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Prologue

IBM is making a comeback. Although many observers had counted the company out--a dinosaur, an implosion, a wreck--its revival was probable, even predictable. Cycles of decline and revitalization have long characterized the company's history. Successful in its established ways, IBM has typically been slow to confront a new technological approach and then has found itself a laggard in need of dramatic change. In times of major technological transition, the company has had to jettison its top leadership and bring in people willing to recognize the need for change and make the break with the past.

Again that has happened at IBM. A new chairman and top management team are now directing the company toward the latest approach to computing--via networks--and IBM is bringing out new products and services designed for networked systems. As Lou Gerstner, IBM's chief executive officer, recently commented, "We are completely transforming the business to address the market for networked computer systems."

But in significant ways, Gerstner has not taken IBM onto a new course so much as to have returned it to its roots. For decades IBM's strategy was to be a one-stop shop for information services for large firms--a strategy we call "singleness." In straying from that strategy during the 1980s, IBM confused and angered its customers. With its current focus on being a full-service provider--G. Richard Thoman, IBM's chief financial officer, talks of a strategy of breadth, of managing IBM's customers' technological integration for them--IBM has revised the singleness strategy for today's information systems.

To say that IBM's recovery was predictable and that it has followed traditional paths, however, is not to belittle the achievements of its managers. The IBM that Lou Gerstner received was bloated with excess bureaucracy and cost, and its people were demoralized. Initially, Gerstner's management team cut costs and downsized. Profitability returned, but not growth. Over time, however, growth has re-emerged. In 1995, IBM's sales reached almost $72 billion, up more than 12 percent from 1994, and there was growth in virtually all segments of the company. Profitability was also up, by 42 percent, and shareholders were richly rewarded: earnings per share rose by 44 percent. Even new mainframe computers were bringing in substantial profit margins. Clearly IBM has been turned around.

But the company is not completely out of the woods. Sales of mainframes depend upon the business cycle in the economically developed world, and economic growth is slowing. IBM continues to face slow going in sales of personal computers and minicomputers. Its new service units have smaller profit margins than those of the hardware businesses that provided profitability in the past. And the company has yet to restore the confidence of its customers and employees that was so badly damaged in the early 1990s.

The causes of IBM's difficulties constitute a warning to business executives and a source of insight to those who study management and business.

Chapter One
The Market Clobbers IBM

The crisis at IBM began innocently enough. Even as the firm's revenue growth slowed and its competitive advantage eroded, most IBMers contently ambled along in their set routines. The firm, too, was content; clouds gathered on the horizon, but IBM continued to set new revenue records each year. Many of its managers argued that real growth would return with renewed economic expansion, pointing out that even though revenue growth had fallen off as recession took its toll on prices and unit sales, total revenue was still rising; this, they argued, indicated that nothing much was wrong with the company.

Hints of real difficulty first appeared in IBM's dealings with its most sophisticated customers--those firms demanding leading-edge information technology. IBM's newest computers seemed to fall short of meeting the needs of these firms, but rather than examine why this was happening, IBM management appeared instead surprisingly ready to abandon these customers.

After one particularly galling instance of the failure of a new leading-edge product, IBM's chief executive spoke publicly about the gap between the company's stated objectives and its achievements.

"Our greatest mistake...is that we walked up to the plate and pointed at the left-field stands. When we swung, it was not a homer but a hard line drive to the outfield. We're going to be a good deal more careful about what we promise in the future."

In the rapid-fire, high-risk world of information technology, the leading edge is a treacherous market, with high costs and razor-thin profit margins. But, it is also the crucible in which ideas are refined and the products forged that will earn huge profits when offered to less demanding customers. That IBM would leave this arena smacked of real trouble to follow.

The press began to describe an IBM in crisis, calling its products dated, its people demoralized, and its managers either hamstrung by rules or running for the exits as their world crashed around them. One reporter noted that "the stock market has been clobbering IBM. The stock has made new lows on heavy volume lately and now sells lower than it did a decade ago." Another wrote that "computer makers are rejoicing at the thought that mighty IBM may have stuck itself well and truly out on a limb."

Within a year, more ominous warning signals appeared. Now new machines in the mainstream product line were slipping in quality. Customers began reporting very late deliveries of new IBM machines, which, once installed, failed to reach anticipated performance levels. IBM's sterling reputation for service and support was being called into question.

