IBM and the Structure of the IT Industry
Saturday, May 01, 2004
Copyright 2004, Adam J. Robinson. All rights reserved. Please email Adam.Robinson@yale.edu for permission to reproduce any part of this essay. Please email me as well for a copy in Microsoft Word format with proper footnoting. Also, check out main site at http://ajrobinson.blogspot.com
International Business Machines Corporation is arguably one of the most profitable business enterprises of all time. Starting as a loose confederation of clock, scale and tabulator manufacturers, IBM's successes throughout the twentieth century shaped the information technology industry into how it is organized today. Consolidating its businesses under such famous CEO's as Thomas Watson Sr., Thomas Watson Jr., and Louis Gerstner, IBM presided over three different revolutions in information handling: From tabulators to electronic keypunching; from punch cards to mainframes; and from mainframes to the networked PC and IT integration.
In the pages that follow, I will consider IBM's rocky transition from the second IT revolution to the third. I will examine the transformations of the IT industry model over the past two decades, and I will analyze the changes that IBM made under Louis Gerstner in order to cope with a vastly different IT marketplace. I will argue that Gerstner's decisions to keep the company together, to redefine its software business, and to shift IBM from a product-oriented business to one that is services-led were the most important changes that ultimately have led to IBM's current success. I will conclude by analyzing IBM's current strategy, its advantages over its competitors, and what I see happening to the company and the industry in the future.
From the System/360 to the Crises of the 1980s
To understand the structure of the IT industry as defined by IBM, one must realize that IBM is the ultimate change agent in the history of information technology. Undoubtedly its most significant move to reorganize the industry was to shift from the stable, immensely profitable punch card business into high-performance computing. The legacy of Thomas Watson Jr., IBM spent over 5 billion (1960s) dollars to create the world's first integrated family of mainframe computers. Dubbed the System/360, this mainframe family was revolutionary in that it was built with high-performance integrated circuits, the precursor component to the semiconductor chip. These chips made the S/360 smaller, cheaper, more powerful and more reliable than any mainframe that preceded it.
But perhaps more important than the advantages of the integrated circuit, the S/360 was a family of computers that ran on the same software and with which all of IBM's computer accessories were compatible, making upgrades relatively simple. From the view of the customer, cost savings as a result of such compatibility were more significant than any addition that could have been made in computing power. As a result, IBM had a virtual monopoly over the mainframe business for the next twenty years. As Rowena Olegario comments: "By the early 1960s, it was clear that IBM had achieved what few other firms of its size had ever managed to do: it exited a thriving business [punch cards] and shifted into a new and risky technology [S/360]. And it made the gamble pay off."
While the S/360 was compatible with all of IBM's own mainframe accessories, it was still very much a proprietary system. Essentially, all of the hardware, software and peripheral products that made up the S/360 were invented and manufactured within the company. IBM scientists and engineers invented semiconductors and then manufactured them in high volume; they invented the memory chip, the relational database, the programming language FORTRAN, an operating system, and a transaction processing system all exclusively for the S/360. In the language of the industry, IBM created its own stack of vertically integrated mainframe systems that sent competitors reeling. The stack consisted of base hardware, an operating system, middleware, application software and IT services. What a customer got when he or she purchased the S/360 was a bundled package that was frequently serviced and maintained. And without the eventual antitrust scrutiny brought about by IBM's marketshare in mainframes (30 percent and growing in the American market by 1969, and 62 percent of the world computer market in 1971), this might still be the model for the industry today.
However, there were two main forces emanating from this period of wild success that would bring IBM to the brink of bankruptcy in 1993. One was the lack of a competitive threat in the marketplace that was the result of the success of the S/360, and the other was a thirteen-year antitrust case brought against IBM by the US Department of Justice beginning in 1969. The case was eventually dropped and classified "without merit" in 1982, but as former CEO Louis Gerstner put it: "For thirteen years IBM lived under the specter of a federally mandated breakup. One has to imagine that years of that form of scrutiny changes business behavior in very real ways."
The most immediate change in the way IBM did business occurred in 1969, when Thomas Watson Jr. "changed the way IBM sold technology. Rather than offer hardware, services and software exclusively in packages, marketers 'unbundled' the components and offered them for sale individually." Unbundling led to the creation of giant hardware, software and services businesses within IBM, but it would be the first rupture in IBM's proprietary stack. While gross margins in each of these enterprises were consistently above 60 percent in the 1970s, the division of IBM's businesses opened the company up to competition strictly from hardware manufacturers, which were separate from competitors in software and competitors in IT services. As a result, IBM was uniquely open to attack in the marketplace from more focused competitors with the advent of UNIX mainframes in the 1980s. Still cushioned from strong marketshare and high profit margins from the days of the S/360, IBM did not even see this first attack coming.
UNIX servers, championed by companies like Sun, HP and SGI presented the first real challenge to IBM's S/360 mainframe model after twenty years of dominance. Proposing to turn the vertically integrated stack that IBM had defined through the S/360 onto its head, UNIX was a system that allowed many different companies to make piece-parts of the overall IT solution for the customer. This introduced competition into the industry at every point in IBM's stack that could be differentiated. All of a sudden, companies that sold only operating systems began to emerge, along with companies that sold only semiconductor chips and companies that sold only memory and storage devices. IBM's ability to rake in profit margins as high as 60 percent was erased as fast as chip speeds were doubling and prices on mainframe parts were being halved.
As IBM became preoccupied with defending its stack against the multi-front attack represented by UNIX, PC makers "came along swinging wrecking balls." IBM had failed to see the importance that the personal computer would have in facilitating the transmission of computing power from CIOs to individual employees, an industry move from centralized to what was called "distributed computing." Drastically falling prices and the customer's demand for a new distributed computing model took the leadership position of the industry away from IBM and planted it firmly in the hands of a third industry stack termed the "Wintel Duopoly."
This third industry alternative caused IBM's finances to hemorrhage. By 1993, the company's net losses reached a record US $8 billion. As Gerstner remarks:
The PC leaders' pitch to customers was simple and compelling: 'You want your employees to make productive use of your business data, applications, and knowledge, which are tied up on old back-office systems. Right now those systems and your PCs don't work together. Since all of your PCs are already Microsoft and Intel machines, you should put in back-office systems that use the same technology.' It was easy to play out the scenario. The PC leaders would march relentlessly up from the PC into business computing and displace IBM products.
The client/server revolution, as it was called, threatened IBM's proprietary stack entirely. Now, IBM's hardware and software was not only incompatible with UNIX-based products, but IBM also refused to open its stack to the likes of Microsoft and Intel. As a result, while all of its competitors gave in to the Wintel duopoly (Intel Pentium processors and Microsoft Windows were immensely popular and highly demanded by consumers), IBM chose to preserve its stack. As customers were lost to companies selling UNIX servers armed with Windows and Intel chips, IBM almost split itself up into separate hardware, software and services businesses. In a last ditch effort, IBM switched CEOs and made some big bets to keep the company together.
Gauging the Industry's True Direction and Becoming the Industry Integrator
Louis V. Gerstner Jr. came to IBM as chairman and CEO on April 1, 1993. He quickly instituted a drastic cost-cutting program that would save US$ 8.9 billion over his nine-year tenure and US $2.8 billion in 1993 alone. To make this happen, he laid off 35,000 people in his first year and sold off assets he deemed unessential to the future of IBM. This included US $2 billion in real estate (such as the tallest building in Atlanta), and IBM's prized art collection and gallery in Manhattan. Additionally, traditional IBM bonuses—such as free country club membership and all inclusive family benefits plans—were significantly reduced. Gerstner's prowess as a manager, however, was not in execution, though he claimed it was. While the IBM CEO was an expert as making his company market-driven, he was especially prescient in the way he thought about IBM's future role in IT—as the industry's integrator.
Unlike almost all of IBM's critics, Gerstner saw the change in the IT industry from vertical to horizontal integration as an unwanted side effect of the customer's demand for lower prices. As former president of American Express (a huge IT consumer), Gerstner knew that while customers wanted lower prices, they were not prepared to create an integrated IT solution for themselves. But in a piece-part IT industry, the customer was stuck trying to customize his or her own solution with technology that often was not even compatible. The result was a drastic under-utilization of information technology by the customer.
While many in the industry (including John Akers, the company's CEO before Gerstner) believed that IBM had to disaggregate into several independent "Baby Blues," Gerstner listened to the customer's needs. He wrote in his book: "CIOs made it very clear that the last thing in the world they needed was one more disk drive company, one more operating system company, one more PC company… more minnows in the ocean." He saw IBM's bigness as a unique competitive advantage which it could use to sit at the end of the now horizontal IT process and customize an integrated solution for the customer. He wanted IBM to take responsibility for translating all of the piece-parts created by IBM's competitors into value for the customer. Essentially, the strategy was to standardize, optimize, outsource and manage IT for the customer. This would be a services-based strategy, and services was already a growth opportunity within IBM that was worth pursuing.
However, Gerstner soon realized that in his pursuit of a growth opportunity in services, he was onto what would be the next restructuring of the IT industry. As Gerstner put it:
"This would be a historic shift in customer buying behavior. For the first time, services companies, not technology firms, would be the tail wagging the dog... If customers were going to look to an integrator to help him envision, design and build end-to-end solutions, then the companies playing that role would exert tremendous influence over the full range of technology decisions—from architecture and applications to hardware and software choices."
With this realization, IBM's services strategy became a strategic imperative for the entire company. In deciding to keep the company together, Gerstner bet that IBM could become the largest and most influential services company in the industry.
Executing the Integrator Strategy
But for IBM to become the foremost integrator of technology, its most important task was first to re-integrate its own "Balkanized businesses." Since Watson Jr. split IBM's businesses into hardware, software and services in 1969, there was a tremendous lack of cooperation among each segment of the business. Even worse were the "geographic fiefdoms" that arose at IBM branches around the world. Global IBM customers would have to begin a totally new relationship with the IBM that they encountered in the countries into which they were expanding. It did not matter that American Express, for example, was one of IBM's biggest customers in the US. If the company wanted to expand into say, Singapore, it would have to start all over with the IBM branch in that country. This branch had no idea about the products that American Express was buying in the States and often did not sell the same type of product or even products that were compatible with their American counterparts. If IBM was going to provide an integrated solution for the customer, all of this clearly had to change.
Gerstner initiated change in two directions: He looked at the treatment of IBM's customers and simultaneously at IBM's top management. With regard to the latter, he disbanded the highest management committee and restructured the board of directors. He focused executives' attention on the most honest scorecard of their performance—IBM's stock price—by employing the use of stock options. Additionally, over his first two years at IBM, Gerstner declared war on the geographic fiefdoms and reorganized the whole company around the customer by dividing them and IBM into twelve global industry groups. He forced the sales departments in each of the most powerful fiefdoms to cooperate and pull their common units together globally.
As services was then only a sub-unit of the sales force, Gerstner slowly began to plant the seeds of his strategy in the sales department by allowing service IBMers to accompany salespeople on visits to customers. Every time a member of the services unit would recommend to the customer a product that did not have the IBM logo, however, the salespeople would go berserk. Gerstner made it his business to defend the services unit until people realized that IBM could not execute the integrator strategy by promoting only IBM products. The days of IBM's own proprietary stack were over. If IBM was to become the industry leader by providing the best solutions to its customers, then it would have to recommend piece-parts made by other companies if the products better served that company's needs. To admit defeat to a competitor in even one area of information technology was previously unheard of at IBM, and it was a huge shock to the company's culture. And it would not be the last.
Another way in which Gerstner fought the fiefdoms and integrated the company was by taking away their marketing budgets. IBM was a global company offering global solutions; it needed to have a unified global brand. So IBM consolidated its advertising and hired one firm, Ogilvy & Mather, to coordinate all of its advertising around the world. The result was the acclaimed ad campaign, IBM: Solutions for a Small Planet. Reducing its number of ad agencies from over seventy to one was a message to the world that IBM was serious about keeping the company together and becoming a world-class integrator. The advertising industry magazine, Ad Age, remarked: "Because computer products, brands and publications have few geographic boundaries, a world approach makes sense… A single agency meshed neatly with Mr. Gerstner's strategy to centralize controls and bring independent units back into the fold."
