Strategic Analysis IBM Corporation 1986-2006

Executive Summary
This paper analyzes the strategic environment and moves of the IBM Corporation over a period of 20 years (1986 to 2006). The IBM Corporation experienced quite a turbulent ride during this period: From most admired company in 1984 to almost dead in 1993 From regaining customer and shareholder confidence in 1993 to a company that matters again in 2001 From mattering again in 2001 to building a new model for growth in the 21st century During this 20 year timeframe, three CEOs played a significant role in leading the company. Under John F. Akers (1986-1993), IBM lost customer and shareholder confidence, posted big losses and laid off almost half of its workforce, mostly due to lack of competitive spirit, lack of customer focus, complacency and arrogance. IBM made a remarkable turnaround under Louis V. Gerstner Jr. (1993-2002), IBMs only outside CEO to date. By differentiating IBMs portfolio, a strong and solid vision for the future (integration, ebusiness), and corresponding moves into high-profit software/middleware and high-growth services, together with a significant culture change, IBM became again a company that matters by the turn of the century. IBM definitely and successfully competes on value again. This revival was further emphasized in the following years by the strategy under Samuel J. Palmisano (2002 and onwards, on demand business, consulting). IBM has consistently built high-value businesses though software and services acquisitions (Lotus, Tivoli, Informix, Rational, PriceWaterhouseCoopers-Consulting, and more), IBM exited non-core businesses in network equipment and application software, and moved away from commoditization sectors through divestments of e.g. its global network to AT&T, disk drives to Hitachi, PC division to Lenovo. This paper analyzes the three periods in detail, and looks primarily at IBMs software and services businesses. Several frameworks for analyzing its strategic moves have been applied. With this renewed focus on differentiation and added value for its clients. It has moved away from commoditization businesses to stay as much as possible out of grip of e.g. Dell, HP, Microsoft, Oracle, EDS and CSC. Its global presence, strong brand, strong sales force, loyal partner channel and complete suite of IT products and services make it a mighty competitor. However, many challenges remain: the company has had trouble showing organic growth, has difficulties penetrating the Small and Medium Business segment, and is threatened by Open Source substitutes in its software portfolio and imitation by the big application vendors.

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Table of Contents
EXECUTIVE SUMMARY ............................................................................................................................. 2 TABLE OF CONTENTS................................................................................................................................ 3 1 2 2.1 2.2 2.3 2.4 2.5 3 4 5 INTRODUCTION............................................................................................................................ 4 IBM'S STRATEGY ......................................................................................................................... 4 IBM BEFORE 1986 .............................................................................................................................. 4 1986-1993: D ECLINE OF A MONOPOLIST, NEAR DEATH EXPERIENCE ...................................................... 5 1993-2002: R EBUILDING A COMPANY THAT MATTERS, DIVERSIFICATION .............................................. 5 2002-2006: SUSTAINING GROWTH AND SHARPENING FOCUS ................................................................. 7 2006 AND BEYOND .............................................................................................................................. 8 IBM SOFTWARE GROUP ............................................................................................................. 8 IBM GLOBAL SERVICES ............................................................................................................. 9 SUMMARY AND CONCLUSIONS.............................................................................................. 11

REFERENCES ............................................................................................................................................. 12 APPENDIX ................................................................................................................................................... 13 EXHIBIT 1. IBM HISTORICAL REVENUES, PROFIT, EMPLOYEES AND STOCKHOLDERS ........................................ 13 EXHIBIT 2. IBM HISTORICAL REVENUES AND PROFITS (1986-2005)................................................................ 14 EXHIBIT 3. IBM HISTORICAL STOCK PRICES .................................................................................................. 16 EXHIBIT 4. MACRO E NVIRONMENT ANALYSIS (PEST) .................................................................................. 17 EXHIBIT 5. MESO E NVIRONMENT A NALYSIS (F IVE FORCES/V ALUE NET )........................................................ 18 EXHIBIT 6. MICRO E NVIRONMENT ANALYSIS OF IBM ................................................................................... 19 EXHIBIT 7. SUSTAINABILITY A NALYSIS TETRA THREAT MODEL .................................................................. 20 EXHIBIT 8. VALUE CHAIN A NALYSIS OF IBM BUSINESS U NITS ...................................................................... 21 EXHIBIT 9. TIMELINE OF IMPORTANT EVENTS FOR IBM (1980-2006).............................................................. 22 EXHIBIT 10. A BRIEF HISTORY OF IBM.......................................................................................................... 23 EXHIBIT 11. IBM STRATEGY AS OF 2006 ...................................................................................................... 26 EXHIBIT 12. IBM SOFTWARE PORTFOLIO...................................................................................................... 27