Finally realizing the real depth of IBM's troubles--that its bread-and-butter mainframes were slowly but steadily being overtaken by faster, cheaper, and more versatile machines from other vendors and that promises were no longer enough to maintain customer loyalty--the firm's chief executive sent the following message to the management team: "We are a big company now, but I hope we haven't grown so big that individual managers no longer feel responsible for the total success of the company. With our decentralization, it's very easy to become so concerned with our own immediate responsibility, that we may forget we are all working for the IBM company...

"Within the last few days, I have talked with two important people anxious to do business with us. These people had been to an embarrassingly large number of places in our company--with no action--before coming to see me. One of them had talked to 18 different IBMers in an attempt to get the answer to a quite simple question. In either case, these men could have been directed to the right person at their first inquiry if the man they approached had simply picked up the telephone and found out who had the information they wanted.

"The man cooling his heels outside your office may not look important to you, but this is no reason for not giving him a full, attentive and courteous hearing. Anyone calling on the IBM company should be treated as if he were the most important caller in the world. He might well be prepared to offer the IBM company something that could make him the most important caller in the world, as far as we are concerned. As we get bigger and more successful, it's easy to feel that we don't need the advice or services of outsiders anymore. Let me assure you that nothing could be further from the truth.

"It is the business of each of us approached by an outsider to make certain the caller is given the courtesy he deserves and referred to the right person. If you are not the right person, please make sure that whomever you refer the caller to is the person who can give him a full and adequate answer. We have not grown so big, and we are not so successful, that we no longer need the help of others. Nor are we so securely on top that we can all lean back in our chairs and lull ourselves into thinking IBM will go on forever, whatever we, as individuals, do or don't do."

Months passed, but the chief executive's impassioned words failed to inspire action. Recognizing the implications of this inaction, the chief executive and his second-in-command began a series of one-on-one dialogues with various division leaders to prod them into action. These meetings, too, had little effect, and it was with a strong sense of urgency that top management decided to create a committee composed of representatives from across the firm to devise a new course of action.

But bringing IBM's disparate functions together to address perceived problems was like touching a match to a puddle of gasoline. Committee meetings soon degenerated into finger-pointing sessions. When the chief executive proposed overhauling the product line to regain technological leadership, it became apparent that despite three or four years of warning signals, many of his subordinates still saw nothing wrong with IBM that an economic rebound wouldn't cure. The problem isn't in the company, they said, and you shouldn't be pressing for extensive changes. Major elements of the company--manufacturing, sales, and engineering--saw inconvenience and threat in his proposals.

The mainframe manufacturing division did not want to believe that market forces were rendering existing technology obsolete; machines based on this technology were still earning IBM the bulk of its profits. Further, the career, prestige, and compensation of every manager in the group was tied to this technology; they had all grown up on it and would have to reeducate themselves or retire if it was changed.

The sales force strongly resisted the idea of replacing well-known, high-margin computers with substantially different machines with lower margins. Sales compensation was driven by quotas based on margins, and the sales force would have to sell considerably more of the new machines to maintain their incomes. This was, of course, in addition to the effort of reeducating themselves and their customers about the new products.

IBM's engineering managers questioned top management's proposal to pull resources from products in which up to twenty years' effort had been invested. An unstated but very real concern to them was that a new hardware design would require technology based on recent scientific advances that many of them had never studied and so could not immediately understand.

An observer summed up IBM's problems:
"There's the company's persistent difficulty in grappling with the new technology and with the expanding demands of the market. There's the absence of any clear, over-all concept of the company's product line; fifteen or twenty different engineering groups scattered throughout the company are generating different computer products, and while the products are in most cases superior, the proliferation is putting overwhelming strains on the company's ability to [support them]. The view at the top is that IBM requires some major changes if it expects to stay ahead."

Does this profile sound like the IBM of today? It most certainly does. But it's not! The chief executive quoted is Thomas J. Watson, Jr.--not John Akers or Louis Gerstner. Watson's memo on individual commitment to the company, quoted on pages 4-5, was distributed in March 1961; the quotation above came from a September 1966 Fortune article, "IBM's $5,000,000,000 Gamble," describing the clash of egos, technology gambles, management disputes, and near-bankruptcy that marked development of IBM's System/360 family of mainframes.