But not only did Gerstner have to reorganize IBM's branches around the world, he also had to focus on reorganizing the managerial structure that had taken hold at IBM's headquarters in Armonk, New York. Within his first month Gerstner disbanded the executive management committee at IBM, the mark of the famed contention system that was useful in the Watson Jr. era to spark competition among IBM's various business units. In a time when IBM had no outside competitors (because of its virtual monopoly over the market for mainframes), stimulating internal competition was probably a useful tool to keep managers and product units from under-producing. However, now that Gerstner wanted IBMers to focus on the external challenges presented by the market, he needed managers of different product groups and geographical areas to work together. To that end, in the MC's place Gerstner created the Corporate Executive Committee and the World Management Council. The former was made up of eleven members and assisted Gerstner in integrating strategy across IBM's businesses. However, it did not accept delegation of problem solving or make any decisions for the business units. The World Management Council was bigger (thirty-five members) and was essentially a forum for managers across the world to bounce ideas off of one another and to find ways to work together on achieving common goals. It was also a way to break up the fiefdoms and to indoctrinate a select group of managers with the integrator strategy and Gerstner's views about the coming restructuring of the industry.
To further integrate IBM and to force executives and different business units to cooperate, Gerstner instituted a new methodology of executive and employee compensation, based heavily on stock options and variable pay schemes. This was perhaps the most important change Gerstner made in terms of execution, because "you can't transform institutions if the incentive programs are not aligned with your new strategy." While the Watsons felt stock options were intended solely to reward executives, Gerstner asserts:
"I wanted IBMers to think and act like long-term shareholders—to feel the pressure from the marketplace to deploy assets and forge strategies that create competitive advantage. The market, over time, represents a brutally honest evaluator of relative performance, and what I needed was a strong incentive for IBMers to look at their company from the outside in. In the past, IBM was both the employer and the scorekeeper in the game. I needed my new colleagues to accept the fact that external forces—the stock market, competition, the changing demands of customers—had to drive our agenda, not the wishes and whims of our team… People had to understand that we all benefited when IBM as a whole did well and, more often than not, lost out when we functioned as a disjointed operation."
As a result, tens of thousands of IBMers received stock options over the next decade. While in 1992 only 1,300 IBM executives received options, that number increased to 72,500 by 2001. Furthermore, the number going to non-executives was more than twice the amount that executives received.
For rank-and-file employees, pay schemes were changed so that they were based on external rather than internal benchmarks. In the past, if a certain type of programmer was paid $75,000 by IBM's competitors, that same programmer-type might be paid thousands of dollars more or less under the Watson system. While this was more egalitarian, it made it easy for IBM's competitors to raid Big Blue for its best employees by offering to pay salaries in line with the rest of the industry. Gerstner knew that IBM's most important assets could walk out the door at any time, and as a result, he quickly made IBM's pay schemes representative of the rest of the industry.
As an added incentive to keep the company's rising stars at IBM, Gerstner made compensation much more performance-based than ever before. However, a substantial part of the variable pay to rank-and-file employees was based on overall IBM performance rather than on the employee's performance or the performance of the employee's individual business unit. For the highest level executives, beginning in 1994, compensation was based entirely on IBM's cumulative performance, in contrast to the performance of the unit that any particular executive managed. A bonus that was based on unit performance was the prior policy and encouraged an individualistic culture rather than one that espoused cooperation and integration across IBM's businesses. In addition to stock options and variable compensation, highest-level executives were also required to own large amounts of IBM stock. That way, the executives felt real pain if the stock went down (the opposite if it went up), instead of only the loss of a theoretical option gain.
Since the bursting of the internet bubble in 2000, however, there has been strong criticism of technology companies giving too many options to their management executives. In bear markets, "options create perverse incentives for executives to cut accounting corners to boost reported earnings and drive up the value of their options; and options can artificially inflate reported profit because companies don't have to count them as expenses." Additionally, bear markets prevent options from translating into real stock ownership. As stock prices become depressed, options can expire worthless and the incentive structure for employees who do not yet own stock is destroyed.
I would question why Gerstner did not give real equity ownership to IBMers. While that would have required IBM to report its bonuses to employees and executives as actual expenses, this would have avoided the potential destruction of the incentive structure that Gerstner created should a bear market have set in. If it had, while everyone would have felt the pain, at least executives owned stock that did not expire worthless like the options held by lower level IBM employees.
In July 2003, responding to increasingly vocal criticism of stock options (which coincided with the last bear market), Microsoft Corporation decided it would change its bonus structure from one that was options-based to one that was equity-based. While IBM has not followed in the footsteps of its biggest rival, the company has recently announced that IBM executives will receive options with strike prices ten percent above IBM's current stock market price. Additionally, they will have to wait at least ten years before these options can be exercised. While this forces executives to take the long view (and presumably keep the accounting books as honest as possible), I would argue that employee performance incentives would be more effective if IBM made the next step and paid bonuses as actual stock ownership rather than IBM stock options.
Another important move Gerstner made in order to execute the integrator strategy was to redefine IBM's software business. Thinking again about the stack industry model, IBM was getting pounded because many different companies were focusing on selling only application software to businesses. Nonetheless, because customers had no idea how to create a total IT solution for themselves, they often went to application software manufacturers such as Oracle, SAP and PeopleSoft for guidance. When businesses would buy a product, they would often ask for recommendations on what hardware they thought the company's software would run best. However, because IBM was a competitor in application software, rarely did software manufacturers recommend IBM hardware to their customers.
Meanwhile, IBM's software business had really only existed to preserve IBM's vertically integrated proprietary stack. Essentially, IBM's focus was on hardware, and software was specifically written for new hardware products so that hardware could be best utilized by businesses. For the reason that IBM's software existed only so that IBM hardware could have obvious uses to the customer, IBM software was not compatible cross-platform—in other words, it did not run on anyone else's machines. So, in order to preserve IBM's proprietary stack, IBM justified an investment of $20 billion from 1975-1995 in application software development and acquisitions at a negative rate of return of around 70 percent!
It took until 1999 for IBM to realize that it could not beat application software manufacturers at their own game. Though the reason is not apparent, I would argue that it took almost three years for IBM to exit this highly unprofitable part of the stack because it would have been too much of a shock to IBM's culture just to fold its entire software business without offering a viable alternative to which it could reassign its software engineers and R&D laboratories.
That alternative presented itself in the form of middleware software. Before the emergence of networked computing, middleware software was viewed as a "strategic backwater" rather than a strategic battleground in the IT industry. However, networked computing (which would occur by means of the internet) meant that there would be more users, devices and transactions for IT systems to handle. There would be an increased demand for ways to integrate applications, processes and systems with users and institutions. Some techies at IBM argued that there would be no operating system out there in the future that would be able to tie everything together; that was fine, however, because middleware existed to do just that.
When IBM saw this strategic alternative in early 1995, the company for the first time chose to pursue an opportunity with its new integrator strategy in mind. In other words, IBM's forthcoming middleware products would have to be able to run on Sun, HP and Microsoft platforms. It would have to connect these platforms and operating systems to application software sold by companies like Oracle and JD Edwards. Middleware, it turned out, would be IBM's point of infiltration into the UNIX and Wintel stacks that were previously aggressively taking marketshare away from IBM. With its move into middleware—initially by acquiring Lotus Development Corporation and Tivoli systems—IBM went on the offensive.
By 1999, IBM was ready to roll out its universally compatible middleware software and roll back its application software and OS/2 operating system. As it exited application and operating system software, however, IBM sent out the message that it was prepared to work with leading application software developers to deliver the best possible IT solutions to customers. IBM attacked the other stacks by structuring detailed partnerships with over 180 software manufacturers that specified "revenue and [market] share targets and measurements by which both companies agreed to abide." In addition to bringing to the table superb hardware and the ability to customize it with the best middleware portfolio in the industry, IBM also marketed to software developers that IBM would support their products with a rapidly expanding services group. And having the weight of IBM's services business behind one's product was not an advantage that software companies could ignore. This contributed to the further growth of IBM's service sector, which burgeoned to $35 billion in revenues by 2001, growing consistently at rates of 20 percent per quarter.
Even more than hardware or middleware, building IBM's services business was the key to the execution of the integrator strategy. As stated, Gerstner saw the IT industry restructuring around IT services companies that could provide a total, customized IT solution to the customer. In the coming restructuring of the industry, services companies would assume the roles of software manufacturers who were haphazardly providing advice about which hardware and operating system were best to buy to run its software applications. For IBM to become the foremost integrator of information technology, it had to evolve from a product oriented business to one that was services-led. This was a huge undertaking.
First of all, services businesses are much harder to manage because one has to build a business that is labor-based as opposed to one that is asset-intensive. While IBM knew how to manage factories and develop technology, in the services business one sells knowledge. In a sense, one delivers the product at the same time that he or she sells it. The business model and economics are entirely different.
In IBM's case, when promising to take over and manage the customer's IT infrastructure, the company was taking a risk not seen at IBM since Watson Jr. bet the company on the S/360. In the new business model, IBM had to be willing to take a company's existing IT infrastructure onto its balance sheet and carry it at a loss until it could be incorporated into IBM's own IT infrastructure, which might not be until five years into the contract. IBM had to bet that its economies of scale were big enough to turn a profit—namely, that it could consolidate many customers' data centers into "server farms" and do with 750 people what three customers each required 1,000 employees to accomplish. As the business expanded, IBM bet that its human resources capabilities were strong enough to hire 1,000 or more workers a month. Most importantly, though, for IBM to succeed in the services business Gerstner argues, "We had to learn how to be disciplined—how to negotiate profitable contracts, price our skills, assess risk, and walk away from bad contracts and bad deals." To take on these kinds of risks, IBM had to be ready to invest both the years and the capital. To drive its economies of scale as well, it had to leverage its size and be able to promote its own hardware and middleware products as honestly the best solutions for customers. By 1999, IBM was an integrated company armed with compatible hardware and middleware as well as partnerships with the most important software developers. While services had already been expanding rapidly for quite some time, IBM was finally ready to offer integrated services solutions to its customers in a way that reorganized the industry and gave the industry's leadership back to Big Blue.
From a stack point of view, IBM made some remarkable changes. In opening up its own proprietary stack, the company exited its most unprofitable IT sectors—its operating system and its application software. At the same time, IBM pushed into the other stacks at the points in which the most profit was to be gained. Thus, while IBM no longer "owned" its own stack, by pursuing growth opportunities in middleware and services (their hardware was already highly competitive), IBM followed both a market-driven approach to revenue creation and an integrated global strategy.
Now, because Gerstner chose to keep the company together, a unified IBM sits at the beginning, middle and end of every stack, with each of its businesses complementing the others. Middleware for instance, allows IBM to customize its hardware and open Linux operating system so that it will work best with the customer's desired business application software. Services help customers decide which software is best for their business and sell IBM hardware and middleware solutions to support it. Finally, IBM's firm grip in the hardware business creates opportunities for IBM Services to court IBM hardware owners and recommend to them a fully integrated and customized IT solution. Because each of its businesses is so integrated with one another, it has made IBM's model difficult to duplicate in the IT industry. In addition, that IBM started off so big allowed it to pour capital into its integration strategy and invest in long-term service relationships with its customers. The ability to do this as well as integrate its own businesses makes IBM's overall strategy a difficult one to replicate.
The Future with E-Business On Demand
So how will all of this affect IBM's performance in the future? It is easy to see how IBM's On Demand strategy evolved out of Gerstner's decision to integrate the company and pursue a services-led strategy. In their words, the On Demand strategy suggests that customers:
Evaluate your business processes. Are they responsive enough? Are they integrated to the point where they can provide real-time information and enable you to respond rapidly to market changes?