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1 Introduction
This paper analyzes the strategy of the IBM Corporation over a period of 20 years (1986-2006). More specifically, it focuses in the last 10 years on one of the IBM business units, the IBM Software Group and its strategic importance to the corporation as a whole. Another significant move is briefly touched upon, namely IBMs commitment to IT services (and the corresponding IBM Global Services organization). I have chosen IBM for two reasons: 1. I have worked for several years for IBM in the Netherlands. This may on one hand give me an advantage in knowing the company and parts of its history, but on the other hand it allows me a moment to reflect on the big picture of the companys strategy. 2. The twenty year period has been quite a turbulent ride for IBM, with ups and huge downs, important reorganizations, turnarounds and strategic repositioning, which provide some very interesting insights.

2 IBM's Strategy
IBM started almost a century ago, with punched card data processing equipment, has evolved to a dominant player in mainframes in the midst of the 20th century, and still is known for late but very successful entering of the PC business in the early eighties, to give its dominance away later to other PC players. Certainly, the past twenty years have been a turbulent ride for the company, and based on Figure 1 below, which plots the IBM Return on Assets and Invested Capital, and the IBM share price, this period can be subdivided in three different discernable phases: 1986-1993 : Decline of a monopolist, near death experience 1993-2002 : Rebuilding a company that matters, diversification 2002-2006 : Sustaining growth and sharpening focus Coincidentally or not, these periods match with three different CEOs, being John F. Akers, Louis V. Gerstner Jr. and Sam Palmisano, respectively. Below, a brief early history, the three mentioned phases and an up-to-date reflection on its strategy will be discussed separately.
20,00% 15,00% 10,00% 5,00% 0,00% -5,00% -10,00% -15,00%
ROA ROIC

Figure 1. IBM Return on Assets (ROA) and Return on Invested Capital (ROIC) and share price (US$) for the period 1985-2005 For each of the above mentioned periods, detailed analysis of strategy (macro, meso, micro and dynamics) has been done in this paper. Results are shown in Exhibits 4,5,6 and 7 in the Appendix. Hereafter, an overview and highlights of the strategy are given per period.

2.1 IBM before 1986

IBM's history dates back decades before the development of electronic computers before that it developed punched card data processing equipment. It originated as the Computing Tabulating

1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005

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Recording (CTR) Corporation, which was incorporated on June 15, 1911 in Binghamton, New York. This company was a merger of the Tabulating Machine Corporation, the Computing Scale Corporation and the International Time Recording Company. The president of the Tabulating Machine Corporation at that time was Herman Hollerith, who had founded the company in 1896. Thomas J. Watson Sr., the founder of IBM, became General Manager of CTR in 1914 and President in 1915. In 1917, the Computing-Tabulating-Recording Company entered the Canadian market under the name of International Business Machines Co., Limited. On February 14, 1924, CTR changed its name to International Business Machines Corporation. IBM or Big Blue could have been effectively described as a near monopolist in the computer market, although it competed in some areas with around eight other computer companies (UNIVAC, Burroughs, Scientific Data Systems, Control Data Corporation, General Electric, RCA and Honeywell). Most of these competitors have vanished over time, and practically non of them exists today. See Exhibit 10 for a more detailed history of IBM.