IBM's struggles in the early 1960s sound remarkably like those of the early 1990s. Then, as now, IBM's stock price was falling, smaller firms with more modern technology were eating away at its markets, and the press was hinting at its dire future "if corrective action was not taken"; yet the 1960s were a prelude to the most profitable period in IBM history.

Certainly IBM's recent difficulties have been much more significant than those of the 1960s. The company has reported billions of dollars in losses--its first ever red ink. Its stock market valuation declined at one point by an amount greater than the annual gross product of some of the smaller industrialized nations. IBM has changed fundamentally, making it so unfamiliar to its employees that some have experienced serious psychological trauma. Finally, almost 200,000 people have lost their jobs. No wonder many industry analysts believe that the company is going to crash and burn, leaving only a crater behind.

So today, as in the 1960s, IBM's epitaph is being written; but we believe that today, just as then, it is premature. There is much to learn from what has happened at IBM, both in past decades and recently, and there will be much to learn from its future course.

WHAT HAPPENED AT IBM?
IBM used to be called the most important company in the most important industry in the world. The stereotypical image of IBM has always been of a monolith, a phalanx in dark blue suits eating the competition's lunch. The editors of The Economist have written glowingly of IBM in its heyday.

"IBM was always more the model of an all-conquering American multinational than such other heavyweights as General Motors or Procter & Gamble. It prevailed in every market it was allowed to enter; it was more widely visible, more scrutinised, more admired. It was the lodestar for other companies. Marketing, training, customer and employee relations, research and development--in all these, IBM's way was the best."

The computer industry remains the most important global industry, mainly because ongoing leaps in technology performance and steady cost reductions are transforming our lives. But neither The Economist editors nor any other analyst would claim such broad importance for IBM today. Its place in the public eye has been taken by firms such as Microsoft and Intel.

How did this happen? Was IBM a victim of its own success, outgrowing the capacity of even the most capable of managers to run it effectively? Did its basic management techniques become obsolete in today's work environment? Is it the victim of a corporate culture that pushed the wrong type of executive to the top?

BREAKING TWO PROMISES: A ROOT CAUSE OF DECLINE
In the 1980s, IBM's margins suffered a steep decline, costs remained level, and profits dove. IBM had become a technology follower to an even greater extent than had been typical in the past--a marked change from the 1960s--during which it had led the information-technology industry with its innovative 360 Series. Further, the company displayed a surprising naivete in its partnering strategies, giving away to Microsoft and Intel extremely profitable portions of the industry and retaining for itself less profitable portions.

These important matters are explored at length in the following chapters, but they are proximate, not root, causes. The decline of profit margins, for example, was due to customers' falling interest in mainframe computers. IBM executives should have foreseen this; that they failed to do so was the result of two other, more basic factors. First, IBM squandered its enormous research and development effort in the 1970s on an effort to build a larger mainframe, instead of developing microcomputer technology, which was about to burst onto the scene bringing with it a future of personal computers, networks, and computer servers. Second, IBM shifted its relationship to its customers and lost touch with their interests and concerns.

What was the root cause of these errors in judgment? How was it that IBM lost the technological leadership it had achieved in the 1960s and became for a brief but crucial period in the 1980s a follower? Finally, after decades of sharp business dealings and building a reputation as the best-managed firm in the industry--many said in any industry--why did IBM executives suddenly made blunder after blunder in dealing with customers and competitors?

IBM's success over many years had been based on two commitments--not formal contracts, but rather understandings based not on legal obligation but on repeated promises. One promise was to IBM's customers; the other to its employees. To its customers, IBM had guaranteed effective, high-quality technology and excellence of service support, maintained by a close and continuing relationship with the customer. IBM rented equipment to its customers and was their partner in data processing and office work. IBM's one-stop shopping ensured large companies that their information systems were up-to-date (though not necessarily state-of-the-art) and reliable. When in doubt, information officers could buy IBM and be confident that their choices could not be faulted.

To its employees, IBM had guaranteed job security. Once a person had a job with IBM, he or she was set for life. Benefits were good; salaries competitive; and the working environment excellent.

Customers were happy, and employees were productive.

But during the late 1980s and early 1990s, IBM abrogated both contracts. IBM's difficulties in the early 1990s--which continue today despite the partial recovery of its share price--have their root cause in the fate of these two promises.