Consider your infrastructure. Is it properly aligned to support your business goals? Is it being fully utilized? Are you getting the maximum return on the IT investment that you've made?
Look at your organization and culture. Is it primed for growth? Are their opportunities to unlock hidden value through collaboration or outsourcing?
From reading this sales pitch, it is quite ironic to see that IBM's new strategy is to do to other companies what Louis Gerstner did to IBM!
If one examines the sales pitch above, which I have taken from the homepage of IBM's global services division, Gerstner's strategy for IBM in the 1990s is quite apparent. First, the pitch asks whether the customer's business processes are integrated and market-driven. Here, IBM can draw on its own experience: IBM can credibly advise a global customer to organize his business around different customer/industry groupings instead of geography so that the customer's strategy is indeed globally unified; IBM can advise to redirect the purpose of executive management from making decisions for individual business units to integrating policy across the company; and IBM can suggest a comprehensive plan for compensation of executives and employees that focuses everybody's attention on the performance of the entire company.
This is also true with regard to consideration of a customer's infrastructure. In creating the services business and agreeing to take over and manage other companies' information systems, IBM had to drive its economies of scale by consolidating and fully utilizing its own IT infrastructure. Even though IBM is an information-handling company, over the last decade, IBM has found ways to streamline its IT infrastructure and reduce IT spending by 31 percent, or $2 billion dollars. IBM did this by consolidating 155 data centers into twelve and reducing the number of internal data networks from 31 to one. It cut the number of applications running on IBM's systems from over 16,000 to 5,300 (and counting), which will reduce maintenance costs for its IT systems in the future. Lastly, from a management perspective, the number of executives with the words "chief information officer" in their title was reduced from 128 to one. All of this has enabled IBM to direct funds away from IT maintenance and toward IT innovation and strategy, which should help to improve IBM's economies of scale in IT infrastructure in the future.
Finally, IBM's pitch asks the customer to examine his company's organization and culture. Here, IBM can draw on its experiences in redeploying resources in the IBM software division away from applications and toward a growth opportunity in middleware software. Additionally, IBM had to deal with several organizational culture clashes when Gerstner fought the geographic fiefdoms and allowed services employees to recommend competitors' products if they provided the best IT solution for the customer. Of key strategic importance as well were IBM's partnerships with application software manufacturers, which funneled business back along the stack by recommending IBM's middleware and hardware to their customers. By suggesting to customers that there might be ways to "unlock hidden value through collaboration or outsourcing," IBM is probably referring to its collaboration with software manufacturers and outsourcing of software applications, which was instrumental to creating an IT solution that was the most effective for the customer. The only difference, now, is that IBM wants to imply that it should be the company with which the customer collaborates or outsources his entire IT infrastructure.
The broad applicability of IBM's integrator strategy is the prime reason why I chose to dig so deeply into IBM's transformation throughout this paper. With companies now trying to globalize their strategies and their operations, I believe that IBM's services business will continue to grow, along with the rest of the IT industry. But in the future, how will IBM fare in comparison to its competitors?
To best answer this final question, one must analyze how the five Porter Forces work into IBM. With concern to direct rivalries of IBM's products, IBM has employed both government command and technology innovation to stave off competition and gain marketshare. As Sam Palmisano, IBM's current chairman and CEO explains: "Either you innovate or you're in commodity hell… If you do what everybody else does, you have a low-margin business. That's not where we want to be." Basically, IBM's On Demand strategy has been one big way in which IBM has tried to differentiate itself from its competitors. IBM backs this strategy up by filing for approximately double the number of US patents (3,228 in 2002) every year than its closest competitor, and by making strategic acquisitions that further differentiate IBM's product. In October 2002, for instance, IBM acquired PriceWaterhouseCoopers Consulting, which will obviously help to improve IBM's new consultative approach to IT services.
Besides product differentiation, IBM has a strong first mover advantage into IT services and huge economies of scale. All three of these factors of IBM's business should provide substantial barriers to entry for potential competitors that provide solutions similar to IBM's On Demand service. As discussed, IBM's economies of scale are the basis for the effectiveness of its outsourcing strategy, and without it, the company would not be able to turn a profit. With regard to first mover advantage, furthermore, IBM's automation of its supply chains has led to the accelerating velocity of IBM's businesses. That is, as a result of IBM factories being electronically integrated into IBM distributors around the world, factory cycle times have improved 50 percent, process yields are over two points higher and orders are now being filled with 99.5 percent accuracy on average. The automation of much of IBM's business has allowed the company to do more business faster, which in turn has allowed the company to sell their services to more customers and deter any potential competitors from entering the market.
Nonetheless, there are some industry heavy-weights with the resources, patience and economies of scale already in existence that will inevitably become substitutes for IBM's On Demand service. Companies like Sun, Cisco, HP, Microsoft, Accenture and Computer Associates are all competitors in IT services, though not to the extent that IBM has pushed into the market (IBM signed $52 billion in new services contracts in 2002, including a $5 billion outsourcing contract with JP Morgan Chase). While the On Demand strategy has already been copied—Hewlett Packard calls its corporate service offerings "adaptive enterprise initiatives; Microsoft offers to make companies "agile" businesses; and Computer Associates outright plagiarized the "On Demand" phrase—the integrator strategy that was required for it to work took a decade to execute and will be difficult for any other company to replicate successfully.
Furthermore, many of the companies listed above still rely on stack models based upon proprietary systems as opposed to open source technology. As the internet makes networking more and more complex, the industry will have to converge upon acceptable standards for the industry that will be customizable for individual companies' IT strategies. While IBM embraced open standards and rewrote its software accordingly from 1995-1999, companies like Microsoft and Sun Microsystems are only just now realizing the weakness of their positions.
The result has been a significant rapprochement between the champions of the two other stacks and an alliance between Microsoft and Sun that will help to make their products work more smoothly together. One New York Times article characterized the alliance, however, as "a marriage of porcupines." It focused on the bad blood between Sun and Microsoft that resulted from Microsoft's bully tactics toward Silicon Valley in the 1990s and the subsequent anti-trust suits brought against Microsoft in both the US and Europe. Although Microsoft has just now agreed to pay Sun almost $2 billion in reparations, it is hard to imagine that the new alliance will be based on a significant degree of trust between the two companies. Nonetheless, "from the point of view of Microsoft's and Sun executives, the new alliance was the natural consequence of new Internet technology that forced them together… The war over differing standards for operating computers no longer makes sense," they said. "Whether it's household plumbing or railroads, at some point you have to standardize the connections."
That this is the best response IBM's leading competitors can come up with should make IBM comfortable in its ability to increase its marketshare in IT services in the future. In addition, as IBM cements more and more long-term service relationships with Fortune 500 companies, IBM will exert considerable supplier power and later entrants into IT services will have only smaller markets to service. Overall, I see IBM's success continuing until at least the next major IT revolution. However, now that IBM has focused so much of its resources on adapting the company in real-time to the fast-changing marketplace, I cannot imagine the next major reorganization of the IT industry occurring at the hands of any company but IBM.
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International Business Machines Corporation is arguably one of the most profitable business enterprises of all time. Starting as a loose confederation of clock, scale and tabulator manufacturers, IBM's successes throughout the twentieth century shaped the information technology industry into how it is organized today. Consolidating its businesses under such famous CEO's as Thomas Watson Sr., Thomas Watson Jr., and Louis Gerstner, IBM presided over three different revolutions in information handling: From tabulators to electronic keypunching; from punch cards to mainframes; and from mainframes to the networked PC and IT integration.
In the pages that follow, I will consider IBM's rocky transition from the second IT revolution to the third. I will examine the transformations of the IT industry model over the past two decades, and I will analyze the changes that IBM made under Louis Gerstner in order to cope with a vastly different IT marketplace. I will argue that Gerstner's decisions to keep the company together, to redefine its software business, and to shift IBM from a product-oriented business to one that is services-led were the most important changes that ultimately have led to IBM's current success. I will conclude by analyzing IBM's current strategy, its advantages over its competitors, and what I see happening to the company and the industry in the future.
To understand the structure of the IT industry as defined by IBM, one must realize that IBM is the ultimate change agent in the history of information technology. Undoubtedly its most significant move to reorganize the industry was to shift from the stable, immensely profitable punch card business into high-performance computing. The legacy of Thomas Watson Jr., IBM spent over 5 billion (1960s) dollars to create the world's first integrated family of mainframe computers. Dubbed the System/360, this mainframe family was revolutionary in that it was built with high-performance integrated circuits, the precursor component to the semiconductor chip. These chips made the S/360 smaller, cheaper, more powerful and more reliable than any mainframe that preceded it.
But perhaps more important than the advantages of the integrated circuit, the S/360 was a family of computers that ran on the same software and with which all of IBM's computer accessories were compatible, making upgrades relatively simple. From the view of the customer, cost savings as a result of such compatibility were more significant than any addition that could have been made in computing power. As a result, IBM had a virtual monopoly over the mainframe business for the next twenty years. As Rowena Olegario comments: "By the early 1960s, it was clear that IBM had achieved what few other firms of its size had ever managed to do: it exited a thriving business [punch cards] and shifted into a new and risky technology [S/360]. And it made the gamble pay off."
While the S/360 was compatible with all of IBM's own mainframe accessories, it was still very much a proprietary system. Essentially, all of the hardware, software and peripheral products that made up the S/360 were invented and manufactured within the company. IBM scientists and engineers invented semiconductors and then manufactured them in high volume; they invented the memory chip, the relational database, the programming language FORTRAN, an operating system, and a transaction processing system all exclusively for the S/360. In the language of the industry, IBM created its own stack of vertically integrated mainframe systems that sent competitors reeling. The stack consisted of base hardware, an operating system, middleware, application software and IT services. What a customer got when he or she purchased the S/360 was a bundled package that was frequently serviced and maintained. And without the eventual antitrust scrutiny brought about by IBM's marketshare in mainframes (30 percent and growing in the American market by 1969, and 62 percent of the world computer market in 1971), this might still be the model for the industry today.
However, there were two main forces emanating from this period of wild success that would bring IBM to the brink of bankruptcy in 1993. One was the lack of a competitive threat in the marketplace that was the result of the success of the S/360, and the other was a thirteen-year antitrust case brought against IBM by the US Department of Justice beginning in 1969. The case was eventually dropped and classified "without merit" in 1982, but as former CEO Louis Gerstner put it: "For thirteen years IBM lived under the specter of a federally mandated breakup. One has to imagine that years of that form of scrutiny changes business behavior in very real ways."
The most immediate change in the way IBM did business occurred in 1969, when Thomas Watson Jr. "changed the way IBM sold technology. Rather than offer hardware, services and software exclusively in packages, marketers 'unbundled' the components and offered them for sale individually." Unbundling led to the creation of giant hardware, software and services businesses within IBM, but it would be the first rupture in IBM's proprietary stack. While gross margins in each of these enterprises were consistently above 60 percent in the 1970s, the division of IBM's businesses opened the company up to competition strictly from hardware manufacturers, which were separate from competitors in software and competitors in IT services. As a result, IBM was uniquely open to attack in the marketplace from more focused competitors with the advent of UNIX mainframes in the 1980s. Still cushioned from strong marketshare and high profit margins from the days of the S/360, IBM did not even see this first attack coming.
UNIX servers, championed by companies like Sun, HP and SGI presented the first real challenge to IBM's S/360 mainframe model after twenty years of dominance. Proposing to turn the vertically integrated stack that IBM had defined through the S/360 onto its head, UNIX was a system that allowed many different companies to make piece-parts of the overall IT solution for the customer. This introduced competition into the industry at every point in IBM's stack that could be differentiated. All of a sudden, companies that sold only operating systems began to emerge, along with companies that sold only semiconductor chips and companies that sold only memory and storage devices. IBM's ability to rake in profit margins as high as 60 percent was erased as fast as chip speeds were doubling and prices on mainframe parts were being halved.
