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IBM’s Shift to Information Services a Model for New Era

The transformation of International Business Machines from a fading giant of the computer industry to a growing global power in information services is one of the great business stories unfolding at the turn of the century.

IBM now gets more than half of its roughly $90 billion in annual revenue from services and software, and only 43% or so from sales of the hardware--computers and components--that used to be its mainstay.

And the predominance of services will only grow in the coming years, as information technology spreads through every industry worldwide.

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The term “services” is deceptively simple. In the new era in which companies rely on information links with customers and suppliers as much as financial links with bankers and investors, services means integrating new computer-communication systems with older systems. It means preparing companies for Internet commerce--devising capabilities, training personnel, assuring system security.

Information services is a vast and rapidly growing business on which corporations, governments and other institutions worldwide will spend $317 billion this year, according to analyst A.M. Sacconaghi Jr. of the Sanford M. Bernstein research firm in New York.

By 2003, Sacconaghi estimates, such service expenditure will grow to $467 billion, as information technology becomes the chief focus of business consulting services.

Four years from now, IBM’s yearly revenue from services and software will total $74 billion, Sacconaghi predicts. The company is already the world leader in IT services, well ahead of competitors EDS, Fujitsu, Andersen Consulting and many others.

An earthquake has occurred. The shift at IBM reflects a change in the strategies a company must follow to be successful in the new era.

In the industrial period just ended, companies tried to hold customers to their product line and theirs alone. IBM above all sought to bind customers to its Big Blue computers and the related software and services it alone could supply.

But in the new era of business, companies specialize in products and services in which they have an edge, and collaborate with others--even with competitors--to augment their strengths. IBM sells services, software and even hardware through others as well as on its own.

This year alone, the big company entered long-term agreements to supply components for Dell Computer even as IBM continues to offer its own PCs. It formed a venture with Cisco Systems to supply networking processors through Cisco, the leading seller of Internet routers and communications systems.

In a sense, the business strategy of “build a better mousetrap and the world will beat a path to your door” is being replaced by “find a customer with mice and sell knowledge of mouse behavior, trapping methods and the efficiency of cats.”

Credit for the change at IBM goes to Chairman Louis V. Gerstner Jr., who took over a sputtering behemoth in 1993 when revenue was flat and profit was declining.

Gerstner saw that IBM was a storehouse of technology and knowledge, thanks to expenditures on research and development--$5.3 billion this year--larger than those of most global businesses. But it wasn’t getting a sufficient return on that R&D; investment. By restricting exploitation of IBM’s knowledge only to what could accompany sales of computer hardware, IBM was losing out to more flexible companies, such as Compaq Computer, Dell, Intel, Microsoft and Cisco.

Gerstner, a onetime management consultant at McKinsey & Co. with an engineering degree, set out to reinvent the giant company.

The moves he made were not simple. He didn’t slash personnel: IBM has 33% more employees today, at 290,000-plus, than it had five years ago.

He pulled the company together. It had been decentralized in many divisions because of fears dating to the 1970s that government antitrust action would break it up.

Gerstner saw companies doing all sorts of transactions on the Internet--placing orders with each other, billing, financing, communicating constantly. The services they needed to make such transactions possible, from guaranteeing privacy and security to boosting speed and breadth of communications, were growing geometrically.

“We’ll see the emergence of electronic marketplaces that will have tremendous discontinuities” with the way business has been done, Gerstner said in a recent BusinessWeek interview.

His reinventions have worked so far. IBM revenue has risen 45% and its net income more than 100% over the last six years. The stock price, adjusted for splits, has climbed more than sevenfold.

To be sure, IBM has its skeptics and Gerstner his critics. Some industry observers see IBM’s ventures with competitors as surrender of its technological birthright.

Critics of Gerstner, such as consultant Bob Djurdjevic of Phoenix-based Annex Research, jeer that IBM’s stock price has been boosted by repeated repurchases of shares, which gives an artificial boost to earnings per share.

But it would be remarkable if such an important company did not spark arguments. And in some cases, Gerstner’s shift of strategy made a virtue of necessity: Lumbering IBM loses hundreds of millions of dollars a year in personal computers; deals with competitors reduce the bleeding. And keeping the support of Wall Street investors while reforming a giant company dictated stock buybacks.

But that financial engineering stage is now about over. Wall Street wants to see revenue growth as proof that the business is attracting new customers.

At this point, sophisticated analysts of technology agree with IBM’s vision that the Internet will transform industry in the next century.

Paul Saffo, a director of the Institute for the Future in Menlo Park, Calif., foresees “Internet LBOs.” Within traditional companies all over the world, there are operations suited for Internet commerce, Saffo says. Such operations will be spun out for separate management.

IBM, with its deep knowledge and resources, will help develop and manage such Internet businesses, as in a recent deal it made to take on Internet operations for the Carrier air conditioning division of United Technologies.

This emblematic company of the 20th century has reinvented itself before. In the 1950s, Thomas Watson Jr. reshaped the company for the coming of the computer. And in 1914, management of a firm called the Computing-Tabulating-Recording Co. was taken over by Thomas Watson Sr., who renamed it grandly, International Business Machines. Reinvention is good for long-distance runners.

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Soft Blue

The shift in IBM’s business from a dependence on sales of hardware (large and small computers and components) for most of its annual revenues to services and software (preparing computer systems for electronic commerce) has been dramatic. The chart contasts software and service revenue with that from hardware as a percentage of IBM’s total revenue--which this year will total more than $90 billion.

Sources: IBM; Sanford M. Bernstein


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