When IBM broke its promise to its customers in order to finance a substantial expansion, its business stagnated. Customers grew angry at IBM's arrogance--its faulty equipment, late deliveries, and failure to keep up with the emerging technology available from other vendors. The company was even castigated for failures in its service--something unthinkable in earlier decades. At the time, IBM's top executives didn't realize that the company was breaking a promise to its customers, and when they did realize it, they didn't care.

When the expansion failed to materialize, IBM broke its promise of security to its employees in order to bail out its shareholders. Breaking this promise impeded IBM's recovery and left its business prospects uncertain. Many employees became disillusioned and ineffective, an avoidable situation. Long allowed by their managers to believe that employment security had little reference to performance, thousands of employees had grown lax, as top performing IBMers complained bitterly in attitude surveys. Had IBM managers dismissed ineffective employees at less than half the rate common at other firms in the industry, it could have significantly reduced its massive financial losses in the 1990s for early retirement and layoffs.

IBM's MEGASTRATEGY
Behind IBM's two promises stood an overall approach to the marketplace within which narrower business strategies could be formulated, modified, and abandoned. The two elements of this megastrategy--what we term singleness and loyalty--are about customers and people, because business, even a high-technology business, is about these things. In high-technology industries, IBM's experience demonstrates that technology comes third, behind marketing and motivation. In business, technology is only a means to an end--not the end itself.

Singleness Singleness at IBM targets customers, assuring them that IBM can be their prime or sole source for information technology. So important has singleness been at IBM, that many observers have remarked, with considerable justification, that IBM looks more like a marketing than a technology company. IBM has, in fact, always been a marketing and service company; despite its commitment to R&D it has rarely been a technology leader. It has nearly always left this role to its smaller, more entrepreneurial competitors.

Historically, only when new ideas achieve sufficient prominence to be of potential interest to the broad marketplace does IBM reassign engineering and manufacturing resources to developing and producing its versions of the new product; only then does IBM energize its large sales force to convince key accounts to accept the new products, with the promise that IBM's service will remain at the same high level. Sperry Rand developed the first mainframe; Burroughs devised seamless operating software; Digital pioneered minicomputers; Apple initiated the PC; and so on. IBM copied early versions of these products, added its own touches, and pushed the results through its top-ranked sales force--ultimately setting market standards.

This pattern did nothing to endear IBM to its smaller competitors, who felt that IBM stole the just rewards of their breakthroughs. Otto Eckstein, an economist, a member of the Council of Economic Advisors under President Johnson, the founder of Data Resources Inc. (now the DRI unit of McGraw-Hill), and a director of the Burroughs Corporation, expressed in the late 1970s the resentment of entrepreneurs toward IBM. Burroughs was steadily losing market share to IBM, and Eckstein complained bitterly that "IBM is a public enemy; it's a shark which destroys innovators."

Ken Olsen, the engineer who founded and led Digital Equipment Corporation, may have been as bitter as Eckstein about IBM, but he expressed it somewhat differently. "When technology leads the information technology industry," he said, meaning when new products and services were emerging from development into the marketplace, "then we at Digital do very well. Our sales are strong and our profitability high. IBM does poorly in that environment. But when technology is stable for a while, then marketing, not technology, leads the industry and IBM does very well. We get hurt."

IBM executives confirm Olsen's point from their own perspective, seeing periods of technology change as challenges to their ability to preserve singleness. IBM, they say, for example, never fully responded to the challenge of the minicomputer. Its too long list of incompatible small computers, while containing some excellent machines that sold well, created confusion within IBM and for its customers.

IBM's focus on marketing to key accounts explains why it has such trouble during times of change in the information-technology marketplace. When there is no market standard on which to fasten, ideas from competing factions of entrepreneurs and engineers within the company create bitter internal controversies and paralysis.

Loyalty IBM's relationship with its employees, more than anything else, has made singleness possible. Essentially, IBM has fostered employee loyalty to the firm, and IBM's loyal, long-term employees have built lasting service relationships with its customers.