As IBM became preoccupied with defending its stack against the multi-front attack represented by UNIX, PC makers "came along swinging wrecking balls." IBM had failed to see the importance that the personal computer would have in facilitating the transmission of computing power from CIOs to individual employees, an industry move from centralized to what was called "distributed computing." Drastically falling prices and the customer's demand for a new distributed computing model took the leadership position of the industry away from IBM and planted it firmly in the hands of a third industry stack termed the "Wintel Duopoly."
This third industry alternative caused IBM's finances to hemorrhage. By 1993, the company's net losses reached a record US $8 billion. As Gerstner remarks:
The PC leaders' pitch to customers was simple and compelling: 'You want your employees to make productive use of your business data, applications, and knowledge, which are tied up on old back-office systems. Right now those systems and your PCs don't work together. Since all of your PCs are already Microsoft and Intel machines, you should put in back-office systems that use the same technology.' It was easy to play out the scenario. The PC leaders would march relentlessly up from the PC into business computing and displace IBM products.
The client/server revolution, as it was called, threatened IBM's proprietary stack entirely. Now, IBM's hardware and software was not only incompatible with UNIX-based products, but IBM also refused to open its stack to the likes of Microsoft and Intel. As a result, while all of its competitors gave in to the Wintel duopoly (Intel Pentium processors and Microsoft Windows were immensely popular and highly demanded by consumers), IBM chose to preserve its stack. As customers were lost to companies selling UNIX servers armed with Windows and Intel chips, IBM almost split itself up into separate hardware, software and services businesses. In a last ditch effort, IBM switched CEOs and made some big bets to keep the company together.
Louis V. Gerstner Jr. came to IBM as chairman and CEO on April 1, 1993. He quickly instituted a drastic cost-cutting program that would save US$ 8.9 billion over his nine-year tenure and US $2.8 billion in 1993 alone. To make this happen, he laid off 35,000 people in his first year and sold off assets he deemed unessential to the future of IBM. This included US $2 billion in real estate (such as the tallest building in Atlanta), and IBM's prized art collection and gallery in Manhattan. Additionally, traditional IBM bonuses—such as free country club membership and all inclusive family benefits plans—were significantly reduced. Gerstner's prowess as a manager, however, was not in execution, though he claimed it was. While the IBM CEO was an expert as making his company market-driven, he was especially prescient in the way he thought about IBM's future role in IT—as the industry's integrator.
Unlike almost all of IBM's critics, Gerstner saw the change in the IT industry from vertical to horizontal integration as an unwanted side effect of the customer's demand for lower prices. As former president of American Express (a huge IT consumer), Gerstner knew that while customers wanted lower prices, they were not prepared to create an integrated IT solution for themselves. But in a piece-part IT industry, the customer was stuck trying to customize his or her own solution with technology that often was not even compatible. The result was a drastic under-utilization of information technology by the customer.
While many in the industry (including John Akers, the company's CEO before Gerstner) believed that IBM had to disaggregate into several independent "Baby Blues," Gerstner listened to the customer's needs. He wrote in his book: "CIOs made it very clear that the last thing in the world they needed was one more disk drive company, one more operating system company, one more PC company… more minnows in the ocean." He saw IBM's bigness as a unique competitive advantage which it could use to sit at the end of the now horizontal IT process and customize an integrated solution for the customer. He wanted IBM to take responsibility for translating all of the piece-parts created by IBM's competitors into value for the customer. Essentially, the strategy was to standardize, optimize, outsource and manage IT for the customer. This would be a services-based strategy, and services was already a growth opportunity within IBM that was worth pursuing.
However, Gerstner soon realized that in his pursuit of a growth opportunity in services, he was onto what would be the next restructuring of the IT industry. As Gerstner put it:
"This would be a historic shift in customer buying behavior. For the first time, services companies, not technology firms, would be the tail wagging the dog... If customers were going to look to an integrator to help him envision, design and build end-to-end solutions, then the companies playing that role would exert tremendous influence over the full range of technology decisions—from architecture and applications to hardware and software choices."
With this realization, IBM's services strategy became a strategic imperative for the entire company. In deciding to keep the company together, Gerstner bet that IBM could become the largest and most influential services company in the industry.
But for IBM to become the foremost integrator of technology, its most important task was first to re-integrate its own "Balkanized businesses." Since Watson Jr. split IBM's businesses into hardware, software and services in 1969, there was a tremendous lack of cooperation among each segment of the business. Even worse were the "geographic fiefdoms" that arose at IBM branches around the world. Global IBM customers would have to begin a totally new relationship with the IBM that they encountered in the countries into which they were expanding. It did not matter that American Express, for example, was one of IBM's biggest customers in the US. If the company wanted to expand into say, Singapore, it would have to start all over with the IBM branch in that country. This branch had no idea about the products that American Express was buying in the States and often did not sell the same type of product or even products that were compatible with their American counterparts. If IBM was going to provide an integrated solution for the customer, all of this clearly had to change.
Gerstner initiated change in two directions: He looked at the treatment of IBM's customers and simultaneously at IBM's top management. With regard to the latter, he disbanded the highest management committee and restructured the board of directors. He focused executives' attention on the most honest scorecard of their performance—IBM's stock price—by employing the use of stock options. Additionally, over his first two years at IBM, Gerstner declared war on the geographic fiefdoms and reorganized the whole company around the customer by dividing them and IBM into twelve global industry groups. He forced the sales departments in each of the most powerful fiefdoms to cooperate and pull their common units together globally.
As services was then only a sub-unit of the sales force, Gerstner slowly began to plant the seeds of his strategy in the sales department by allowing service IBMers to accompany salespeople on visits to customers. Every time a member of the services unit would recommend to the customer a product that did not have the IBM logo, however, the salespeople would go berserk. Gerstner made it his business to defend the services unit until people realized that IBM could not execute the integrator strategy by promoting only IBM products. The days of IBM's own proprietary stack were over. If IBM was to become the industry leader by providing the best solutions to its customers, then it would have to recommend piece-parts made by other companies if the products better served that company's needs. To admit defeat to a competitor in even one area of information technology was previously unheard of at IBM, and it was a huge shock to the company's culture. And it would not be the last.
Another way in which Gerstner fought the fiefdoms and integrated the company was by taking away their marketing budgets. IBM was a global company offering global solutions; it needed to have a unified global brand. So IBM consolidated its advertising and hired one firm, Ogilvy & Mather, to coordinate all of its advertising around the world. The result was the acclaimed ad campaign, IBM: Solutions for a Small Planet. Reducing its number of ad agencies from over seventy to one was a message to the world that IBM was serious about keeping the company together and becoming a world-class integrator. The advertising industry magazine, Ad Age, remarked: "Because computer products, brands and publications have few geographic boundaries, a world approach makes sense… A single agency meshed neatly with Mr. Gerstner's strategy to centralize controls and bring independent units back into the fold."
But not only did Gerstner have to reorganize IBM's branches around the world, he also had to focus on reorganizing the managerial structure that had taken hold at IBM's headquarters in Armonk, New York. Within his first month Gerstner disbanded the executive management committee at IBM, the mark of the famed contention system that was useful in the Watson Jr. era to spark competition among IBM's various business units. In a time when IBM had no outside competitors (because of its virtual monopoly over the market for mainframes), stimulating internal competition was probably a useful tool to keep managers and product units from under-producing. However, now that Gerstner wanted IBMers to focus on the external challenges presented by the market, he needed managers of different product groups and geographical areas to work together. To that end, in the MC's place Gerstner created the Corporate Executive Committee and the World Management Council. The former was made up of eleven members and assisted Gerstner in integrating strategy across IBM's businesses. However, it did not accept delegation of problem solving or make any decisions for the business units. The World Management Council was bigger (thirty-five members) and was essentially a forum for managers across the world to bounce ideas off of one another and to find ways to work together on achieving common goals. It was also a way to break up the fiefdoms and to indoctrinate a select group of managers with the integrator strategy and Gerstner's views about the coming restructuring of the industry.
To further integrate IBM and to force executives and different business units to cooperate, Gerstner instituted a new methodology of executive and employee compensation, based heavily on stock options and variable pay schemes. This was perhaps the most important change Gerstner made in terms of execution, because "you can't transform institutions if the incentive programs are not aligned with your new strategy." While the Watsons felt stock options were intended solely to reward executives, Gerstner asserts:
"I wanted IBMers to think and act like long-term shareholders—to feel the pressure from the marketplace to deploy assets and forge strategies that create competitive advantage. The market, over time, represents a brutally honest evaluator of relative performance, and what I needed was a strong incentive for IBMers to look at their company from the outside in. In the past, IBM was both the employer and the scorekeeper in the game. I needed my new colleagues to accept the fact that external forces—the stock market, competition, the changing demands of customers—had to drive our agenda, not the wishes and whims of our team… People had to understand that we all benefited when IBM as a whole did well and, more often than not, lost out when we functioned as a disjointed operation."
As a result, tens of thousands of IBMers received stock options over the next decade. While in 1992 only 1,300 IBM executives received options, that number increased to 72,500 by 2001. Furthermore, the number going to non-executives was more than twice the amount that executives received.
For rank-and-file employees, pay schemes were changed so that they were based on external rather than internal benchmarks. In the past, if a certain type of programmer was paid $75,000 by IBM's competitors, that same programmer-type might be paid thousands of dollars more or less under the Watson system. While this was more egalitarian, it made it easy for IBM's competitors to raid Big Blue for its best employees by offering to pay salaries in line with the rest of the industry. Gerstner knew that IBM's most important assets could walk out the door at any time, and as a result, he quickly made IBM's pay schemes representative of the rest of the industry.
As an added incentive to keep the company's rising stars at IBM, Gerstner made compensation much more performance-based than ever before. However, a substantial part of the variable pay to rank-and-file employees was based on overall IBM performance rather than on the employee's performance or the performance of the employee's individual business unit. For the highest level executives, beginning in 1994, compensation was based entirely on IBM's cumulative performance, in contrast to the performance of the unit that any particular executive managed. A bonus that was based on unit performance was the prior policy and encouraged an individualistic culture rather than one that espoused cooperation and integration across IBM's businesses. In addition to stock options and variable compensation, highest-level executives were also required to own large amounts of IBM stock. That way, the executives felt real pain if the stock went down (the opposite if it went up), instead of only the loss of a theoretical option gain.
Since the bursting of the internet bubble in 2000, however, there has been strong criticism of technology companies giving too many options to their management executives. In bear markets, "options create perverse incentives for executives to cut accounting corners to boost reported earnings and drive up the value of their options; and options can artificially inflate reported profit because companies don't have to count them as expenses." Additionally, bear markets prevent options from translating into real stock ownership. As stock prices become depressed, options can expire worthless and the incentive structure for employees who do not yet own stock is destroyed.
I would question why Gerstner did not give real equity ownership to IBMers. While that would have required IBM to report its bonuses to employees and executives as actual expenses, this would have avoided the potential destruction of the incentive structure that Gerstner created should a bear market have set in. If it had, while everyone would have felt the pain, at least executives owned stock that did not expire worthless like the options held by lower level IBM employees.
In July 2003, responding to increasingly vocal criticism of stock options (which coincided with the last bear market), Microsoft Corporation decided it would change its bonus structure from one that was options-based to one that was equity-based. While IBM has not followed in the footsteps of its biggest rival, the company has recently announced that IBM executives will receive options with strike prices ten percent above IBM's current stock market price. Additionally, they will have to wait at least ten years before these options can be exercised. While this forces executives to take the long view (and presumably keep the accounting books as honest as possible), I would argue that employee performance incentives would be more effective if IBM made the next step and paid bonuses as actual stock ownership rather than IBM stock options.
Another important move Gerstner made in order to execute the integrator strategy was to redefine IBM's software business. Thinking again about the stack industry model, IBM was getting pounded because many different companies were focusing on selling only application software to businesses. Nonetheless, because customers had no idea how to create a total IT solution for themselves, they often went to application software manufacturers such as Oracle, SAP and PeopleSoft for guidance. When businesses would buy a product, they would often ask for recommendations on what hardware they thought the company's software would run best. However, because IBM was a competitor in application software, rarely did software manufacturers recommend IBM hardware to their customers.