2.2 1986-1993: Decline of a monopolist, near death experience

Please refer to Exhibits 4,5,6 and 7 for detailed strategic analysis of the period. These years can effectively be described as the after days of monopoly. Under CEO John F. akers, IBM still had a significant stronghold in mainframes. IBM entered late in the PC market in the early eighties, but gained ground quickly due to the pact with Intel and Microsoft. However, the contract with these parties paved the way for dominance of the Microsoft/Intel duo in the PC market, opening the doors for new entrants like Compaq, HP, Dell, and many other smaller players14. In the meantime mainframe substitute players in the so-called open systems arena (Unix, Wintel, ) also started to erode IBMs mainframe business (Sun Microsystems, Digital, DEC, HP). 1 In the years 1991-1993 IBM posts big losses (see Exhibit 1), with the $8.1 billion in 1993 the biggest corporate loss in history (at that time). Clearly, IBM had run into a crisis, and there are many different factors that have contributed to this1: The near monopoly in mainframes had strong influence on the company strategy and culture High R&D expenditure, slow to market Complacency, arrogance and complexity within the organization (slack) Lack of customer orientation Lock-in of customers Unsatisfied customers Antitrust lawsuits Results on performance IBM Return on Assets sharply declines (from +10% to -8%, see Exhibit 2), and IBM shares plummet in the beginning of the nineties (from US$40 to US$25, see Exhibit 3).

2.3 1993-2002: Rebuilding a company that matters, diversification

Please refer to Exhibits 4,5,6 and 7 for detailed strategic analysis of the period. In 1993, Louis V. Gerstner Jr. comes on board, as the first outside IBM CEO, having served for McKinsey & Company and American Express. He was said to be hired to split up the company in healthy parts. Soon after his entry, he realized that IBM had most to offer its customers by its total solutions. Gerstner restructures the company significantly. With 214.000 people, the IBM workforce is in 1994 almost half of what it was in 1986, and many employees are sent home with large golden handshakes (which constitute the majority of the financial losses of 1993). Gerstner realizes the need for diversification in the new IT industry and redefines the IBM portfolio. The core of IBMs business remains servers (and the cash cow the mainframe, still today). But to the hardware offerings also new open systems are added. Gerstner sees great strategic opportunity for

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the future in services. Because of the new modular way of customer buying behaviour of IT systems and software, there will be huge demand for integration, implementation and consulting services. The newly formed IBM Global Services division is the growth engine of the IBM Corporation for the next decade or more. Then, Gerstner also decides to form an separate Software Group division, which specializes in socalled middleware, the layer between applications and the operating system. Similar to the services view, Gerstner sees future need for companies to integrate diverse IT systems and application. The strategic acquisitions of the Lotus Corporation in 1995 and Tivoli in 1996, and the existing strength of IBM in middleware applications and database in the mainframe space, define a significant IBM Software Group (effectively then, and still today, the second largest software company in the world, after Microsoft). The figure to the right gives a schematic interpretation of the attractiveness around 1995 of the three businesses/sectors, and IBMs capabilities. At the same time, Gerstner decides to focus, and exits the application software business, because this is not a core competence of IBM, and this field is dominated by SAP, Siebel, Baan, JD Edwards, PeopleSoft, . Instead, IBM will partner with these companies, to sell infrastructure, middleware and services together with these application vendors (complementors). At first sight, these moves into software and services may seem quite bold. However, IBM sold a lot of software and services as part of the (outrageously priced) mainframes for years. According to Gerstner in 1990, if it had had a separate software entity, IBM would have been the largest software supplier in the world in terms of revenue1. The challenge lay in the fact that the software unit would have to be run as a software business, and IBMs software had to opened up to the rest of the IT world, so that it could operate with and on other systems and software. This signified a dramatic change in working for IBM and its employees. Services were bundled normally with the hardware, but now the newly formed IBM Global Services organization and its professionals, integrated competitors products, all or not with IBM products. IBM guaranteed a certain independence, which was and still is not always completely believed by its clients, as there is a fear of being run over by a train of IBM representatives, products and services.5 The Internet (and IBMs corresponding e-business view, companies integrated end-to-end over the Internet) was the major driver for both the Software and the Services businesses. IBMs own transition and cost cutting in its own decentralized IT automation and its consolidation and standardization experiences in its internal global IT operations, laid the foundation of a global outsourcing and transformation practice for its clients. By eating its own cooking, IBM boosted revenues from its (global) enterprise customers through large scale consolidation, outsourcing activities (operations, applications, and even business process outsourcing and business transformation outsourcing contracts).7 The new IBM, with its diversified portfolio, was now quickly #1 (services and hardware) or #2 (software) in all its major practices (the GE way). IBM competes again on value and moved away from commodity businesses (like networking equipment) and divested its Global network operations to AT&T in 1998. See Exhibit 9 for a complete list of acquisitions and divestitures. The companys culture was one of the strongest known in US organizations. However, the culture was severely in need of a makeover. Complacency, internal rivalry and arrogance needed to make place for customer dedication, competitive spirit and trust and responsibility in all relationships. Gerstner formed new governance models and new and fresh management teams that helped him implement this desperately needed change.