Today's management gurus suggest that firms use value-driven leadership. IBM was using this concept as early as the 1920s. It was formally articulated in a management document in the early 1960s, when Tom Watson, Jr., the firm's chairman, commented that he couldn't manage 300,000 people (IBM's size at that time), but he could certainly lead them. IBM's values were expressed in three fundamental principles of management: respect for the individual, excellence in execution, and the best customer service. Respect for the individual led IBM to embrace a no-layoff practice because it contributed to employee loyalty.

The consequences of this policy have been widely noted. For example, no group of IBM employees in America has ever been unionized, although IBM is a very tempting target. Several years ago, the general president of what was then America's second largest union commented at a conference about the difficulty of trying to unionize IBM. "I once served on a committee with Tom Watson, Jr., the chairman of IBM," he began. "I have never met a more gentlemanly person. He was the soul of honesty and fairness. If that's the kind of executive IBM produces, then I can understand why we've never been able to unionize the company."

For decades, IBM has been the place where people in the computer industry go to work if they place a high priority on employment security. The personal risk-takers go to firms in the Silicon Valley or the Pacific Northwest. In 1991, when IBM broke its loyalty contract by laying off personnel for lack of work, it demoralized these employees, causing some of the best to leave. If downsizing continues, even more of these people may be driven out, and no company can maintain standards in the face of a steady loss of its best people.

A STRATEGIC ERROR OF ENORMOUS MAGNITUDE
Until the early 1990s, recessions in major industrialized countries had been out of phase: When America went into recession, Japan and Europe boomed, and vice versa. In consequence, large international firms like IBM counted on offsetting economic experience in different countries. In the early 1990s, the first simultaneous recession in each of the world's seven major economies caught IBM with excess people and capacity. But IBM had too many people and too much manufacturing capacity for a more fundamental reason. It involved a strategic planning error made by IBM's top executives in 1981 that cast a long shadow over the company's future.

The disaster began gently. IBM had been growing at more than 10 percent per year, and the information technology industry was projected to continue to grow at that rate. In 1980, IBM had approximately $40 billion in sales. In the late 1970s, considerable capacity had been added and more was coming onstream in the early 1980s. If the company's growth rate continued, IBM would be a $100 billion company in 1990. Top executives began to ask themselves if they could manage a firm that large.

A lengthy period of analysis and discussion followed, at the conclusion of which John Opel, then chief executive, and other company leaders decided that IBM could and should attempt to reach $100 billion in sales by 1990. To make that possible, the company accelerated a rapid expansion of personnel and manufacturing capacity that had begun in the 1970s under Opel's predecessor, Frank Cary. More than 100,000 people were added to payrolls; numerous factories and other facilities were built.

John Opel was concerned about the Japanese copying IBM's products and challenging IBM in the marketplace. IBM's salvation, he decided, would be to become the low-cost producer so that IBM could beat Japanese price competition. IBM therefore built automated production capacity, the lowest-cost factories for semiconductors and mainframe computers in the world.

By 1990, IBM was ready to do $100 billion a year in business. Unfortunately, sales were about $50 billion: The company was heavy with unneeded capacity and people. In 1986, at the height of the buildup, IBM had 407,000 people worldwide. By 1994, this number was reduced to only 215,000. Planning mistakes of such magnitude inevitably have major adverse financial consequences--in IBM's case, some $23 billion in special charges were made against earnings, and the company had its first ever red ink. Note, however, that IBM has never taken an operating loss in a full business year. The red ink of the early nineties was all in restructuring charges, the costs of letting people go and closing plants and other facilities.

But was this error, in fact, strategic? Shouldn't it be said that IBM's failure was one of implementation, not of strategy? The industry's rate of growth would have sustained IBM's own target of being a $100 billion company by 1990 had IBM had the products and services its customers wanted. But IBM's top executives had intended to achieve growth through mainframe sales, adding facilities and people for that purpose. When mainframes lost sales volume, the strategy collapsed in ruins. The strategic error was in basing ambitious growth targets on the existing technological paradigm.

WHEN CRITICS TOOK CHARGE
Having made one egregious strategic error, IBM's top executives followed it with another. Desperately trying to rescue the firm's sinking fortunes and driven by the increasing anger and exasperation of shareholders, IBM went to its critics for advice.

In the past IBM had been so successful that its market value put its executives well beyond the influence of the public equity markets. IBM's chief financial officer once responded to a question about a possible takeover attempt with the comment "seventy billion dollars [then the value of IBM's stock] is a lot of junk bonds!" What he meant, of course, was that no corporate raider could raise so much money, leaving IBM well insulated from a takeover, the most extreme expression of shareholder discontent. IBM management thus had a fairly free hand to run the firm as it saw fit.