Meanwhile, IBM's software business had really only existed to preserve IBM's vertically integrated proprietary stack. Essentially, IBM's focus was on hardware, and software was specifically written for new hardware products so that hardware could be best utilized by businesses. For the reason that IBM's software existed only so that IBM hardware could have obvious uses to the customer, IBM software was not compatible cross-platform—in other words, it did not run on anyone else's machines. So, in order to preserve IBM's proprietary stack, IBM justified an investment of $20 billion from 1975-1995 in application software development and acquisitions at a negative rate of return of around 70 percent!
It took until 1999 for IBM to realize that it could not beat application software manufacturers at their own game. Though the reason is not apparent, I would argue that it took almost three years for IBM to exit this highly unprofitable part of the stack because it would have been too much of a shock to IBM's culture just to fold its entire software business without offering a viable alternative to which it could reassign its software engineers and R&D laboratories.
That alternative presented itself in the form of middleware software. Before the emergence of networked computing, middleware software was viewed as a "strategic backwater" rather than a strategic battleground in the IT industry. However, networked computing (which would occur by means of the internet) meant that there would be more users, devices and transactions for IT systems to handle. There would be an increased demand for ways to integrate applications, processes and systems with users and institutions. Some techies at IBM argued that there would be no operating system out there in the future that would be able to tie everything together; that was fine, however, because middleware existed to do just that.
When IBM saw this strategic alternative in early 1995, the company for the first time chose to pursue an opportunity with its new integrator strategy in mind. In other words, IBM's forthcoming middleware products would have to be able to run on Sun, HP and Microsoft platforms. It would have to connect these platforms and operating systems to application software sold by companies like Oracle and JD Edwards. Middleware, it turned out, would be IBM's point of infiltration into the UNIX and Wintel stacks that were previously aggressively taking marketshare away from IBM. With its move into middleware—initially by acquiring Lotus Development Corporation and Tivoli systems—IBM went on the offensive.
By 1999, IBM was ready to roll out its universally compatible middleware software and roll back its application software and OS/2 operating system. As it exited application and operating system software, however, IBM sent out the message that it was prepared to work with leading application software developers to deliver the best possible IT solutions to customers. IBM attacked the other stacks by structuring detailed partnerships with over 180 software manufacturers that specified "revenue and [market] share targets and measurements by which both companies agreed to abide." In addition to bringing to the table superb hardware and the ability to customize it with the best middleware portfolio in the industry, IBM also marketed to software developers that IBM would support their products with a rapidly expanding services group. And having the weight of IBM's services business behind one's product was not an advantage that software companies could ignore. This contributed to the further growth of IBM's service sector, which burgeoned to $35 billion in revenues by 2001, growing consistently at rates of 20 percent per quarter.
Even more than hardware or middleware, building IBM's services business was the key to the execution of the integrator strategy. As stated, Gerstner saw the IT industry restructuring around IT services companies that could provide a total, customized IT solution to the customer. In the coming restructuring of the industry, services companies would assume the roles of software manufacturers who were haphazardly providing advice about which hardware and operating system were best to buy to run its software applications. For IBM to become the foremost integrator of information technology, it had to evolve from a product oriented business to one that was services-led. This was a huge undertaking.
First of all, services businesses are much harder to manage because one has to build a business that is labor-based as opposed to one that is asset-intensive. While IBM knew how to manage factories and develop technology, in the services business one sells knowledge. In a sense, one delivers the product at the same time that he or she sells it. The business model and economics are entirely different.
In IBM's case, when promising to take over and manage the customer's IT infrastructure, the company was taking a risk not seen at IBM since Watson Jr. bet the company on the S/360. In the new business model, IBM had to be willing to take a company's existing IT infrastructure onto its balance sheet and carry it at a loss until it could be incorporated into IBM's own IT infrastructure, which might not be until five years into the contract. IBM had to bet that its economies of scale were big enough to turn a profit—namely, that it could consolidate many customers' data centers into "server farms" and do with 750 people what three customers each required 1,000 employees to accomplish. As the business expanded, IBM bet that its human resources capabilities were strong enough to hire 1,000 or more workers a month. Most importantly, though, for IBM to succeed in the services business Gerstner argues, "We had to learn how to be disciplined—how to negotiate profitable contracts, price our skills, assess risk, and walk away from bad contracts and bad deals." To take on these kinds of risks, IBM had to be ready to invest both the years and the capital. To drive its economies of scale as well, it had to leverage its size and be able to promote its own hardware and middleware products as honestly the best solutions for customers. By 1999, IBM was an integrated company armed with compatible hardware and middleware as well as partnerships with the most important software developers. While services had already been expanding rapidly for quite some time, IBM was finally ready to offer integrated services solutions to its customers in a way that reorganized the industry and gave the industry's leadership back to Big Blue.
From a stack point of view, IBM made some remarkable changes. In opening up its own proprietary stack, the company exited its most unprofitable IT sectors—its operating system and its application software. At the same time, IBM pushed into the other stacks at the points in which the most profit was to be gained. Thus, while IBM no longer "owned" its own stack, by pursuing growth opportunities in middleware and services (their hardware was already highly competitive), IBM followed both a market-driven approach to revenue creation and an integrated global strategy.
Now, because Gerstner chose to keep the company together, a unified IBM sits at the beginning, middle and end of every stack, with each of its businesses complementing the others. Middleware for instance, allows IBM to customize its hardware and open Linux operating system so that it will work best with the customer's desired business application software. Services help customers decide which software is best for their business and sell IBM hardware and middleware solutions to support it. Finally, IBM's firm grip in the hardware business creates opportunities for IBM Services to court IBM hardware owners and recommend to them a fully integrated and customized IT solution. Because each of its businesses is so integrated with one another, it has made IBM's model difficult to duplicate in the IT industry. In addition, that IBM started off so big allowed it to pour capital into its integration strategy and invest in long-term service relationships with its customers. The ability to do this as well as integrate its own businesses makes IBM's overall strategy a difficult one to replicate.
So how will all of this affect IBM's performance in the future? It is easy to see how IBM's On Demand strategy evolved out of Gerstner's decision to integrate the company and pursue a services-led strategy. In their words, the On Demand strategy suggests that customers:
Evaluate your business processes. Are they responsive enough? Are they integrated to the point where they can provide real-time information and enable you to respond rapidly to market changes?
Consider your infrastructure. Is it properly aligned to support your business goals? Is it being fully utilized? Are you getting the maximum return on the IT investment that you've made?
Look at your organization and culture. Is it primed for growth? Are their opportunities to unlock hidden value through collaboration or outsourcing?
From reading this sales pitch, it is quite ironic to see that IBM's new strategy is to do to other companies what Louis Gerstner did to IBM!
If one examines the sales pitch above, which I have taken from the homepage of IBM's global services division, Gerstner's strategy for IBM in the 1990s is quite apparent. First, the pitch asks whether the customer's business processes are integrated and market-driven. Here, IBM can draw on its own experience: IBM can credibly advise a global customer to organize his business around different customer/industry groupings instead of geography so that the customer's strategy is indeed globally unified; IBM can advise to redirect the purpose of executive management from making decisions for individual business units to integrating policy across the company; and IBM can suggest a comprehensive plan for compensation of executives and employees that focuses everybody's attention on the performance of the entire company.
This is also true with regard to consideration of a customer's infrastructure. In creating the services business and agreeing to take over and manage other companies' information systems, IBM had to drive its economies of scale by consolidating and fully utilizing its own IT infrastructure. Even though IBM is an information-handling company, over the last decade, IBM has found ways to streamline its IT infrastructure and reduce IT spending by 31 percent, or $2 billion dollars. IBM did this by consolidating 155 data centers into twelve and reducing the number of internal data networks from 31 to one. It cut the number of applications running on IBM's systems from over 16,000 to 5,300 (and counting), which will reduce maintenance costs for its IT systems in the future. Lastly, from a management perspective, the number of executives with the words "chief information officer" in their title was reduced from 128 to one. All of this has enabled IBM to direct funds away from IT maintenance and toward IT innovation and strategy, which should help to improve IBM's economies of scale in IT infrastructure in the future.
Finally, IBM's pitch asks the customer to examine his company's organization and culture. Here, IBM can draw on its experiences in redeploying resources in the IBM software division away from applications and toward a growth opportunity in middleware software. Additionally, IBM had to deal with several organizational culture clashes when Gerstner fought the geographic fiefdoms and allowed services employees to recommend competitors' products if they provided the best IT solution for the customer. Of key strategic importance as well were IBM's partnerships with application software manufacturers, which funneled business back along the stack by recommending IBM's middleware and hardware to their customers. By suggesting to customers that there might be ways to "unlock hidden value through collaboration or outsourcing," IBM is probably referring to its collaboration with software manufacturers and outsourcing of software applications, which was instrumental to creating an IT solution that was the most effective for the customer. The only difference, now, is that IBM wants to imply that it should be the company with which the customer collaborates or outsources his entire IT infrastructure.
The broad applicability of IBM's integrator strategy is the prime reason why I chose to dig so deeply into IBM's transformation throughout this paper. With companies now trying to globalize their strategies and their operations, I believe that IBM's services business will continue to grow, along with the rest of the IT industry. But in the future, how will IBM fare in comparison to its competitors?
To best answer this final question, one must analyze how the five Porter Forces work into IBM. With concern to direct rivalries of IBM's products, IBM has employed both government command and technology innovation to stave off competition and gain marketshare. As Sam Palmisano, IBM's current chairman and CEO explains: "Either you innovate or you're in commodity hell… If you do what everybody else does, you have a low-margin business. That's not where we want to be." Basically, IBM's On Demand strategy has been one big way in which IBM has tried to differentiate itself from its competitors. IBM backs this strategy up by filing for approximately double the number of US patents (3,228 in 2002) every year than its closest competitor, and by making strategic acquisitions that further differentiate IBM's product. In October 2002, for instance, IBM acquired PriceWaterhouseCoopers Consulting, which will obviously help to improve IBM's new consultative approach to IT services.
Besides product differentiation, IBM has a strong first mover advantage into IT services and huge economies of scale. All three of these factors of IBM's business should provide substantial barriers to entry for potential competitors that provide solutions similar to IBM's On Demand service. As discussed, IBM's economies of scale are the basis for the effectiveness of its outsourcing strategy, and without it, the company would not be able to turn a profit. With regard to first mover advantage, furthermore, IBM's automation of its supply chains has led to the accelerating velocity of IBM's businesses. That is, as a result of IBM factories being electronically integrated into IBM distributors around the world, factory cycle times have improved 50 percent, process yields are over two points higher and orders are now being filled with 99.5 percent accuracy on average. The automation of much of IBM's business has allowed the company to do more business faster, which in turn has allowed the company to sell their services to more customers and deter any potential competitors from entering the market.
Nonetheless, there are some industry heavy-weights with the resources, patience and economies of scale already in existence that will inevitably become substitutes for IBM's On Demand service. Companies like Sun, Cisco, HP, Microsoft, Accenture and Computer Associates are all competitors in IT services, though not to the extent that IBM has pushed into the market (IBM signed $52 billion in new services contracts in 2002, including a $5 billion outsourcing contract with JP Morgan Chase). While the On Demand strategy has already been copied—Hewlett Packard calls its corporate service offerings "adaptive enterprise initiatives; Microsoft offers to make companies "agile" businesses; and Computer Associates outright plagiarized the "On Demand" phrase—the integrator strategy that was required for it to work took a decade to execute and will be difficult for any other company to replicate successfully.
Furthermore, many of the companies listed above still rely on stack models based upon proprietary systems as opposed to open source technology. As the internet makes networking more and more complex, the industry will have to converge upon acceptable standards for the industry that will be customizable for individual companies' IT strategies. While IBM embraced open standards and rewrote its software accordingly from 1995-1999, companies like Microsoft and Sun Microsystems are only just now realizing the weakness of their positions.
