The Big Blues : After early forecasts of record profits, IBM is singing a different tune.
This is the year IBM was supposed to get its bottom-line act together.
But, barring a near-miracle, International Business Machines Corp. will finish 1989 without matching its record $6.58-billion profit of five years earlier, and without much prospect of doing it next year.
IBM stunned Wall Street last week by announcing that third-quarter profits would be well below earlier estimates, and possibly below the earnings of $1.2 billion for the same period in 1988. Further, the company acknowledged that profits for all of 1989 could dip below the $5.8 billion earned last year.
It was the second time in six months that IBM had jolted investors with news that its profits would be lower than expected. And several analysts fear that, without significant changes, things are going to get worse at IBM before they get better.
“This isn’t the last we’ve heard from IBM on earnings drops,” said Steven Cohen, an analyst with SoundView Financial in Stamford, Conn. “I’m very concerned.”
It’s not that IBM hasn’t tried to boost its profits. Over the last three years, the company has closed several plants, eliminated 6,500 jobs, induced more than 15,000 employees to take early retirement and transferred 20,000 workers from desk jobs to the sales force to trim costs and bring in more business. Taking their cue directly from Chairman John Akers, IBM engineers and sales staffers have been hustling and paying attention to their customers as never before.
But the job of overhauling and refocusing the world’s largest computer maker has proven far tougher than initially anticipated.
“It’s depressing,” said John Jones of Montgomery Securities, a San Francisco brokerage firm. “IBM is on the right track, but the turnaround process is far more difficult than anyone ever imagined.”
Competing on Price
To be sure, IBM is hardly struggling to stay afloat. It is still among the most profitable high-technology companies in the nation and has been actively investing in young companies with promising technologies. But its profit margin is well below that of the early 1980s, and it shows little sign of immediate improvement.
Of particular concern to many analysts is the realization that IBM is increasingly being forced to compete on price, a particularly difficult battlefront for a company whose overhead costs run 50% higher than industry averages.
In the past, analysts say, IBM had competed by claiming that its products and service were superior. But that edge has been eroding, leaving the company to slug it out on price.
Just Tuesday, the company announced rebates, free software and instant credit with the purchase of certain personal computers. It has also cut prices on selected mainframe models and other products.
This year, IBM has also used its vast cash resources to finance an attractive leasing program designed to keep customers from defecting to other manufacturers.
For its part, IBM has blamed its latest problems on a strong U.S. dollar, which diminishes the value of foreign sales; delayed shipments of a new disk drive memory system, and an increasing number of customers deciding to lease equipment, rather than buying it outright. IBM officials declined to be interviewed for this story.
Regardless of the reasons, the results on the bottom line are the same. “If it’s not one thing, it’s another with them,” said Ulric Weil, a computer market analyst in Washington. “There’s always something marring the beautiful picture IBM is trying to draw.” Analysts say the disk drive delay and the planned unveiling of a new top-of-the-line mainframe computer system within the next 18 months have combined with a general softening of the once-torrid buying pace. As a result of the upcoming product transition, customers are more interested in leasing equipment, both to save money and guard against buying machines that will soon become obsolete.
‘Sucker for a Bargain’
And, analysts say, IBM has been more than willing to write those leases, especially at attractively discounted prices. According to SoundView Financial’s Cohen, IBM’s leasing business was 68% higher during the first half of 1989 than in the comparable period last year.
To some analysts, IBM has been fueling demand for its products in the current soft market by making its prices too attractive to ignore, a tactic that may generate sales, but only at the expense of profits. “Everyone is a sucker for a bargain,” said Weil. “Even in a world of tough competition, if you discount enough, someone will take you up on your offer. And you know that if IBM could sell it at full list price, they would.”
Although IBM says the company generates more revenues from a three- or five-year lease than an outright sale, the profits are significantly lower the year the lease is booked, a factor that unnerves short-term investors on Wall Street.
But even for the long term, say some analysts, the trend toward leasing signals an ominous message.
“IBM has been ineffective in differentiating its product from the competition,” said Cohen, “and it’s been forced to resort to competing on price to push its product out the door. The problem is that its costs are too high for this strategy, so its earnings are caught between a rock and a hard place.”