But in the early 1990s, as sales stagnated and restructuring charges turned operating profits into reported losses, the price of IBM stock dropped precipitously. The firm's market value dipped to a point where a takeover was quite feasible, and most of the formerly happy institutional investors became extremely displeased. It was at this point that IBM executives lost much of their freedom of action. Casting about for ways to revitalize the company's share price, they were forced to listen to their critics' suggestions. They discovered that, in today's world, investors' representatives are not content merely to vote with their feet--that is, to sell a firm's shares when they've lost confidence in its management. Instead, they offer management their suggestions, in the form of conditions they set for recommending that investors purchase the stock.

As IBM lost ground, a wave of criticism developed: Its executives were to blame for not abandoning mainframes, for underestimating the market impact of the personal computer, for being arrogant and bureaucratic, and for having a bloated work force. Along with the critique came a solution: Throw out a bunch of people and break the company up! And IBM's executives began to take the advice.

The suggestion seemed plausible enough. IBM had lost to retirement or to other firms most of its senior sales and marketing group, the analysts pointed out; the company couldn't get them or its market dominance back. So, the logic went, IBM executives were mistaken in presuming that they could recreate a dominant integrative-technology company: IBM could no longer provide one-stop shopping for its customers. It ought, instead, to become simply a holding company--a portfolio manager. It ought to divide itself into several businesses and cut them loose to operate independently in the marketplace.

Business magazines printed articles estimating the value of an IBM broken into pieces and divested. Not surprisingly, the separate pieces of IBM were valued much more highly than the company as a single unit. All that should be retained of the old IBM, some asserted, were those parts in which the IBM name had a compelling draw for customers: certainly mainframes and perhaps the IBM personal computer. All else should be separately packaged and sold.

During the divestiture process, the argument continued, IBM's greatest asset would be the huge base of IBM equipment installed and still operating in the world. IBM should turn this base into a service business and milk it for cash, using the cash to invest in new areas of the changing information technology industry. In short, IBM should manage itself like other successful companies, in particular, like General Electric.

Responding affirmatively to its critics, IBM's executives set in motion a process to split IBM into different units. Suddenly there were multiple IBM units. Although the field sales force was not splintered, people in the field no longer understood the company's sales strategy nor felt that they could speak for the company as a whole. While Wall Street applauded, customers became first disillusioned and then angry, complaining of decreased support from their IBM account teams and of increased difficulty in doing business with IBM.

The advice to break up IBM was dead wrong. IBM executives had been handed a conventional solution to the company's ailments, but the critics had overlooked the important point that these suggestions meant junking IBM's decades-old relationships with its customers and employees. Why were these wrong-headed remedies pressed upon the company? The problem lies to a large degree in the analysts' valuation methodologies, which systematically undervalue intangible human and relationship assets while fully recognizing their costs, and in the capital markets' short-term transaction mentality and lack of perspective on the long-term forces. Investment analysts thus project short-term disruptions in technology into long-term disasters and pressure companies to cut costs by driving out the very people who could fix the short-term problems. This policy increases the burdens placed on managers in companies engaged in making wholesale transitions between technologies--as was IBM--rather than supporting them.

This is not what shareholder advocates have in mind when they talk about the discipline of the capital markets. Instead of the arm's-length, buy-or-sale decisions that should influence management by signaling investor disapproval of a firm's performance, leaving the managers to figure out how to do better, IBM confronted a sort of management by remote control. Analysts not only undertook to tell IBM's management to do better, but told them how to do it. Unfortunately for IBM and for its shareholders, management listened.

To his great credit, in one of his first actions as IBM chief executive, Louis Gerstner announced in 1993 that he would not throw a fragmentation grenade at the company--that is, he would not break it up--and, in fact, he has installed a coordinating council of top management to help him pull the company back together.

WHAT ABOUT TECHNOLOGY? IBM got into difficulty because it abrogated its contracts with its customers and its employees and because a key strategic error led the firm to overextend. Then it worsened the errors by a radical reorganization that exacerbated the underlying difficulties. These errors resulted in falling profit margins, leaving the company's earnings badly squeezed. But many observers of IBM tell the story differently. Their version usually insists that IBM fell behind in technology and thereby lost the market.

