View items related to this story


It's raking in new business, its stock is roaring, and it's regaining the respect of Corporate America. What's Gerstner's secret?

It's getting harder to remember the days when IBM was regarded as a national disaster. In the latest quarter alone, IBM snagged a staggering $11 billion in the lucrative computer-services business--winning four out of five deals it went after. A new mainframe model, introduced in September, is sold out for months. Sales of personal computers have risen 25%, and the company can't keep up with demand for its new home PC. Most important, IBM's core business--selling computers and all manner of information technology to major corporations--is healthier than it has been in years: These customers will spend $58.3 billion with IBM in 1996, a respectable 8% jump from $54 billion in 1995.

As investors have come to fully understand the scope of this winning streak, they have aggressively bid up IBM shares. From around 129 in October, IBM has been on an increasingly rapid rise. In a nine-point streak on Friday, Nov. 15, it hit 145, a nine-year high. The following Monday, it jumped to 149 before settling back to 146 3/4. By Nov. 22 it hit 158 1/2, helping lift the Dow Jones industrial average through a series of new records. Daniel Mandresh, an analyst at Merrill Lynch & Co., predicts the stock could hit 195 by the end of next year--20 points over the company's 1987 high.

Why, it's as if Wall Street has found a new growth stock to love. And in a way, it has. The 7%-to-10% revenue increase that analysts expect from IBM this year may not be much by the standards of, say, Microsoft Corp. or Intel Corp. But the increase of $5 billion is huge--equivalent to adding another Dell Computer in revenues. Factoring in this new growth potential, analysts say that the stock, even now, is undervalued. Instead of trading at 10 times projected 1996 earnings per share, as it has been--the sort of multiple associated with a no-growth utility--IBM's growth rate and excellent cash flow should warrant a price-earnings ratio closer to that of other high-tech companies. Compaq Computer Corp., for example, commands 18 times earnings. IBM is doing its part, too. On Nov. 26, the board authorized the repurchase of $3.5 billion in IBM stock.

Some analysts reason that IBM's p-e should go higher. Even though two thirds of its revenue now comes in relatively low-margin segments such as PCs, workstations, and services, IBM is still one of the more profitable computer makers. For the year, it is expected to earn $6 billion on revenue of $77 billion, according to Mandresh. If the economy holds, the outlook is for more of the same for at least the next few years. Mandresh predicts earnings of $6.5 billion on $83 billion in revenue in 1997 and $6.9 billion on $89 billion in 1998. That's why, 30 years after it helped lead the 1960s' go-go market, IBM is again an issue that money managers don't want to miss out on. ''I wish I had kept more,'' says fund manager James Cramer of Cramer & Co., who sold when IBM hit 90, but recently bought 50,000 new shares. ''It's a changed company. The fundamentals are the best they've ever been.''

IBM has arrived at this happy juncture by doing lots of things right since Chairman and Chief Executive Louis V. Gerstner Jr. took over 3 1/2 years ago. But the secret to IBM's success isn't great technology, cutthroat pricing, or flashy marketing moves. It's approaching double-digit growth for the first time in almost seven years for one main reason: Under Gerstner, IBM has gone back to the most basic notion of how to succeed in business: talking to customers, learning their needs, and figuring out how to satisfy them. ''That sounds simple, but show me companies that are really good at it,'' says Gerald Ross, a co-founder of Change Lab International Inc., a consultant in Stamford Conn. ''It's easy to say but hard to do.''

Making that customer connection, it turns out, is Gerstner's thing. ''I came here with a view that you start the day with customers, that you start thinking about a company around its customers, and you organize around customers,'' he told BUSINESS WEEK in a recent series of interviews. That approach, in part, is the reason why IBM is on such a tear in computer services--and one of the reasons why Wall Street is suddenly so fond of IBM. For the first time in years, almost every cylinder in the massive IBM engine is firing: new mainframes, PCs, and minicomputers are selling well. And IBM has worked hard to put itself in position to be the indispensible helper that companies need to put all those products--and many more--together in complex network setups such as corporate intranets. Now, computer services is IBM's biggest growth business--expected to skyrocket to $16 billion by the end of this year, up from $12.7 billion in 1995 and just $9.7 billion two years ago. ''What really differentiates IBM is its ability to integrate products, and its breadth,'' says Steven Milunovich, a Morgan Stanley & Co. analyst. ''Customers are trusting IBM again.''

DEAF EARS. Even the competition acknowledges the improvement--and the threat. When it comes to competing with IBM, says Richard C. Watts, general manager of Hewlett-Packard's Computer System group, ''it's a harder fight than it was.'' And IBM's focus on the service end of the business is something that other computer makers will adopt, says Sun Microsystems Inc. Chairman Scott McNealy. ''Customers want you to help them fix something,'' he says.