The result has been a significant rapprochement between the champions of the two other stacks and an alliance between Microsoft and Sun that will help to make their products work more smoothly together. One New York Times article characterized the alliance, however, as "a marriage of porcupines." It focused on the bad blood between Sun and Microsoft that resulted from Microsoft's bully tactics toward Silicon Valley in the 1990s and the subsequent anti-trust suits brought against Microsoft in both the US and Europe. Although Microsoft has just now agreed to pay Sun almost $2 billion in reparations, it is hard to imagine that the new alliance will be based on a significant degree of trust between the two companies. Nonetheless, "from the point of view of Microsoft's and Sun executives, the new alliance was the natural consequence of new Internet technology that forced them together… The war over differing standards for operating computers no longer makes sense," they said. "Whether it's household plumbing or railroads, at some point you have to standardize the connections."
That this is the best response IBM's leading competitors can come up with should make IBM comfortable in its ability to increase its marketshare in IT services in the future. In addition, as IBM cements more and more long-term service relationships with Fortune 500 companies, IBM will exert considerable supplier power and later entrants into IT services will have only smaller markets to service. Overall, I see IBM's success continuing until at least the next major IT revolution. However, now that IBM has focused so much of its resources on adapting the company in real-time to the fast-changing marketplace, I cannot imagine the next major reorganization of the IT industry occurring at the hands of any company but IBM.
"Big Blue's Big Bet: Less Tech, More Touch." Article by Steve Lohr for New York Times.
Published 01/25/2004. © 2004, The New York Times Company.
Gerstner, Louis. Who Says Elephants Can't Dance? © 2002, HarperBusiness: New York, NY.
"Global Thinking Paces Computer Biz." Article by Bradley Johnson for Ad Age Magazine.
Published 03/06/1995. © 1995, Crain Communications, Inc.
"IBM Archives: History of IBM, 1960s." Accessed 02/04/2004.
http://www-1.ibm.com/ibm/history/history/decade_1960.html
"IBM's On Demand Transformation: Reinventing the Enterprise." Webcast presented by Bob
Greenberg, CIO and Vice President of On Demand Technology Enablement at IBM.
Presented 07/16/2003. http://www-306.ibm.com/webcasts/WCPGateway.wss?jadeAction=WEBCAST_LAUNCHPAGE_HANDLER&WCP_WEBCAST_ID_KEY=0330002
"IBM's On Demand Transformation: Reinventing the Enterprise." Webcast presented by Linda
Sanford, Senior Vice President of Enterprise On Demand Transformation and IT at IBM.
Presented 07/16/2003. http://www-306.ibm.com/webcasts/WCPGateway.wss?jadeAction=WEBCAST_LAUNCHPAGE_HANDLER&WCP_WEBCAST_ID_KEY=0330001
"IBM to Trim Use, Value of Options in Compensation." Article by William M. Bulkeley for Wall Street Journal. Published 02/25/2004. © 2004, Dow Jones and Company, Inc.
"Lieberman Would Expand Options Grants To Include Less Highly Paid Employees" Article by Jacob M. Schlesinger for Wall Street Journal. Published 04/02/2002. © 2002, Dow Jones and Company, Inc.
McCraw, Thomas. Creating Modern Capitalism. © 2000, Harvard University Press: Cambridge Massachusetts.
"Microsoft and Sun End Long Acrimony in Surprise Accord." Article by Steve Lohr for New York Times. Published 04/03/2004. © 2004, The New York Times Company.
"Microsoft Junks Stock Options." Published 07/09/2003 by CBSnews.com. © 2003, MarketWatch.com. L.L.C.
http://www.cbsnews.com/stories/2003/07/09/tech/main562318.shtml
"Silicon Valley Seeks Peace in War With Microsoft." Article by John Markoff for New York Times. Published 04/04/2004. © 2004, The New York Times Company.
"Take Your First Step Toward Becoming an On Demand Business." Accessed 04/23/2004.
http://www-1.ibm.com/services/ondemand/start_overview.html
Thursday, February 05, 2004
Appendix: IBM Case Study
Copyright 2004, Adam J. Robinson. All Rights Reserved. Do not reproduce without consent from the author. He can be reached at Adam.Robinson@yale.edu. Also, Check out the main Website at www.ajrobinson.blogspot.com
WHAT IS IBM?
All information and Statistics in this presentation come from either http://www.IBM.com, http://www.nytimes.com, or http://www.wsj.com:
IBM's character has been formed over nearly 100 years of doing business in the field of information-handling. Nearly all of the company's products were designed and developed to record, process, communicate, store and retrieve information -- from its first scales, tabulators and clocks to today's powerful computers and vast global networks. IBM helped pioneer information technology over the years and it stands today at the forefront of a worldwide industry that is revolutionizing the way in which enterprises, organizations and people operate and thrive.
Currently, from an investment outlook, IBM believes investors, particularly those who invest in the technology sector, reward companies that adapt, that continually create and lead the high-value spaces—“because that’s the only way to deliver consistent, long-term earnings growth in an industry that is constantly evolving.” It believes investors reward companies that “manage for the long haul, run highly efficient operations and are managed by experienced and disciplined leaders. And, at a time when industry growth projections are highly unreliable, the firm is catering to investors rewarding companies that outperform their competitors—no matter the rate at which the industry is growing or contracting.” They say, “This is why we have made marketshare a top priority.”
FROM IBM’s 2002 ANNUAL REPORT:
o IBM is the world's largest information technology company, as well as the world's largest business and technology services provider ($36 billion); and the world's largest IT financier ($35 billion in assets).
o All of IBM's core businesses - from servers to storage systems, to middleware, to services - gained marketshare in 2002.
o In terms of IT finance, IBM signed $35 billion in new financial agreements in 2002, $14 billion for customer and government financing and $22 billion for commercial financing.
o IBM Global Services signed $53 billion in new contracts in 2002, of which 42 contracts were each worth in excess of $100 million, and five which exceeded $1 billion.
o In October 2002 IBM acquired PricewaterhouseCoopers Consulting. With some 30,000 employees and offices in 52 countries, PwC Consulting brought additional depth and leadership capabilities to IBM's services-led business.
o IBM paid an effective tax rate of 30.0% in 2002, up from 29.7% in 2001.
SOME 2003 STATISTICS:
o IBM took in 89 billion dollars in revenue last year and 62% of its sales are overseas from one of its locations in 90 countries. 57% of its 316,000 person workforce is deployed outside of the US. The company plans to expand to 330,000 in 2004.
o IBM common stock is currently at a 52-week-high of $100.00. Market Capitalization is $170.7 billion. P-E ratio is 22.87.
o The current Chairman and CEO of IBM is Samuel J. Palmisano.
HISTORY:
Charles R. Flint arranged the merger of the International Time Recording Company, Computing Scale Company, and the Tabulating Machine Company to form the Computing-Tabulating-Recording Company (C-T-R) in 1911. The new company was based in New York City and had 1,300 employees. C-T-R was renamed International Business Machines Corporation on Feb 14, 1924, because the scope of the business was widening into electronic keypunching.
When the diversified businesses of C-T-R proved difficult to manage, Flint turned for help to the former number two executive at the National Cash Register Company, Thomas J. Watson, Sr. Within 11 months of joining C-T-R, Watson became its president. The company focused on providing large-scale, custom-built tabulating solutions for businesses, leaving the market for small office products to others. During Watson's first four years, revenues more than doubled to $9 million. He also expanded the company's operations to Europe, South America, Asia and Australia.
During the Great Depression of the 1930s, IBM managed to grow while the rest of the U.S. economy floundered. Because Watson continued the firm’s capital investments, IBM was ready when the Social Security Act of 1935 brought the company a landmark government contract to maintain employment records for 26 million people. It was called "the biggest accounting operation of all time," and it went so well that orders from other U.S. government departments quickly followed.
After inventing several primitive electronic calculators in the 40s (most of the production facilities were used then to manufacture war materials) IBM in the 1950s took computing first to vacuum tubes and then transistorized machines. By 1959, IBM had an automatic production line for transistors and had created the three most powerful mainframes in the world.
In 1969, under the stewardship of Watson’s son as CEO, IBM changed the way it sold technology. Rather than offer hardware, services and software exclusively in packages, marketers "unbundled" the components and offered them for sale individually. Unbundling gave birth to the multibillion-dollar software and services industries, of which IBM is today a world leader.
In 1973, under Frank T. Carey, IBM introduced the floppy disk, Bank ATM’s, and the electronic laser prism price reading machines used by cashiers in supermarkets. These were the most significant inventions by IBM that affected the mainstream consumer until 1981, when IBM introduced the PC. When designing the PC, IBM for the first time contracted the production of its components to outside companies. The processor chip came from Intel and the operating system, called DOS (Disk Operating System) came from a 32-person company called Microsoft.
During the 1980s and early 1990s, IBM was thrown into turmoil by back-to-back revolutions. The PC revolution placed computers directly in the hands of millions of people. And then, the client/server revolution sought to link all of those PCs (the "clients") with larger computers that labored in the background (the "servers" that served data and applications to client machines). Both revolutions transformed the way customers viewed, used and bought technology. And both fundamentally rocked IBM. Businesses' purchasing decisions were put in the hands of individuals and departments - not the places where IBM had long-standing customer relationships. Piece-part technologies took precedence over integrated solutions. The focus was on the desktop and personal productivity, not on business applications across the enterprise. By 1993, the company's annual net losses reached a record $8 billion. Cost management and streamlining became a chief concern. And IBM considered splitting its divisions into separate independent businesses.
Louis V. Gerstner, Jr. arrived as IBM's chairman and CEO on April 1, 1993. Gerstner brought with him a customer-oriented sensibility and the strategic-thinking expertise that he had honed through years as a management consultant at McKinsey & Co. Soon after he arrived, he had to take dramatic action to stabilize the company. These steps included rebuilding IBM's product line, continuing to shrink the workforce and making significant cost reductions. Despite mounting pressure to split IBM into separate, independent companies, Gerstner decided to keep the company together. He recognized that one of IBM's enduring strengths was its ability to provide integrated solutions for customers - someone to represent more than piece parts or components. Splitting the company would have destroyed this unique IBM advantage. This advantage is exactly what is exploited by IBM’s new Business on Demand Strategy.
BUSINESS ON DEMAND – The New, New Thing?
There is somewhat of a comparison to Jim Clark’s New New Thing Ideas… This is Healtheon not just for health care, but 12 industries ranging from health care to finance. “The promise of on demand is that a company or institution can provide products, services, information, health care, education, government services and so on—all “on demand” for customers, citizens, patients and students. These “sense-and-respond” or “real-time” enterprises enjoy enormous competitive advantages. They are able to convert fixed costs into variable costs. They can greatly reduce inventories. And, most compellingly, they are extremely responsive to the needs of their customers, employees and partners.”
Samuel J. Palmisano, Chairman and CEO of IBM, said in an interview with the NY times, "We now see an opportunity to set the agenda again." He concluded: "I am confident that we are on the verge of the next great opportunity for our company, and for the entire information technology industry." He was talking about IBM’s new E-business On-Demand Strategy. What is it, and how does it work?
Currently, the pace of change in the information technology industry is accelerating, and its scope and impact are widening. The ON-DEMAND STRATEGY is IBM’s response to this new market environment. In their words, the strategy entails evolving IBM into “an enterprise whose business processes – integrated end-to-end across the company and with key partners, suppliers and customers – can respond with speed to any customer demand, market opportunity or external threat.” By making themselves into the first and ultimate On-Demand company, IBM plans to serve as a role model and consultant for other companies who want the same for their own firm operations. IBM is trying to position itself as a company which will either build you a self-sustaining on-demand infrastructure (using its own research facilities, hardware and software) or the company to which you can outsource all of your data processing needs, organizing and distilling the information for you in such a way that enables you to respond to the market in real-time.
