Big Blue Wields the Knife Again

To wrest profits from its ailing IT-services business, IBM is slashing its North American workforce and finding efficiencies overseas

by Steve Hamm

On the surface, IBM seems to be cruising. Its stock is trading near a six-year high, at almost $106, and its overall financial performance has been improving steadily for more than a year. On May 29, the company raised this year's per-share earnings forecast after stepping up a stock repurchase plan.

Yet the company is battling a bugbear that keeps it from breaking out and prevents the stock from really soaring. Ironically, its problem is with the $48 billion-a-year business that saved it from ruin in the 1990s: IT services. What was once IBM's (IBM) growth engine seems to be turning into a chronically slow-growing, low-margin drag on the rest of the company.

Fresh evidence of IBM's trouble with services came May 30, when the company revealed that it had just eliminated 1,573 services jobs, mostly in North America, bringing to 3,023 the total jobs cut in the high-cost region this quarter alone. That's a small percentage of the company's total workforce of more than 355,000. Yet when weighed against rapid growth in low-cost India, where the staff topped 53,000 at the beginning of the year, the cuts underscore the biggest challenge facing Big Blue: the Indian tech industry.

Indian Rivals Force Change

IBM remains the No. 1 tech-services company in the world, with 7.2% of the market last year, but its share slipped from 7.5% in 2005, according to Gartner Dataquest (IT). India's tech-services exports grew 32%, to $31 billion last fiscal year, ended in March, and are expected by analysts to top $60 billion by 2010. With a combination of low labor costs, high quality, and efficiency in how it handles jobs, the Indian companies have forced IBM and other Western services giants to fundamentally restructure the way they do business and massively shift work offshore. "The Indians are doing to the world's IT processes what the Japanese did to manufacturing," says analyst John McCarthy of Forrester Research (FORR).

IBM's answer isn't as simple as moving more jobs offshore. The company has developed a system that lets it shift work to the areas with available skills at the lowest-available costs. The goal is to deliver higher-quality services at competitive prices. "Clearly one opportunity associated with globalization is costs," IBM Chief Executive Samuel Palmisano told a gathering of stock analysts on May 17. "You have access to expertise wherever it is in the world—if you have the infrastructure and the relationships to take advantage of it."

Continuing Trend

Job reductions are nothing new for IBM's huge global-services workforce, which has been under the knife continuously in the past two years. The cuts started when IBM, shocked by very poor results for the first quarter of 2005, began a major restructuring in Europe and the U.S. that eliminated 15,000 jobs in a matter of months. Ever since then, every few months, a new batch of jobs is trimmed from high-cost countries, including 700 in the first quarter of this year.

The trend is likely to continue. In the first quarter, the largest chunk of the services business, called Global Technology Services, grew a relatively healthy 7%, but its operating margin narrowed, shrinking by 2.5 points to just 7.8%. In comparison, the top Indian services outfits have operating profits of between 25% and 30%.

And their quarterly revenues are growing 30% to 40% year over year. IBM "is in a transition," says S. Padmanabhan, an executive vice-president at Tata Consultancy Services, India's largest IT-services firm. "We have been doing this for over 35 years, and it has taken a lot of intellectual capital to fine-tune the process. It's taking these companies time to reach our level of maturity."