Before IBM could help its customers, it had to fix itself. Gerstner, who arrived in April, 1993, after a 27-year career in consulting and management at McKinsey, American Express, and RJR Nabisco, had no illusions about his expertise in picking technology winners and losers. But he knew a lot about how big companies work--and why sometimes they don't.

One of IBM's most glaring problems, Gerstner concluded, was not its various technology gaffes but that it had basically screwed up relations with its customers. Once famous for blanketing big corporations with legions of pin-striped marketing and field-engineering troops, Big Blue had become distant, arrogant, unresponsive. In the 1980s, the company that had taught corporations how to use computers in the first place--in the process earning entree into every major boardroom in America--changed gears. It shifted to a high-growth strategy, that emphasized pushing hardware (often not the best and rarely the most competitively priced) rather than dealing with a client's business problems.

At first, that strategy paid off. But by the early 1990s, the growth evaporated. Meanwhile, the company squandered what it had taken decades to build: a position of trust with customers and the ear of top decision-makers in corporations. ''I started out selling to the corner office,'' says William A. Etherington, a 32-year sales veteran and the head of IBM's industry sales units. ''Then, we started to get moved to the cfo, and then to the data processing executive, and finally to the data center manager.'' Gerstner saw firsthand how bad things had gotten shortly after joining. When he invited CEOs of major corporations for a technology briefing, managers had to scramble to find enough chief executives to fill the 20 slots.

From the beginning, Gerstner set about rebuilding ties to IBM's biggest customers, laying the foundation for the successful services strategy. ''I want to take IBM back to its roots,'' says Gerstner. He made it a point to get out of the office and meet regularly with customers--something his immediate predecessor John F. Akers had rarely done. By his reckoning, Gerstner still spends 40% of his time with customers, often chatting CEO to CEO, to learn what's going on.

He listens--and he acts. When he heard customers complain about the high prices of mainframe software, Gerstner quickly ended the ongoing debate within the company about software pricing and ordered cuts up to 30%. Customers balked at investing more in proprietary hardware and software, so he pushed for more industry standards, such as Sun's Java programming language. Corporations were having trouble running complex computer networks, so IBM bought Tivoli Systems for $743 million to improve its systems management skills. Clients were growing leery of spending so much on technology and not seeing the payoff. IBM set about transforming its sales force into a global network of experts in everything from banking to higher education.

To be sure, IBM can't get by on a shoe shine and a smile. It needs to continually develop or acquire the technology and the skills that customers are clamoring for. Indeed, the turnaround is still a work in progress. For example, IBM has yet to prove that it can consistently keep up with ever-shortening product cycles of the computer business, particularly in PCs and Internet-related software. And for the growth scenario to play out, IBM needs more than its recent surge in service business and a healthy mainframe-replacement cycle. Among other things, it needs to revive its flagging $8.5 billion mainframe software trade and stagnant maintenance business, reverse its slide in the potentially lucrative mainframe disk-storage area, and do better in fast-growing markets such as PC servers.

Also, it remains to be seen whether Gerstner can really carry off his strategic initiatives: the $3.5 billion purchase of Lotus Development Corp., the Tivoli deal, and the alliance with Sun Microsystems to make Java a major computing ''platform.'' Microsoft Chairman William H. Gates III gleefully notes IBM's dismal track record with projects such as the PowerPC microprocessor (which has not dented Intel's dominance) or OS/2, the personal-computer operating system that all but disappeared in a world of Windows PCs. Will IBM do better with Lotus or Java? ''They have an absolutely perfect track record on software initiatives,'' Gates says sarcastically.

But even Gates has to concede that IBM does have momentum. And now that Big Blue is on a winning streak, that could lead to more interest in its products, which could lead to more sales and more earnings--and higher stock prices. ''There's a horde mentality in this industry,'' says Lynn Berg, an analyst with Gartner Group. ''Part of the reason Microsoft is so successful is that people are afraid of making an unpopular choice,'' she says.

RAP SESSION. Folks used to say that about IBM, and if the company can rebuild relations with customers, they could be saying it again. Which is why Lou Gerstner's world tour keeps rolling on. A typical CEO schmooze trip begins just after dawn on a drizzly, cold October morning. The 54-year-old CEO arrives at the Westchester County Airport from his home in nearby Greenwich, Conn., and boards IBM's Gulfstream iv. At 7 a.m.--Gerstner has moved up the departure hour three times to make sure he's not late--the plane takes off for Toronto, where Gerstner will meet with 20 top executives invited from such organizations as Rubbermaid Inc. and the University of North Carolina.