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A value based player needs to do R&D and be innovative, in order to stay competitive in the future. IBM continued to invest a significant portion of its revenues (about $5 billion, or 7%) in R&D, accelerating innovation and time-to-market, and building an 11 consecutive year record of the largest number of filed US patents. Furthermore, IBM opened op much of its technology (hardware and software) to its partners and competitors. This started an effective era of copetition, which successfully grew the pie for all parties, whereas IBM was able to make extra money of its R&D activities. IBMs R&D efforts have led to significant breakthroughs, even Nobel prizes, beating the best human chess player Kaparov with an IBM parallel computer in 1997, creating new semiconductor technologies, quantum computing breakthroughs, building supercomputers of more than 100.000 processors, leading edge processor technology in its servers, and being monopolist in todays gaming consoles, designing and manufacturing the processors in the Microsofts Xbox 360, Nintendos GameCube and Sonys PlayStation 3. Results on performance IBM Return on Assets sharply increased (from -8% to +10%, see Exhibit 2), and IBM shares surge again, outpacing the Dow Jones Industrials and other indices (from US$25 to US$130, see Exhibit 3). IBM is hit by the collapse of the dot com bubble, but far from as hard as many of its competitors. Historical figures of all IBM divisions can be found in Figure 4 and Table 1 of Exhibit 2.

2.4 2002-2006: Sustaining growth and sharpening focus

Please refer to Exhibits 4,5,6 and 7 for detailed strategic analysis of the period. Samuel J. Palmisano takes over the CEO responsibility in 1992, an IBM salesman with more than 35 years of duty. Shortly after his official appointment, IBM announces that it will acquire PriceWaterhouseCooper-Consulting (PWC-C) for $3.5 billion, which it will integrate in its Global Services Business Consulting Services department. This is a very interesting move, that builds on the Gerstner strategy in terms of value based competition, cementing its lead over competitors as HP (which bidded for PWC-C, too a year before for $17 billion!), Dell and services companies as Atos Origin, EDS, CSC, Capgemini, 5 Palmisano effectively strengthens IBMs focus on high-value solutions (like consulting, total solutions, outsourcing, ..), mostly in the enterprise space, IBMs stronghold. There is a push towards the so-called Small and Medium Business segment (SMB), but true success remains unachieved in this area. In 2003, Palmisano also decides to divest the harddisk drive business to Hitachi, with whom it already had a joint venture. But plain disk capacity is commoditizing rapidly and margins are low. IBM continues to make (enterprise) storage systems and software. IBM had already moved out of most consumer businesses, but with the 2004 divestiture of IBMs PC business to the Chinese company Lenovo, the only (partial) remaining consumer activity is history as well. The latter move again signifies IBMs strategy to move away from commoditizing businesses: its PC business of about $10 billion a year made approximately only 1% profit, and was outperformed by Dell and HP for years already. Palmisano also re-establishes IBM Corporate Values (in a new form), which focus on innovation, dedication to client success and trust and responsibility. Again this emphasizes focus on differentiation, creativity and high value for customers, employees and IBM shareholders.

