They are calling it a 'remarkable transformation' and the 'business turnaround of the decade'. UK analyst Robin Bloor goes even further. 'It is probably the most brilliant performance by a chief executive in the last 20 years,' he says. Analysts, journalists, business gurus, authors and even his peers in the computer industry are all agreed that Lou Gerstner has achieved the near impossible since he took over as chairman and chief executive of IBM in 1993. Between 1991 and 1993, IBM lost $16 billion (£9.8bn) - more money than its nearest competitor took in sales in a full year. 'Gerstner didn't just turn the ship around, he stopped it sinking and then turned it around,' says Bloor. From 1995 onwards, IBM under Gerstner has produced steady profits and has grown, particularly in share value. Yet, while there is general agreement about the miracle of IBM's return from a near-death experience to a lengthy period of stability and profit, there is less agreement on where it will go from here. While Gerstner has grown the business by $20 billion from its low point in 1993, some doubt that the company can sustain growth and keep its shareholders happy. As Gerstner has ruthlessly pulled IBM out of declining businesses and pushed it into newer and more promising areas, a lot of people wonder whether the new businesses will cover the lost revenues from declining areas. Can Gerstner keep IBM ahead of its rivals? And if he can, what will IBM look like in the future? Changing the fundamentals Gerstner made it clear from the start that there would be no sacred cows at IBM: that he was willing to change anything and everything. Just how much Gerstner was prepared to change IBM became clearer this year when Big Blue signed a series of highly public and ground-breaking deals to supply hot IBM technology to some of its fiercest rivals, such as EMC, Dell, Acer, Cisco, 3Com and Compaq. In most cases, IBM is offering its best and newest technology and, in some cases, the expertise of its services division, IBM Global Services (IGS), for hard cash or reciprocal technology. While analysts have been keen to portray this as a simple way for IBM to cash in on its technology assets, it goes a little deeper. Take the PC market as an example. At a conference of IBM's business partners earlier this year, Gerstner said: 'the PC era is over'. It's easy to understand what he meant. IBM has been pushing the 'network-centric' model of computing, which puts the emphasis on the network rather than the devices attached to it, longer than most. However, in view of the performance of IBM's PC division, it would be understandable if the death of the PC was just wishful thinking. Throughout the 1990s, IBM's PC division jumped between massive losses and decent profits from year to year, and continues to do so today. Last year, the division lost $992 million. This year, it expects to do much better. However, analysts are still predicting a loss. The agreements with Dell, Compaq and Acer, and other agreements in the pipeline show that IBM is looking for ways to make money from PCs which might not involve selling them to end users in future. IBM has a long-standing relationship with Taiwanese supplier Acer. This dates from Big Blue's realisation that its cost structure made it impossible for the PC division to compete at the low-end of the market. IBM paid Acer to manufacture PCs, which were then sold on to customers - often at a loss. At the same time, IBM pushed its own high-end PCs onto the market. Big Blue claimed, rightly, that it could offer the best technology in the world, but unfortunately at a price users were often not inclined to pay. The rational behind IBM's new deals with Acer and Dell, plus a forthcoming deal with Compaq, is that it might as well sell its great technology to its competitors and make a profit, even if it's cutting the throat of its own PC division. Dell is buying a range of disks and controllers, chips and other products from Big Blue. No technology seems sacred. IBM only began shipping its first microprocessors using the latest copper technology in June, but is already producing Alpha chips based on this breakthrough technology for arch-rival Compaq. IBM's services expertise is also being shared. Dell needs help with a worldwide service operation and IBM will supply it, helping a company primarily built on direct sales of 'boxes' to provide the sort of services blue-chip organisations want from suppliers. This will help Dell to compete on better terms with companies such as IBM. The strategy of helping your competitors to sell against you is not only confined to PCs. In a prime example of finding a way to make a profit out of a business that has failed, IBM has sold its interest in 'nuts and bolts' network hardware to rival Cisco. At the same time, Big Blue signed an agreement to provide Cisco with advanced hardware to help that company's efforts in the market. The prime mover behind these initiatives is James Vanderslice, a senior vice president in charge of the IBM technology group, which comprises the storage business, chip development and networking hardware. Vanderslice became a force within IBM when he turned around the storage business, which had been hammered by rivals EMC and StorageTek. His brief now is to build up the technology group as a major focus for new business primarily through the reseller business: selling technology and products to other suppliers. Big Blue is looking to services to provide significant growth. Its services arm is among the world's leading outsourcing and IT services players. Despite the success stories, sometimes trusting your fate with an experienced company does not guarantee a smooth IT transition, as Hershey Foods found to its cost this year. The number one confectionery supplier in the US decided in 1997 to revolutionise its functionally-based manufacturing and distribution systems by introducing SAP software. Hershey chose IGS as its partner to mastermind an operation that would affect no less than 28 manufacturing plants in the US, Canada and Mexico. Hershey is a conservative company and allowed 30 months for implementation. It went live in July this year and immediately hit problems. Hershey warned that it might not be working properly until October this year and any problems would affect earnings. It wasn't working properly in October, which was bad news for Hershey and its shareholders, since the run up to Halloween is one of the biggest sales periods. At least one retailer said Hershey was flying confectionery to its stores to meet orders as other retailers reported overstock, understocks and all kinds of problems in a peak selling period. 