In Toronto, Gerstner chats excitedly about the Internet and technology issues confronting top management, as his car makes the 50-minute slog downtown through rush-hour traffic. There is no entourage. Just Gerstner. ''The networked world offers the promise that maybe the information technology industry will start to, for the first time in a decade or so, address CEO-level issues,'' he says. At The King George Hotel, he bounds out of the car to the elevators. In a conference room upstairs, the CEOs sit around a horseshoe-shaped table. Gerstner slips off his jacket and holds forth for the next 90 minutes--no slides, no canned presentation, and no eye-glazing discourse on technology. He launches into a high-level rap session, a wide-ranging discussion that touches on everything from the quality of public schools to the changes technology is bringing to financial-services companies.

The pitch is subtle but effective. The audience is left with the impression that Gerstner--and by extension, IBM--has figured out how the 21st century high-tech society and economy will unfold. ''He acts as a translator to his clients,'' says Wolfgang R. Schmidt, the chairman and CEO of Rubbermaid who has come to Toronto for a primer on the new technology. ''He's able to connect.''

''SELLING TRUST.'' IBM isn't the only company trying to get close to its customers, especially at the CEO level. From DuPont to Marriott to Hewlett-Packard, relationship building has become the mantra for corporate honchos. ''More and more CEOs have become conscious that they are the CEO of marketing. You're selling trust,'' says Philip Kotler, a professor at Northwestern University's J.L. Kellogg School of Management. And that, says Kotler, starts at the highest levels of the organization. ''It's building bridges, not just between the salesman and the purchasing manager: It's CEO to CEO,'' he says.

The approach is simple, but it works. When Gerstner and his management team came calling on Procter & Gamble Co. last December, they got a warm reception: It was the first time an IBM CEO had visited in decades--despite the fact that $35 billion P&G is one of the best IBM accounts. Gerstner had run into P&G Chairman and CEO John E. Pepper at a business function where Pepper mentioned that he and his senior managers were wrestling with how to better exploit new technology such as the Internet to streamline operations, speed innovation, and reach customers through new channels. Within a few days, the IBM chairman called Pepper to suggest that he bring his management team out to P&G for a daylong briefing on their vision of a new era of electronic commerce. ''It was a very proactive step to call and say: 'I'll bring my management team out,''' Pepper says.

The packaged-goods giant is still working on its technology plan. But IBM is deeply involved--and in position to sell computers, network services, software, and whatever technology P&G decides to buy. ''The meeting was an eye-opener and a catalyst for the role information technology could play strategically,'' says Pepper.

When Ameritech Corp. was looking to farm out its data processing operations, Gerstner made a sales call at the Chicago-based Baby Bell. He also phoned Ameritech Chairman and CEO Richard C. Notebaert several times before the deal was done. Of all the companies bidding on the $2.6 billion, 10-year contract, says Notebaert, ''Lou was the only CEO who was deeply involved.'' The attention paid off. IBM won the business. And the relationship that Gerstner built helped the companies get together on a $400 million joint venture that will offer help-desk services to other corporations.

In a world turned on end by the Internet, these new relationships could now help IBM seize a golden opportunity. Gerstner foresees tremendous growth potential by providing customers in industries as far afield as health care and utilities with the complex software, systems, and networks for electronic commerce. Over the past year, IBM executives have hatched plans for everything from online shopping malls to an electronic infrastructure serving a consortium of banks.

Whether it's a network for a single company or an industrywide effort, IBM is approaching all these deals as a way to build ties that will bring more business in the future. For example, instead of cramming its gear down the throats of customers, the company is increasingly adept at blending technology from many sources to build a system. ''The NIH [not invented here] syndrome is not getting in the way,'' says Sun's McNealy.

While IBM may sacrifice some short-term hardware and software sales, it stands to reap greater rewards by creating a lasting relationship with a customer. ''They are helping us find solutions, whether with their hardware or someone else's,'' says Robert G. Miller, chairman and CEO of Fred Meyer Inc., a $4 billion retailer in the Pacific Northwest that uses IBM mainframes to keep tabs on more than 225,000 items in its 216 stores. That builds intense customer loyalty, says Gartner's Berg. ''IBM has figured out how to position themselves as a neutral third party,'' she says. ''The next thing you know, they are the infrastructure for how these companies do business. That's something that will bear fruit for years.''

