In Defense of IBM

IBM’s current financial results have made the news again—relatively good profits but flat or declining revenues for the past five years as well as a stagnant stock price.^3,4,5,6 Rather than dismiss this historic company (founded in 1911) as an obsolete tech titan, however, I find myself instead appreciating what IBM has achieved over the past 100 years as well as thinking about what it might do in the future. IBM has struggled to grow but has also demonstrated the ability to navigate through multiple technological and business disruptions. These include mechanical punch-card tabulators to electromechanical calculators and then mainframes, personal computers, complex software programs, and now “cloud-based” services of almost magical sophistication, like the Watson artificial intelligence system that won the 2011 “Jeopardy!” game show.^a

There are many accounts of IBM’s history, so I will not attempt to relate all the details here.^1,b However, most important to appreciate the modern company takes us back to 1993, when IBM appointed a new CEO, Louis Gerstner, who joined an organization that had just recorded the largest corporate loss in history— nearly $9 billion. IBM still dominated mainframes but that business was shrinking. The company had successfully launched a personal computer in 1981 but lost control over the new platform business to Microsoft and Intel. Gerstner’s predecessor, John Akers, responded by laying off approximately 100,000 employees and devising a plan to split up the company into more than a dozen firms. Instead, IBM’s board of directors hired Gerstner, and he decided to keep the company together but change the strategy.^c

Should we always judge the value of a company simply on sales growth and profit? Maybe not.

IBM’s mainframe business faced a major disruption not only from the personal computer, a mass-market product that produced much smaller profit margins. Within a year or so, Gerstner also had to deal with the Internet and the World Wide Web—another historic disruption that would eventually offer a lot of software and services for free. To his credit, Gerstner saw the Internet less as a threat and more as a new opportunity. He understood that large customers faced challenges similar to what he had experienced at RJR Nabisco and American Express—how to combine the new technologies with the old systems. He settled on using professional services—IT consulting around “e-business” as well as system customization, integration, maintenance, and outsourcing—to help large customers pull together hardware and software for mainframes, PCs, and the Internet.

Over the next 20 years, Gerstner and his successors, Sam Palmisano and Virginia Rometty, would continue on this path, adding other skills and new businesses, along with a much more responsive strategy and resource allocation process.² As the accompanying table shows, the structural changes they introduced have been dramatic. Hardware accounted for 49% of revenues in 1993 and only 11% in 2014. Services have grown from 27% to 61%, and software products from 17% to 27%. Annual revenues did stall at approximately $100 billion over the past several years and even declined in 2014 by $7 billion. Part of the reason is that, following Gerstner’s lead, IBM has continued to shed commodity businesses—the list now includes PCs, semiconductors, printers, storage equipment, low-end servers, and call centers. Yet the company still managed to generate more than $18 billion in operating profits in 2014 on sales of under $93 billion. Moreover, hardware, software, and services are all more profitable today than they were when Akers left the company in 1993.

IBM’s biggest structural challenge today is that it has become so dependent on professional services, and these kinds of revenues are difficult to scale and automate. They grow approximately on a one-to-one ratio with headcount increases. In fact, in terms of revenues generated per employee, not adjusted for inflation, IBM employees are no more productive today than they were in 1993 (see the table here). Not surprisingly, IBM’s market value (about $170 billion in May 2015) is far behind Apple ($750 billion), Microsoft ($395 billion), Google ($370 billion), and even Facebook ($220 billion), and just ahead of Intel ($160 billion).

Another reason for lagging sales productivity is that technology has become cheaper. Not only do we see this in hardware and software products but in maintenance and services. Software as a service (SaaS) and cloud computing, as well as overseas development and service centers in low-wage areas such as in India, have reduced the need for lucrative maintenance and other technical services. These trends have brought down the total cost of enterprise computing and have meant less revenues for companies such as IBM.

Critics also point out that IBM has propped up the value of company shares through stock buybacks ($108 billion worth since 2000) instead of investing in research and development at the level of other enterprise technology companies, or making big transformational acquisitions.⁷ (By comparison, Microsoft, Oracle, Google, and SAP generally spend 13% or 14% of revenues on R&D. Apple, because of its limited consumer product lines and rapid sales growth, only spends about 3% of sales on R&D.) For a company whose business is mainly services, though, IBM still spends a lot on R&D. And big R&D spending has not necessarily helped other companies like Microsoft and Intel grow faster than the enterprise computing market, which is increasing sales slowly compared to hot consumer product segments like smartphones and tablets, or even SaaS for small and medium-size enterprises.

But should we always judge the value of a company simply on sales growth and profits? Maybe not. We are now moving into an era of exciting opportunities for new types of products and services that blend big data and “intelligent” analytics with massive computing power—precisely the combination of skills and technologies that few firms, other than IBM, possess within the same organization. One potential example of this combination is the application of IBM Watson to problems such as reducing healthcare costs, diagnosing diseases, minimizing pollution, or optimizing energy usage.

Gerstner’s main contribution was to keep IBM as one company with a clear purpose—service the data processing needs of large organizations, public and private. Those customers often tackle enormously complex problems of value to business, government, and society. In the 1930s, for example, IBM built the information infrastructure for the U.S. Social Security system. In the 1950s and 1960s, it pioneered anti-missile defense software as well as airline reservation systems. Today, it is tackling new applications for artificial intelligence. IBM has always taken on the biggest information technology problems since its predecessor company first began making mechanical tabulators for census taking more than 100 years ago. I expect it will still be taking on society’s most complex data processing and analysis problems 100 years from now.

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