'Our third-quarter sales and earnings declined primarily as a result of problems encountered,' said Kenneth Wolfe, Hershey's chairman and chief executive. From October until the end of the year, Hershey would normally expect to make 40% of its annual sales, but it has already warned that it expects the problems to continue. One thing customers normally expect when dealing with IBM is reliability. They know that Big Blue will get things done. Not, it seems, in Hershey's case. Gerstner believes that along with services and software, the technology group will be one of the biggest growth engines within IBM. The group generated $7 billion in revenue last year, and has been growing at more than 10% throughout the decade. Analysts predict that it will reach close to $9 billion this year. The PC business, in contrast, is going the other way. It once peaked at about $20 billion per year, but analysts predict that it will generate some $14 billion in revenue this year. 'I think this is just one of Lou's ideas maturing,' says Bloor. 'He was very impressed with IBM's research and development when he took over, but the technology did not get to market as often as it could have or as successfully. He and his team have been working on ways to make this happen, and a dominant idea was to OEM anything that research and development produced.' There are other areas of new reseller business for IBM. The company has developed a specialised processor, keypad and screen combination for next-generation mobile phones that it is pushing at the mobile phone manufacturers. It has also signed a cross-patenting deal with 3Com. Bloor believes that there is a definite change of emphasis within IBM to sell as much technology to other high-tech companies as to end users. Matthew Nordan, an analyst with researcher Forrester Research goes even further, saying that IBM is positioning itself as a 'portfolio manager that maximises its return by any means necessary'. Will this change the face of Big Blue? Gerstner says no, not exactly. While praising the efforts of the software, services and technology/reseller divisions in a speech to shareholders earlier this year, Gerstner said the new emphasis on services and the reseller business did not mean that IBM was 'transforming into a different company'. 'Hardware remains critical to our business model and our strategic direction.' OK, so IBM isn't going to be wholly a services company, but who will be buying most of the hardware in future? The business of ebusiness In 1995, Gerstner pushed IBM behind the new network/Internet model of computing. He was one of the first chief executives at a major computer company to do so. While 'the visionary' Bill Gates was writing The Road Ahead with hardly a mention of the Net, Gerstner was exhorting IBM's senior management to adopt all things networked. Big Blue has enjoyed some success as a result. The initiative to Internet-enable just about every piece of kit that IBM sold, and a number of Internet software products combined with an advertising campaign helped position IBM as a major player in the space. However, Bloor believes that it did not pay off nearly as handsomely as it should have. He says the advertising captured customers' imagination, but not necessarily the cash. This year, IBM launched an internal campaign called Mind Share into Market Share, which is an admission that it did not achieve the market share it had hoped for, says Bloor. He believes there are four reasons for the failure: - Most of the new and powerful ebusinesses rose up from the smaller business space. Start-ups used technology from companies they already had relationships with or which they saw as at the heart of ebusiness. Primarily Sun Microsystems (for Unix), Netscape (for server software), Microsoft (for Windows NT) and Oracle for database. Some even dabbled with Linux and Apache. IBM missed here simply because it had not established much of a foothold in this space. - IBM did very poorly in the Internet service provider (ISP) market, where its Unix hardware could and should have performed well. For a while, IBM regarded the ISPs as an 'unprofitable sector' and did not attach much importance to them. - IBM's global networks division prevented it from doing business with the telcos. The telcos saw IBM as a competitor. - Although IBM did well in the space where it already had relationships with the customer, mainly large companies, these firms did not constitute the early market. Even when IBM did have a good relationship, quite often the web site was set up by the marketing department. Other analysts say that IBM did better than Bloor suggests and that Big Blue's positioning helped out its server business. Whatever happened in the past, IBM arguably now has a major opportunity and the means to exploit it. When Big Blue sold off its Global Network division to AT&T in a $5 billion deal last year, it was left free to do business with the telcos, and 'now has partnerships with all of them'. IBM has raised its profile with startups, and its successful advertising campaigns continue. However, judging by what it has been telling some analysts, it is about to jump heavily into the application service provider market. 