic reinventions to rekindle sales growth, the company bet it could satisfy shareholders with more buybacks and bigger dividends on top of steady cash flow. Analysts such as Brian Marshall, formerly of the investment firm International Strategy and Investment Group, saw that it wouldn’t be that easy. If chasing higher earnings per share got in the way of creating — or at least catching — the next big technology wave, he argued, no amount of financial engineering would protect investors from the kind of decline suffered by onetime tech leaders such as Digital Equipment, Dell and Hewlett-Packard.

The Reference Shelf

  • Bloomberg Businessweek feature article on the trouble with IBM.
  • Harvard Business School case study of Gerstner’s makeover of IBM.
  • Thomas J. Watson’s autobiography, “Father, Son & Co: My Life at IBM and Beyond.”
  • Video of Bloomberg’s Cory Johnson analyzing the financial engineering that’s boosted IBM’s share price.
  • A plain-English primer on the capabilities of the Watson supercomputer.
  • Video of Ginni Rometty’s talk about IBM’s R&D strategy at a 2013 Fortune conference.

First Published Jan. 30, 2014

To contact the writer of this QuickTake:

Peter Burrows in San Francisco at pburrows@bloomberg.net

To contact the editor responsible for this QuickTake:

Jonathan I. Landman at jlandman4@bloomberg.net