The value added to a company by IBM via the on-demand strategy is the remolding of the firm’s business model so that it is flexible enough to thrive in an increasingly turbulent market environment. This means transforming companies into even more focused, streamlined, responsive, variable and resilient enterprises that connect their businesses end-to-end with suppliers at one extreme and customers at the other, seamlessly fusing the best of business and technology. This should accelerate value creation. People want and will invest in a company that is intuitive in sensing and responding to change; flexible in terms of structuring costs and adapting processes; focused on the unique things that set it apart; and resilient in managing change and threats.
How did IBM implement the On-Demand Strategy for Itself?
“IBM has committed to becoming the premier on demand business and has identified four focus areas: Integrated Supply Chain, Total Buyer Experience, On Demand Workplace, and IT Enablement.”
Information Technology (IT Enablement – reducing underutilization) and Creating an On Demand Workplace:
o IBM originally had a patchwork of IT support systems to service about two dozen business units. In the past 15 months, 155 data centers were consolidated into 12. The number of internal networks was reduced from 31 to 1. 16,000 applications that organize and distill information for IBM cut to 5300 right now. 1 CIO from 128.
o Since 1994, IT spending has gone down 31%, or 2 billion dollars. Nonetheless, the firm has created w3, the IBM intranet that connects 320,000 employees, and allows an employee’s computer to become his or her office, saving some other 2 billion in real estate costs. In implementing this new strategy, IT plans to become more important with less funds directed toward the maintenance of its systems. This is being achieved through the simplification and consolidation described above.
Integrated Supply Chain and Creating a Total Buyer/Distributor Experience:
o Automation, or creating touchless, self-configuring optimizing manufacturing designs, is the fastest way to go about achieving an on-demand supply chain, with the ultimate goal of giving the business the ability to adapt/change on its own.
o The on-demand supply chain has first been implemented at IBM’s new 300 mm Semiconductor plant in NY, where cycle time has improved 50%, process yields are up to 2 points higher, and direct spending on labor is 50% lower than in the previous facility. The change has been to wire the system such that customer orders are plugged into the system electronically by the customers themselves.
The manufacturing plant then automatically responds to the new ordering information requirements and re-optimizes the manufacturing strategy accordingly (and instantaneously). It does so based on new manufacturing algorithms run on Linux grids that self-configure and optimize production for the plant at any given time.
o The first distributor to take advantage of this seamless, touchless, on-demand manufacturing was Magirus, a key European IBM distributor. Through electric automation of their ordering system, the company has seen IBM manufacturing cycle time go down 70%, and orders filled with 99.5% accuracy. This is a huge competitive advantage.
ON DEMAND STRATEGY GOALS:
o Exceed financial expectations of the on-Demand strategy. IBM wants to be #1 in customer satisfaction (currently #3), wants to be #1 in employee satisfaction (currently at the industry average), as well as have the biggest market share in all of the product markets in which it participates.
o IBM wants to be a role model in moving toward the on-Demand strategy and wants to make all of its internal workings on-Demand for its customers.
o Want to enable businesses today to respond in real time to whatever the day brings—a change in supply or demand, a shift in the preferences of buyers, students or citizens, the vagaries of capital markets or the aftermath of a natural disaster.
SELLING THE STRATEGY TO OTHER COMPANIES:
Evaluate your business processes. Are they responsive enough? Are they integrated to the point where they can provide real-time information and enable you to respond rapidly to market changes?
Consider your infrastructure. Is it properly aligned to support your business goals? Is it being fully utilized? Are you getting the maximum return on the IT investment that you've made?
Look at your organization and culture. Is it primed for growth? Are there opportunities to unlock hidden value through collaboration or outsourcing?
HOW THE 5 PORTER FORCES WORK INTO IBM:
Direct Rivalry
• "Either you innovate or you're in commodity hell," Mr. Palmisano explained during a 90-minute interview at the company's headquarters in Armonk, N.Y. "If you do what everybody else does, you have a low-margin business. That's not where we want to be." - Samuel J. Palmisano, Chairman and CEO of IBM.
• As an information handling company, IBM must compete with other information handlers. Additionally, they have to compete with other technology creators. In the new strategy, they must compete with technology consulting firms. To do this IBM has utilized Command and Technology. IBM has:
o For the tenth consecutive year, received the most U.S. patents over any other company -- 3,288 U.S. patents in 2002, nearly double the number of the next closest company. Over the past decade, the U.S. Patent Office has issued IBM 22,357 patents - more than for ten of our top U.S. competitors combined.
o Achieved the world's largest portfolio of software patents. IBM received 7,500 software patents between 1993 and 2002. The number of software patents received by IBM in 2002 was 1,332.
o Been awarded the 2000 U.S. National Medal of Technology for the company's record of innovation in storage technology. This marks the seventh time that IBM and its scientists have received the nation's highest award for technological innovation, more than any other company or organization.
o IBM has employed a total of five Nobel Prize Laureates: two still working with the company.
o In October 2002, acquired PricewaterhouseCoopers Consulting. With some 30,000 employees and offices in 52 countries, PwC Consulting brought additional depth and leadership capabilities to IBM's services-led business.
o All of this is part of IMPLEMENTING THE ON-DEMAND STRATEGY, which should establish IBM as the first-mover in what is and will be a heavily competitive industry.
Barriers to Entry:
• First Mover Advantage: Automation leads to accelerating velocity of the business (doing more, faster), which means more market share and higher revenues until other companies adopt and implement the strategy.
• Companies which move first to become on demand will be first to respond with flexibility and speed to external threats, marketplace opportunities, and the needs of their customers, employees, and partners.
• Economies of Scale: More variability in the fixed cost structure because less technology maintenance costs in a more streamlined organization. Faster return on capital invested. Manipulation of huge client base as an IT provider to implement the new strategy.
• The On-Demand Strategy has been one huge attempt at differentiating IBM’s product from the competition, which it is convinced, should allow IBM to reap bigger profit margins. IBM is moving toward making itself far more a side-by-side partner with businesses, helping them improve their marketing, planning, procurement and customer service, rather than merely a supplier of hardware and software.
• This is the new way for securing and maintaining relationships with big corporate customers, as profit margins in supplying the hardware and software for these companies’ mainframes are dwindling.
• Bundling IT consulting with hardware and software supplies. Through integrated business solutions, IBM is taking advantage of its huge network of products/services.
Substitution:
• IBM has strong competitors and resulting direct substitute products in all three of its businesses: Software, Hardware, and IT services.
• The main rival in software is Microsoft, which IBM uses Linux and Open Source systems in its mainframes to compete with. Additionally, Oracle products such as Oracle Financial have made back office outsourcing less necessary for small to midrange businesses.
• In Hardware, the main rivals are Sun Microsystems, which specializes in Servers and Mainframe Computing, and Cisco, which specializes in complex networks and virtualization, or making a network of computers as powerful as one large supercomputer.
• In Services, IBM was unparalleled in its new combined on-Demand strategy until recently. Hewlett-Packard now speaks of its corporate offerings as its "adaptive enterprise initiative"; Microsoft says its offerings will make companies "agile" businesses; and Computer Associates simply copied the "on demand" phrase.
• IT services also rivals include companies like Accenture, and smaller more boutique-like firms that cater to smaller markets. IBM Global Services still is the behemoth here though, with $52 billion in new contracts in 2002. They signed a $5 billion dollar outsourcing deal with JP Morgan Chase, and today signed a 2 billion dollar deal with Sprint. The latter expects its customer service costs to plunge $550 million over the next three years. There is no substitute for that.
Buyer/Supplier Power:
• IBM’s diversified products and services and original position in the Information Technology field make it independent of any Supplier or Buyer Power. This is a particular advantage in the IT industry when Microsoft has such a strong hold on software operating systems and Intel such a strong hold on processing chips. Because personal computing is just one segment of IBM’s business, IBM has been able to focus on open source/standards computing, which has led it to use Linux operating systems in its servers and its own in-house semiconductor manufacturing plants.
• IBM is investing in the technology truth that corporate customers don't so much buy technology products, since the technology changes so fast, as invest in a relationship with a trusted supplier. This is the basis for IBM’s on-Demand strategy.
WHAT IS IBM?
All information and Statistics in this presentation come from either http://www.IBM.com, http://www.nytimes.com, or http://www.wsj.com:
IBM's character has been formed over nearly 100 years of doing business in the field of information-handling. Nearly all of the company's products were designed and developed to record, process, communicate, store and retrieve information -- from its first scales, tabulators and clocks to today's powerful computers and vast global networks. IBM helped pioneer information technology over the years and it stands today at the forefront of a worldwide industry that is revolutionizing the way in which enterprises, organizations and people operate and thrive.
Currently, from an investment outlook, IBM believes investors, particularly those who invest in the technology sector, reward companies that adapt, that continually create and lead the high-value spaces—“because that’s the only way to deliver consistent, long-term earnings growth in an industry that is constantly evolving.” It believes investors reward companies that “manage for the long haul, run highly efficient operations and are managed by experienced and disciplined leaders. And, at a time when industry growth projections are highly unreliable, the firm is catering to investors rewarding companies that outperform their competitors—no matter the rate at which the industry is growing or contracting.” They say, “This is why we have made marketshare a top priority.”
FROM IBM’s 2002 ANNUAL REPORT:
o IBM is the world's largest information technology company, as well as the world's largest business and technology services provider ($36 billion); and the world's largest IT financier ($35 billion in assets).
o All of IBM's core businesses - from servers to storage systems, to middleware, to services - gained marketshare in 2002.
o In terms of IT finance, IBM signed $35 billion in new financial agreements in 2002, $14 billion for customer and government financing and $22 billion for commercial financing.
o IBM Global Services signed $53 billion in new contracts in 2002, of which 42 contracts were each worth in excess of $100 million, and five which exceeded $1 billion.
o In October 2002 IBM acquired PricewaterhouseCoopers Consulting. With some 30,000 employees and offices in 52 countries, PwC Consulting brought additional depth and leadership capabilities to IBM's services-led business.
o IBM paid an effective tax rate of 30.0% in 2002, up from 29.7% in 2001.
SOME 2003 STATISTICS:
o IBM took in 89 billion dollars in revenue last year and 62% of its sales are overseas from one of its locations in 90 countries. 57% of its 316,000 person workforce is deployed outside of the US. The company plans to expand to 330,000 in 2004.
o IBM common stock is currently at a 52-week-high of $100.00. Market Capitalization is $170.7 billion. P-E ratio is 22.87.
o The current Chairman and CEO of IBM is Samuel J. Palmisano.
HISTORY:
Charles R. Flint arranged the merger of the International Time Recording Company, Computing Scale Company, and the Tabulating Machine Company to form the Computing-Tabulating-Recording Company (C-T-R) in 1911. The new company was based in New York City and had 1,300 employees. C-T-R was renamed International Business Machines Corporation on Feb 14, 1924, because the scope of the business was widening into electronic keypunching.
When the diversified businesses of C-T-R proved difficult to manage, Flint turned for help to the former number two executive at the National Cash Register Company, Thomas J. Watson, Sr. Within 11 months of joining C-T-R, Watson became its president. The company focused on providing large-scale, custom-built tabulating solutions for businesses, leaving the market for small office products to others. During Watson's first four years, revenues more than doubled to $9 million. He also expanded the company's operations to Europe, South America, Asia and Australia.
During the Great Depression of the 1930s, IBM managed to grow while the rest of the U.S. economy floundered. Because Watson continued the firm’s capital investments, IBM was ready when the Social Security Act of 1935 brought the company a landmark government contract to maintain employment records for 26 million people. It was called "the biggest accounting operation of all time," and it went so well that orders from other U.S. government departments quickly followed.
After inventing several primitive electronic calculators in the 40s (most of the production facilities were used then to manufacture war materials) IBM in the 1950s took computing first to vacuum tubes and then transistorized machines. By 1959, IBM had an automatic production line for transistors and had created the three most powerful mainframes in the world.