Did IBM fall behind in technology? The company did cease for a while to be a technology leader, but it didn't fall behind. Yes, IBM tried to hang on to mainframe revenues even as customers were shifting to smaller systems. But mainframes had been highly profitable; why shouldn't the company have tried to stretch out their contribution to earnings? IBM had products in smaller computers, as well, ready to meet changing customer demand. Technology was not decisive.

But didn't IBM lose out on the microcomputer? Not at all--at least, not initially. Apple brought the first micro to market, but it was a poor machine, and IBM quickly responded with its own version. It named the product--the personal computer--and quickly grabbed some 90 percent of the market, a share still held by IBM and its compatibles. Yes, IBM did lose most of that share to clone makers, but not because it was late with or lacked the technology.

It is crucial to distinguish at this point between technology and product. IBM had the technology its customers wanted, but because it had lost touch with its customers' needs, it often did not have the product. The weakness of IBM's product line can be exaggerated, however. It had, in fact, strong contenders in each segment of the early-1990s information-technology marketplace. The major products, with the colloquial labels attached to them by IBMers, were mainframes--"beat the Japanese"; RS 600--"the UNIX competitor"; AS 400--"bury Digital"; and networked PCs--"crush Microsoft and Compaq." It was as strong a product line as IBM has ever had.

The myth continues to dog IBM that its current troubles mean that it is washed up as a significant force in information technology--that it can no longer develop leading-edge technology, and that without such technology it will fall behind and fail. In fact, IBM continues to make considerable contributions to information technology. Despite its financial difficulties, the company still maintains an R&D effort nearly equivalent to that of the rest of the industry combined.

AT THE MERCY OF CYCLES
IBM is at the mercy of three different cycles: an economic cycle of expansion and recession in the major nations of the world; its own organizational cycle of innovation and bureaucracy; and a technological cycle of integration and disintegration in the information-processing industry. IBM benefits when the economic cycle is in its expansion phase, the organizational cycle is in its innovation phase, and the technological cycle is in its integration phase. In the early 1990s, the news was all bad: The world's major economies were in recession; IBM itself was bureaucratic; and the company's existing technology paradigm, built around centralized data processing and the mainframe computer, was disintegrating. It's little wonder that IBM suffered substantially.

In the mid-1990s, each of the cycles is turning. The world's major economies are recovering, and customers are again buying big computers; IBM has awakened itself, and under new leadership is shedding its bureaucratic moss and achieving dramatic administrative and selling cost reductions; and a new technological paradigm--client-server architecture--has emerged and is consolidating itself in a new integrative phase. The confluence of favorable trends in all three cycles makes IBM's future bright.

Singleness prospers as technology consolidates. This element of IBM's megastrategy commits IBM to pulling together for its major customers the divergent elements of information technology. In periods of technology consolidation, IBM's ability to act as a one-stop shop serves it extremely well. What corporate buyer wants to have to deal with many vendors for a single system when one vendor will do?

It had been the instability of technology since the mid-1980s that so damaged IBM. The market standard prevailing since before the 1960s--proprietary, centralized mainframe computing--was cast into doubt, and a replacement did not immediately appear. For all of the hoopla over distributed systems, many major users have adopted a wait-and-see attitude while they try to understand these systems' pitfalls and potential. Until the market standard is clear, a marketing company like IBM is frozen in place; industry leadership slides almost by default into the hands of smaller, technology-dominated firms with a clear point of view--their own technology will win out. The information-technology industry has fragmented into the chaos of open systems, with integrators, software vendors, computer-chip vendors, operating-system vendors, and platform builders all competing for attention, and full-service vendors like IBM suddenly appearing to be dinosaurs.

Unfortunately for the niche players, large-scale users of computing are not technology hounds. Their basic needs have not changed since Thomas J. Watson, Sr., first set out to sell them tabulators back in 1914; they want technology that is functional, reliable, cheap, and easy to use: They want to plug it in, turn it on, and have it work between scheduled service calls. And they want to do business with vendors who can market to them.

Now that the outlines of a post-mainframe market standard are finally appearing through the fog of industry fragmentation, a new opportunity to establish a single solution and to market it on the fundamental basis of cost and service is again in sight. This is a market in which IBM's singleness and marketing focus should again stand it in good stead.