'Our worry is that IBM is so closely associated with early Internet business models that it will find it hard to convince the market that it can stay hip to future market changes,' warns James Governor, an analyst with researcher Illuminata. Servers in the frame Will these new areas of business help to offset declines in IBM's traditional markets for servers of all sizes from mainframes to PCs? While no one denies that IBM is seeing some tailing off in some of these areas, observers generally agree with IBM's contention that most of the business remains if not buoyant, then better than expected. While Unix is catching up with IBM's mainframes in terms of raw power, it still cannot beat the reliability and it lacks many of the added services. 'Mainframe sales are not slowing apart from the year 2000 freeze effect,' says Bloor. 'Figures given to me by IBM show the OS/390 market growing, and I get similar information from Bull and ICL.' Indeed, analyst GartnerGroup believes that IBM is selling OS/390 boxes into 50 to 60 organisations each year which have never used mainframes before. Not bad of for a supposedly dead technology. Nordan believes the Sequent acquisition 'positions IBM for dominance in high-end servers'. Big Blue bought Sequent in July for $810 million, boosting its armoury of high-end server technology. The Sequent purchase will also help IBM in the NT/Windows 2000 market. A lot depends on what happens next year. No one really knows to what extent the millennium bug has stalled system sales, and there is every possibility that sales will pick up some time next year as a backlog of application development work is dealt with. The key question is whether IBM will benefit or lose out as users start replacing mainframes they haven't dared touch other than for remedial work. Lou gets pervasive Just as he did five years ago with network computing, Gerstner has developed a favoured phrase. He calls it 'pervasive computing'. 'Computing will be everywhere because the basic elements of the technology, chips and storage devices and networking, are getting even smaller, more powerful and less expensive,' says Gerstner. 'There will be a proliferation of computing appliances providing access to the Internet. Cellphones, screen phones, web TVs, computers you carry in your pocket or those you wear. Shipments of these devices are forecast to outpace sales of PCs within five years.' Gerstner sees a major opportunity for IBM and, no doubt, will shed no tears if the PC is no longer the access method of choice to the Internet. Signs are that IBM will develop a lot of technology for pervasive computing, but it must decide whether or not to produce for other suppliers or attack the consumer market. No doubt if Gerstner's heart was to decide the matter, he would take IBM further into consumer sales. It is an area he understands well from his days at American Express and Nabisco, and he enthusiastically backed IBM's abortive attempt to turn OS/2 into a consumer product as OS/2 Warp in 1995. He would not be the first chief executive with a consumer background to try that. John Sculley believed the potential mass market appeal of the Newton was the answer to Apple's problems. But Gerstner has learned from the Warp debacle. 'We'll build some of these new devices,' he says, but don't look to IBM to be a major player in the consumer market. IBM will stick to its old strength of providing infrastructure and its new strength in selling technology to firms that will sell it to the users. An unsteady course As these old and new strategies unravel, IBM's future is certainly not assured. Wall Street teeters between confidence that problems have been solved and skittishness at the very first signs of trouble. On 20 October, when IBM told analysts that its earnings for the next period would be hit by, among other things, year 2000 lockdown, its share value dropped by 12%. This was hardly news, since all the major vendors have been predicting a slow down in sales around this period. In IBM's case, the market reacted as a matter of course. However, by the beginning of November, financial analysts were still agreed that IBM was on the right track for the time being, with 12 recommending a 'strong buy' and seven a 'moderate buy'. Only one recommends selling. The most frequent reasons cited for analyst optimism are the server strategy, IBM regaining its position as a player in storage and the potential growth in the reseller business. Whatever happens over the next few years it will not belittle Gerstner's achievements. And while there is some confidence that if anyone can keep IBM afloat it is Gerstner, the jury will not make its final judgment until Big Blue proves its new direction will not once again leave it sinking in need of rescue. ARE YOU BEING SERVED? In the main, IBM's customers and partners know what the want from IBM Global Services (IGS). One example is Allied Signal, a supplier of aerospace and car components as well as chemicals and fibres. When signed up to IGS last month, it was looking for Big Blue to manage virtually its whole IT operation, from mainframes to helpdesks. Larry Kittelberger, Allied's chief information officer, said his company opted for IGS because of its experience in 'large-scale systems integration and systems management'. It's this issue of size that Alan Flack, manager of marketing communications for IGS north region, cites as a winning ticket for IBM. 'IGS is the largest IT services supplier,' he says. 'It has the expertise of 136,000 employees, who share their knowledge through world-class intellectual capital management systems.' And IGS is still growing. 'Through the third quarter of 1999, we hired nearly 17,000 professionals,' he says. Flack believes the latest deal with Cable & Wireless Communications (CWC) is typical of the way IBM will expand. The a £1.8 billion strategic outsourcing contract involved 1,100 CWC staff transferring to IBM. Senior IBM employees now work from CWC's offices and the two companies work closely together on the challenges facing CWC in the competitive telecoms industry. Most customers who sign up with IGS believe they are getting the services arm of an IT company that has been it, seen it, done it, and has all the T-shirts to prove it.
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