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The new vision, building on Gerstners e-business, now is on demand business: An On Demand Business is an enterprise whose business processes integrated end-to-end across the company and with key partners, suppliers and customers can respond with flexibility and speed to any customer demand, market opportunity or external threat. Sam Palmisano described it as follows : On Demand Business is our way of describing a fundamental shift in computing architecture and how it is applied to business a shift toward integrated solutions and quantifiable business value, not just technology features and functions. . Again this vision signifies focus on value, differentiation and innovation, towards clients, employees and shareholders. The new CEO does not go without worries though, although Return on Assets and profitability (Exhibit 2) increase, revenue stagnation seems to be a major issue. More specifically, organic growth seems unachievable. Despite moves to penetrate the Small and Medium Business segment effectively, the company does not really succeed, and the complexity of its partners/alliances and copetition strategy make significant growth difficult. Results on performance IBM Return on Assets stays relatively constant (around +10%, see Exhibit 2), and IBM shares stay flat around US$80 (see Exhibit 3). Organic growth is the major challenge for the company. Historical figures of all IBM divisions can be found in Figure 4 and Table 1 of Exhibit 2.

2.5 2006 and beyond

IBM describes its vision as follows : IBM strives to lead in the invention, development and manufacture of the industry's most advanced information technologies, including computer systems, software, storage systems and microelectronics. IBM translates these advanced technologies into value for our customers through its professional solutions, services and consulting businesses worldwide. More details on IBMs strategy for 2006 and beyond (from Annual Report 2005) is described in Exhibit 11. Hardware revenues and growth are solid (according to Gartner 2005, IBM is still leader in terms of revenue with 32% market share). The low-end space is dangerous because of commoditization by players a Dell and Sun. Intel servers cannibalize the midrange Unix systems and even mainframes. For the software and services businesses a closer look is taken in the next two chapters.

3 IBM Software Group

Lou Gerstner installed the IBM Software Group as a separate entity in 1995. IBM had offered a lot of software with its mainframes, but most of it was closed and proprietary. Through steady internal development and select acquisitions over the past several years, IBM has become the leader in enterprise-class middleware, which helps companies integrate and manage their operations. An important differentiator for IBMs software business today is that it is entirely built on open standards, supporting a wide variety of hardware platforms and applications. This gives IBM clients flexibility and choice, and makes it easy for them to integrate their infrastructure and business operations. The major software acquisitions by IBM in the past have been : Lotus in 1995 for US$3.5 billion, Tivoli in 1996 for US$0.7 billion, Informix in 2001 for US$1 billion, Rational in 2002 for US$2.1 billion and Ascential 2005 for US$1.1 billion. See Exhibit 12 for an overview of IBMs software portfolio. Because of the high margin on software products, the IBM Software Group contributes a significant portion to the overall profitability of the company (about 30%, whereas the revenue portion is only about 17%). See also Exhibit 8 for Value Chain analysis of the different IBM businesses. With the new Software Strategy, an effective era of copetition has started for IBM. It sells its middleware directly to enterprises, through resellers and Independent Software Vendors (ISVs), and has it integrated by its own Global Services organization or other IT Services companies.

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The portfolio today is vastly different from its inception in 1995, and revenue has grown van $11 billion to almost $16 billion. IBMs view on its competitive conditions The company operates in businesses that are subject to intense competitive pressures. The company's businesses face a significant number of competitors, ranging from Fortune 50 companies to an increasing number of relatively small, rapidly growing and highly specialized organizations. The company believes that its combination of technology, performance, quality, reliability, price and the breadth of products and service offerings are important competitive factors.

IBM Software

According to IBM itself, the software market is highly competitive. The above figure graphically depicts how IBM Software is squeezed between three forces: First of all, other important players in the middleware/applications market challenge the IBM products like databases, application servers, . (Microsoft, Oracle, Computer Associates, BMC, BEA, Symantec). Secondly, large application builders such Microsoft, Oracle and SAP, are pushing their software downward to the middleware market to expand their portfolio and to try to control standards (imitation) And last but not least, the substitute Open Source movement offers free, or at least very low priced software and support with freely accessible, community developed Open Source alternatives (like Sendmail, JBoss, MySQL, ). These forces will likely make it difficult for IBM to sustain growth of its software revenue and capture its added value in the future. Potential price erosion may take place. However, the Software portfolio has very strategic implications, and certainly is one of the big drivers of profitability in the near/medium future.