In 1969, under the stewardship of Watson’s son as CEO, IBM changed the way it sold technology. Rather than offer hardware, services and software exclusively in packages, marketers "unbundled" the components and offered them for sale individually. Unbundling gave birth to the multibillion-dollar software and services industries, of which IBM is today a world leader.
In 1973, under Frank T. Carey, IBM introduced the floppy disk, Bank ATM’s, and the electronic laser prism price reading machines used by cashiers in supermarkets. These were the most significant inventions by IBM that affected the mainstream consumer until 1981, when IBM introduced the PC. When designing the PC, IBM for the first time contracted the production of its components to outside companies. The processor chip came from Intel and the operating system, called DOS (Disk Operating System) came from a 32-person company called Microsoft.
During the 1980s and early 1990s, IBM was thrown into turmoil by back-to-back revolutions. The PC revolution placed computers directly in the hands of millions of people. And then, the client/server revolution sought to link all of those PCs (the "clients") with larger computers that labored in the background (the "servers" that served data and applications to client machines). Both revolutions transformed the way customers viewed, used and bought technology. And both fundamentally rocked IBM. Businesses' purchasing decisions were put in the hands of individuals and departments - not the places where IBM had long-standing customer relationships. Piece-part technologies took precedence over integrated solutions. The focus was on the desktop and personal productivity, not on business applications across the enterprise. By 1993, the company's annual net losses reached a record $8 billion. Cost management and streamlining became a chief concern. And IBM considered splitting its divisions into separate independent businesses.
Louis V. Gerstner, Jr. arrived as IBM's chairman and CEO on April 1, 1993. Gerstner brought with him a customer-oriented sensibility and the strategic-thinking expertise that he had honed through years as a management consultant at McKinsey & Co. Soon after he arrived, he had to take dramatic action to stabilize the company. These steps included rebuilding IBM's product line, continuing to shrink the workforce and making significant cost reductions. Despite mounting pressure to split IBM into separate, independent companies, Gerstner decided to keep the company together. He recognized that one of IBM's enduring strengths was its ability to provide integrated solutions for customers - someone to represent more than piece parts or components. Splitting the company would have destroyed this unique IBM advantage. This advantage is exactly what is exploited by IBM’s new Business on Demand Strategy.
BUSINESS ON DEMAND – The New, New Thing?
There is somewhat of a comparison to Jim Clark’s New New Thing Ideas… This is Healtheon not just for health care, but 12 industries ranging from health care to finance. “The promise of on demand is that a company or institution can provide products, services, information, health care, education, government services and so on—all “on demand” for customers, citizens, patients and students. These “sense-and-respond” or “real-time” enterprises enjoy enormous competitive advantages. They are able to convert fixed costs into variable costs. They can greatly reduce inventories. And, most compellingly, they are extremely responsive to the needs of their customers, employees and partners.”
Samuel J. Palmisano, Chairman and CEO of IBM, said in an interview with the NY times, "We now see an opportunity to set the agenda again." He concluded: "I am confident that we are on the verge of the next great opportunity for our company, and for the entire information technology industry." He was talking about IBM’s new E-business On-Demand Strategy. What is it, and how does it work?
Currently, the pace of change in the information technology industry is accelerating, and its scope and impact are widening. The ON-DEMAND STRATEGY is IBM’s response to this new market environment. In their words, the strategy entails evolving IBM into “an enterprise whose business processes – integrated end-to-end across the company and with key partners, suppliers and customers – can respond with speed to any customer demand, market opportunity or external threat.” By making themselves into the first and ultimate On-Demand company, IBM plans to serve as a role model and consultant for other companies who want the same for their own firm operations. IBM is trying to position itself as a company which will either build you a self-sustaining on-demand infrastructure (using its own research facilities, hardware and software) or the company to which you can outsource all of your data processing needs, organizing and distilling the information for you in such a way that enables you to respond to the market in real-time.
The value added to a company by IBM via the on-demand strategy is the remolding of the firm’s business model so that it is flexible enough to thrive in an increasingly turbulent market environment. This means transforming companies into even more focused, streamlined, responsive, variable and resilient enterprises that connect their businesses end-to-end with suppliers at one extreme and customers at the other, seamlessly fusing the best of business and technology. This should accelerate value creation. People want and will invest in a company that is intuitive in sensing and responding to change; flexible in terms of structuring costs and adapting processes; focused on the unique things that set it apart; and resilient in managing change and threats.
How did IBM implement the On-Demand Strategy for Itself?
“IBM has committed to becoming the premier on demand business and has identified four focus areas: Integrated Supply Chain, Total Buyer Experience, On Demand Workplace, and IT Enablement.”
Information Technology (IT Enablement – reducing underutilization) and Creating an On Demand Workplace:
o IBM originally had a patchwork of IT support systems to service about two dozen business units. In the past 15 months, 155 data centers were consolidated into 12. The number of internal networks was reduced from 31 to 1. 16,000 applications that organize and distill information for IBM cut to 5300 right now. 1 CIO from 128.
o Since 1994, IT spending has gone down 31%, or 2 billion dollars. Nonetheless, the firm has created w3, the IBM intranet that connects 320,000 employees, and allows an employee’s computer to become his or her office, saving some other 2 billion in real estate costs. In implementing this new strategy, IT plans to become more important with less funds directed toward the maintenance of its systems. This is being achieved through the simplification and consolidation described above.
Integrated Supply Chain and Creating a Total Buyer/Distributor Experience:
o Automation, or creating touchless, self-configuring optimizing manufacturing designs, is the fastest way to go about achieving an on-demand supply chain, with the ultimate goal of giving the business the ability to adapt/change on its own.
o The on-demand supply chain has first been implemented at IBM’s new 300 mm Semiconductor plant in NY, where cycle time has improved 50%, process yields are up to 2 points higher, and direct spending on labor is 50% lower than in the previous facility. The change has been to wire the system such that customer orders are plugged into the system electronically by the customers themselves.
The manufacturing plant then automatically responds to the new ordering information requirements and re-optimizes the manufacturing strategy accordingly (and instantaneously). It does so based on new manufacturing algorithms run on Linux grids that self-configure and optimize production for the plant at any given time.
o The first distributor to take advantage of this seamless, touchless, on-demand manufacturing was Magirus, a key European IBM distributor. Through electric automation of their ordering system, the company has seen IBM manufacturing cycle time go down 70%, and orders filled with 99.5% accuracy. This is a huge competitive advantage.
ON DEMAND STRATEGY GOALS:
o Exceed financial expectations of the on-Demand strategy. IBM wants to be #1 in customer satisfaction (currently #3), wants to be #1 in employee satisfaction (currently at the industry average), as well as have the biggest market share in all of the product markets in which it participates.
o IBM wants to be a role model in moving toward the on-Demand strategy and wants to make all of its internal workings on-Demand for its customers.
o Want to enable businesses today to respond in real time to whatever the day brings—a change in supply or demand, a shift in the preferences of buyers, students or citizens, the vagaries of capital markets or the aftermath of a natural disaster.
SELLING THE STRATEGY TO OTHER COMPANIES:
Evaluate your business processes. Are they responsive enough? Are they integrated to the point where they can provide real-time information and enable you to respond rapidly to market changes?
Consider your infrastructure. Is it properly aligned to support your business goals? Is it being fully utilized? Are you getting the maximum return on the IT investment that you've made?
Look at your organization and culture. Is it primed for growth? Are there opportunities to unlock hidden value through collaboration or outsourcing?
HOW THE 5 PORTER FORCES WORK INTO IBM:
Direct Rivalry
• "Either you innovate or you're in commodity hell," Mr. Palmisano explained during a 90-minute interview at the company's headquarters in Armonk, N.Y. "If you do what everybody else does, you have a low-margin business. That's not where we want to be." - Samuel J. Palmisano, Chairman and CEO of IBM.
• As an information handling company, IBM must compete with other information handlers. Additionally, they have to compete with other technology creators. In the new strategy, they must compete with technology consulting firms. To do this IBM has utilized Command and Technology. IBM has:
o For the tenth consecutive year, received the most U.S. patents over any other company -- 3,288 U.S. patents in 2002, nearly double the number of the next closest company. Over the past decade, the U.S. Patent Office has issued IBM 22,357 patents - more than for ten of our top U.S. competitors combined.
o Achieved the world's largest portfolio of software patents. IBM received 7,500 software patents between 1993 and 2002. The number of software patents received by IBM in 2002 was 1,332.
o Been awarded the 2000 U.S. National Medal of Technology for the company's record of innovation in storage technology. This marks the seventh time that IBM and its scientists have received the nation's highest award for technological innovation, more than any other company or organization.
o IBM has employed a total of five Nobel Prize Laureates: two still working with the company.
o In October 2002, acquired PricewaterhouseCoopers Consulting. With some 30,000 employees and offices in 52 countries, PwC Consulting brought additional depth and leadership capabilities to IBM's services-led business.
o All of this is part of IMPLEMENTING THE ON-DEMAND STRATEGY, which should establish IBM as the first-mover in what is and will be a heavily competitive industry.
Barriers to Entry:
• First Mover Advantage: Automation leads to accelerating velocity of the business (doing more, faster), which means more market share and higher revenues until other companies adopt and implement the strategy.
• Companies which move first to become on demand will be first to respond with flexibility and speed to external threats, marketplace opportunities, and the needs of their customers, employees, and partners.
• Economies of Scale: More variability in the fixed cost structure because less technology maintenance costs in a more streamlined organization. Faster return on capital invested. Manipulation of huge client base as an IT provider to implement the new strategy.
• The On-Demand Strategy has been one huge attempt at differentiating IBM’s product from the competition, which it is convinced, should allow IBM to reap bigger profit margins. IBM is moving toward making itself far more a side-by-side partner with businesses, helping them improve their marketing, planning, procurement and customer service, rather than merely a supplier of hardware and software.
• This is the new way for securing and maintaining relationships with big corporate customers, as profit margins in supplying the hardware and software for these companies’ mainframes are dwindling.
• Bundling IT consulting with hardware and software supplies. Through integrated business solutions, IBM is taking advantage of its huge network of products/services.
Substitution:
• IBM has strong competitors and resulting direct substitute products in all three of its businesses: Software, Hardware, and IT services.
• The main rival in software is Microsoft, which IBM uses Linux and Open Source systems in its mainframes to compete with. Additionally, Oracle products such as Oracle Financial have made back office outsourcing less necessary for small to midrange businesses.
• In Hardware, the main rivals are Sun Microsystems, which specializes in Servers and Mainframe Computing, and Cisco, which specializes in complex networks and virtualization, or making a network of computers as powerful as one large supercomputer.
• In Services, IBM was unparalleled in its new combined on-Demand strategy until recently. Hewlett-Packard now speaks of its corporate offerings as its "adaptive enterprise initiative"; Microsoft says its offerings will make companies "agile" businesses; and Computer Associates simply copied the "on demand" phrase.
• IT services also rivals include companies like Accenture, and smaller more boutique-like firms that cater to smaller markets. IBM Global Services still is the behemoth here though, with $52 billion in new contracts in 2002. They signed a $5 billion dollar outsourcing deal with JP Morgan Chase, and today signed a 2 billion dollar deal with Sprint. The latter expects its customer service costs to plunge $550 million over the next three years. There is no substitute for that.
Buyer/Supplier Power:
• IBM’s diversified products and services and original position in the Information Technology field make it independent of any Supplier or Buyer Power. This is a particular advantage in the IT industry when Microsoft has such a strong hold on software operating systems and Intel such a strong hold on processing chips. Because personal computing is just one segment of IBM’s business, IBM has been able to focus on open source/standards computing, which has led it to use Linux operating systems in its servers and its own in-house semiconductor manufacturing plants.
• IBM is investing in the technology truth that corporate customers don't so much buy technology products, since the technology changes so fast, as invest in a relationship with a trusted supplier. This is the basis for IBM’s on-Demand strategy.