REVENUE RIVER. In the process, IBM could be building up a nice annuity for itself. How? Because the new electronic-commerce systems are so complicated and the technology is evolving so rapidly that customers are opting to let IBM handle all the details and pay a fee for the service. That's what online tenants that take space in World Avenue, IBM's Internet mall, will do, for example. Such constant revenue flow could even out the cyclical nature of the hardware business and, to the analysts, guarantee future earnings. ''The volatility of earnings is less,'' says Morgan Stanley's Milunovich. Already, nearly 35% of IBM's revenue comes as steady monthly payments, he estimates.

No chance is missed to make better customer connections, even if that's not the apparent agenda. Take the 1996 Olympics. IBM spent a huge $75 million on the event and suffered a public-relations black eye when its network could not get the scores out to the media. But the Games were a great success in terms of flesh-pressing. IBM hosted 1,600 executives from client companies around the world, including 800 CEOs. Gerstner was in a conference room at the Ritz Carlton, showing the CEOs how the huge IBM Olympic network operated. ''He was demonstrating various pieces of software and showing us how to do different things,'' says Ameritech's Notebaert. He also closed some business, inking a deal with Helmut Werner, CEO of Mercedes-Benz, that had been in the works since the end of 1994. It revolved around a proposal by IBM to collaborate on efforts to shrink the number of electronic components in a car. For Mercedes, 30% of its parts bill, or $3.3 billion a year, is electronic components of one kind or another. ''It's a natural marriage,'' says Werner. ''We know how to build cars, and IBM knows how to build systems.''

Now that the orders are rolling in, don't expect Gerstner to slow down. In November alone, he crisscrossed Europe several times, hitting four countries in seven days. Since taking over IBM, he has logged 542 flights in the corporate jet and 408,000 air miles. This schedule hasn't done much for his golf game, Gerstner jokes (he declines to divulge his handicap.) Nor has it allowed him much time for pastimes such as gardening or fly fishing, although he did manage a day outing on a friend's boat off Nantucket in September.

On the other hand, with the stock at its current levels, Gerstner can look forward to a fabulous payday. At current prices, Gerstner's stock options are worth a cool $80 million (table, page 158).

Of course, the CEO schmooze sessions can only do so much. That's why Gerstner continues to tinker with his organization to make sure that it has the right people in the right places to maintain ties with customers and translate their requirements into products and services. He is even sending IBM executives back to school for a course in the basics of market and customer selection, and sometimes he's the lecturer himself. ''The art of management is about choice,'' says Chief Financial Officer G. Richard Thoman, who has been leading the effort.

The day-in, day-out contact, however, still falls to the sales force. And there, Gerstner has also made his mark. To staff new marketing units aimed at particular industries--such as insurance, finance, and health--Gerstner has hired consultants from Booz, Allen & Hamilton, McKinsey, Coopers & Lybrand, and other firms. The top requirements: intense knowledge of their industries and customer contacts at the highest levels.

Take higher education. Sean C. Rush, the general manager of the unit, ''knows as much about running this institution as I do,'' says Michael G. Hooker, chancellor of the University of North Carolina. Rush spent 12 years in higher education as a consultant for Coopers & Lybrand. Hooker had avoided using IBM equipment and software after bad experiences with the company in the late 1980s. Now, the educator is listening as IBM pulls out all the stops to win the university's business. ''One of the things I bring with me is a set of relationships in higher education,'' says Rush.

Not every customer is dazzled by IBM's new performance. Jorge Rincon Gonzalez, director general of support systems at Grupo Nacional Provincial, one of Mexico's largest insurance companies, flew to Venice to attend a special insurance seminar set up by IBM. That was after Fred J. Amoroso, the general manager of IBM's insurance-industry marketing unit, came calling. Rincon says that he's impressed with IBM's new attitude and has even asked Amoroso's team to review his company's strategic plan. However, he doubts that he'll make any sharp switch from other suppliers--Hewlett-Packard, Electronic Data Systems, and Xerox--in IBM's favor. Lou Gerstner's IBM, he says, is ''a big step forward, but that doesn't mean we're getting married.'' Maybe not, but at least IBM is back on the dance card--in corporations and on Wall Street.

By Ira Sager in Armonk, N.Y., with bureau reports


COVER IMAGE: How IBM Became a Growth Company Again

CHART: IBM Stock Price 1960-1980

CHART: IBM Stock Price 1981-1996

CHART: IBM Stock Price Oct. 1 - Nov. 22, 1996

PHOTO: IBM Salesman in 1957

TABLE: Where IBM Has Taken Back Lost Ground

TABLE: A Little Something Extra in the Pay Envelope


Return to top of story


Updated June 14, 1997 by bwwebmaster
Copyright 1996, Bloomberg L.P.
Terms of Use