4 IBM Global Services

The IT services sector is huge (about US$560 billion in 2002 according to Gartner, approaching US$1 trillion by 2010). Since the inception of IBM Global Services under Gerstner in 1996, this division has been the growth engine of IBM (see Exhibit 2), creating significant shareholder value.

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IBM Global Services ranks as the largest IT services provider in the world, and its US$3.5 billion acquisition of PWC-Consulting has only cemented its position at the top of the market7. The PWC-C takeover came at a time when IBM Global Services is feeling the pinch as clients freeze their discretionary IT services spend, and look to renegotiate the terms of their existing outsourcing deals. The close to US$40 billion revenues that IBM GS generated accounted for 40% of IBM's total 2001 sales and the services division currently has 180,000 employees. Its activities range from product support, implementation, project management and application development to activities in consulting and outsourcing (operational, business process outsourcing, business transformation outsourcing). IBM Global Services has many competitors (EDS, CSC, Accenture, Atos Origin, CGEY, ). But unlike these competitors, which are for the most part specialized service providers, IBM Global Services has an unparalleled potential to leverage products, research and talent from the various other business units of its parent. The flipside of this proposition is the wariness of customers over sourcing hardware, software and services from one company, despite the fact that IBM Global Services employs more third-party equipment than it does IBM's own. Again, the copetition strategy of IBM gives a significant share to its Global Services arm on implementing both IBM and non-IBM products. On the other hand, the fact that other IT services companies compete with Global Services, often results in technology choice of products competing with IBMs portfolio. The strategy has turned out to work very successfully over the past 10 years, but there already signs of stagnation because of this complex competitive force field.

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5 Summary and Conclusions

After losing its dominant position in the IT industry in the late 1980s, resulting in a near-death experience in 1993, IBM has made a remarkable turnaround under Lou Gerstner. By differentiating its portfolio, a strong and solid vision for the future (integration, e-business), and its corresponding moves into high-profit software/middleware and high-growth services, together with a significant culture change, IBM is again a company that matters at the turn of the century. IBM definitely and successfully competes on value again, and this is emphasized in the following years by the strategy under Sam Palmisano (on demand business, consulting). IBM has consistently built high-value businesses though acquisitions (Lotus, Tivoli, Informix, Rational, PWC-C, ), exited non-core businesses in network equipment and application software, formed alliances with most major IT product and services companies and strategically moved away from commoditization businesses through divestments (Global network to AT&T, disk drives to Hitachi, PC division to Lenovo). However, challenges remain for the company in several areas : It proves to be difficult for the company to sustain organic growth. Stagnation in software and hardware sales, and even in some of its services business force it to look in new sectors The sheer size and corresponding complexity of the organization make it hard to define a consistent way for growth and competition. In many areas IBM lives in copetition with almost all other IT companies. The hardware business is threatened at the bottom by Dell and Sun, with low-cost Intel systems The software business is threatened from three different angles : traditional competitors, application vendors moving down to middleware, and substitute Open Source products. Services business seems to be stagnating, possibly due to shrinking IT budgets of its clients, or more demanding and savvy buyers. Offshoring companies, especially Indian ones, provide a competitive threat to IBMs outsourcing and offshoring business, although IBM has successful alliances with these companies and large activities in India itself. Potential areas for growth: One of the potential areas for growth is the Small and Medium Business (SMB) segment, where there is huge opportunity. However, IBMs traditional stronghold in high-end and enterprise solutions, do not make it necessarily suitable for this segment. Moreover, it meets strong competitors like Microsoft, Oracle, Dell and many services companies that have a strong and successful focus on this segment. Emerging countries (China, Brazil, Russia, India, Eastern Europe,) still provide opportunities for growth, and many ongoing activities are already taking place. Other areas could be grid computing, supercomputing, gaming, IBMs R&D activities and its strong services arm will need to drive future innovation and growth. Whether shareholder value can be increased (and the $100 billion revenue threshold exceeded), remains to be seen

END OF REPORT

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