The single solution will best be provided by vendors that can offer truly compatible components--that is, hardware, operating systems, software applications, and service and support designed from the ground up to work together. A fragmented information-technology industry cannot provide such "one-call-gets-all" systems. Software firms like WordPerfect and Borland are already discovering that users want software suites instead of separate spreadsheets or word-processing programs; hardware builders like Compaq or Dell are forced to pre-install software suites--often at cost--to attract buyers. As its smaller rivals seek alliances or mergers in order to integrate their products, IBM is already there: It is the only major player in information technology that remains committed to all five segments of the open-systems marketplace and retains singleness as an operating philosophy.

For all the billions of dollars IBM has spent on new technology, its distinctive competence as an organization has never rested on technology. It is because technology is again yielding to marketing as the driving force in the information-technology industry that IBM, with its focus on providing complete, integrated solutions to its major business customers, can see light at the end of its tunnel. Surveys of IBM's customers done for this book (see Chapter 11) offer evidence pointing strongly to IBM's opportunity. Chief information officers at major companies have a very positive view of IBM. They still see IBM as the firm most likely to deliver the information technology that their companies will use in the future; and, for the most part, they expect IBM to recover its former leadership role in the industry. But the company can still snatch defeat from the jaws of victory.

A POINT OF DECISION FOR IBM
The market is returning to ground on which IBM is better equipped to fight, but the company must reestablish itself with its customers and employees. Much written about IBM stresses weaknesses in past leadership. But IBM's success depends less on the personalities of its leaders than on correctly assessing the strategic direction in which technology is moving, maintaining--or rebuilding--customer relationships, and motivating its people.

In the customer and motivation dimensions, IBM must make the right choices. In the technological dimension, as big customers move toward distributed systems based on microcomputer networks, with a relatively minor role reserved for mainframe storage hubs, IBM will be in a position to build market share by providing the best price and service--without post-purchase integration headaches.

WILL BIG COMPANIES REVIVE?
During the 1980s and early 1990s, bigness in business seemed a liability. The adage "the bigger they are, the harder they fall" prevailed. Big firms were advised to break themselves up into smaller units. Executives at large firms envied the agility of smaller firms and tried to imitate it. No large firm seemed to embody the hazards of large size more than IBM.

IBM's experience thus has important implications for the future of all large companies--especially its recent recovery of profitability. Scale, market power, and cash flow still count for a great deal in business; the advantages they give an organization are only blunted--not offset--by the bureaucratic rigidity that so often accompanies them. In today's business climate, the adage is shifting toward "The bigger they are, the harder they hit."

Why is it that for several years large companies like IBM were unable to convert the strengths of bigness into marketplace success? First, because overly optimistic strategies were based more on pride than reality. Second, because focus on financials inadvertently crippled other business functions, including often production and marketing. Third, because top executives of large firms came to believe that they could dictate to their customers what to buy, only to discover that they could not. Fourth, because large American businesses broke faith with their employees, and when employee loyalty was lost, they had nothing with which to replace it. Fifth, because when faced with strategic crises demanding tough decisions, top executives fled into reorganizations, leaving the strategic crises unresolved.

Virtually all of these wounds were self-inflicted. A new generation of chief executives, schooled by the errors of the past and committed to correcting them, has assumed the leadership of large firms, and the strengths of bigness are being reasserted. IBM's experience shows that large companies with established customer bases prosper only when they are responsive to the changing desires of their customers. Hence, each decision must be examined in terms of its impact on customers, no matter how unrelated that decision may seem at first glance. Because the conduct of employees is crucial to customer satisfaction--both in product and service--a company cannot cast away the loyalty of its employees without suffering serious repercussions. When loyalty has been lost, performance must be revived by systems that reward employees immediately for success--not in the longer term, as did employment security.

These lessons learned, large companies can survive and prosper. Business history offers few examples of large-scale turnarounds: Ford in 1945, Pepsi when Don Kendall took over, Xerox in responding to Japanese competition, and perhaps Goodyear in 1993. Will IBM be able to do the same, inventing its own course to revitalization, or has it been so damaged by recent setbacks that it will miss the opportunities now looming before it? It is these questions that this book seeks to answer.

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