Big Blue's Big Bet: Less Tech, More Touch
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By STEVE LOHR
The New York Times
January 25, 2004
nytimes.com
PEOPLE tend to underestimate Samuel J. Palmisano, the chairman and chief executive of I.B.M. It's not just that he is an I.B.M. lifer, who joined Big Blue more than 30 years ago and rose through the ranks, while the famous names of the computer industry are mostly entrepreneurial founders - Bill Gates, Steve Jobs, Andy Grove, Larry Ellison, Scott McNealy.
There is also the understandable comparison with Mr. Palmisano's predecessor, Louis V. Gerstner Jr. A respected outsider, whose résumé included RJR Nabisco, American Express and McKinsey & Company, Mr. Gerstner was recruited in 1993 to resurrect a fallen corporate icon. He saved the day, became a celebrity chief executive and wrote a best-selling book about the turnaround. Mr. Gerstner's manner was formal, sometimes curt; his brilliance was obvious, his comments concise, and he led from the front.
Mr. Palmisano, who is 52, is very different, from his body language to his conversation. Where Mr. Gerstner marched down a hall, Mr. Palmisano ambles. Ask him a question, and the reply often includes an informal digression or two. Tall, beefy and relaxed, he looks every inch the former college football lineman he is.
His sense of humor is reflexively self-deprecating. Earlier this month, at an I.B.M. meeting in Las Vegas, he observed, as an aside: "I'd be a lousy politician. I don't have much curb appeal."
But if the style is understated, the moves Mr. Palmisano has made since he became chief executive less than two years ago have been bold, even risky. And if successful, his strategy promises to redefine not only I.B.M., but also what it means to be a computer company - making it far more a side-by-side partner with businesses, helping them improve their marketing, planning, procurement and customer service, rather than merely a supplier of hardware and software.
"The aim is to create a very deep connection between I.B.M. and its customers, and at that level it is a very powerful strategy," said David B. Yoffie, a professor at the Harvard Business School. "But it's making I.B.M. more like a service business with technology thrown in than a technology business."
TO pursue his strategy, Mr. Palmisano needed to add expertise in business consulting and software. The largest purchases came in 2002, when he acquired PricewaterhouseCoopers Consulting for $3.5 billion and Rational Software for $2.1 billion.
More fundamental changes have come in the last year, and some are just now falling into place. In particular, I.B.M. has shaken up its software, services and research divisions. With the addition of PwC Consulting, the big I.B.M. services unit is more focused on executive-level business consulting instead of traditional technology services, like managing data centers for corporate customers.
This year, the 38,000 people in I.B.M.'s software group are being reorganized and retrained to focus on making and selling products tailored to the most common business problems of 12 major industries, including banking, insurance, automobiles, utilities, consumer packaged goods, telecommunications and life sciences.
Likewise, the 3,000 researchers in I.B.M.'s labs are moving well beyond the hard science of making computers and programs run faster and more efficiently. They are also focusing on solving business problems and modeling patterns of human behavior, giving their work more of the flavor of social science. "I think it's a huge opportunity, but it is also a huge cultural change in research," said Paul M. Horn, the director of I.B.M. labs.
Mr. Palmisano's strategy is an aggressive effort to climb quickly up the economic ladder to the higher ground of the technology business, where profit margins are fatter. In part, the plan is a response to the industry trend of intensifying price competition in traditional hardware and software, which have become more like commodities, with slender margins. I.B.M. cannot sustain itself as a supermarket of technology, not with 316,000 employees worldwide and annual research and development spending of $5 billion. The Dell model of being a hyper-efficient distributor is not for Big Blue.
"Either you innovate or you're in commodity hell," Mr. Palmisano explained during a 90-minute interview at the company's headquarters in Armonk, N.Y. "If you do what everybody else does, you have a low-margin business. That's not where we want to be."
The rapid pace of change in computing also means that I.B.M. must not only shift its technology portfolio but also constantly fine-tune its work force. The company plans to transfer 3,000 jobs overseas, many of them white-collar jobs like computer programming, to lower-cost labor markets like India and China.
But I.B.M. also says it will add 4,500 jobs this year in the United States, including programmers with specialized skills. Over all, the company intends to hire 15,000 workers worldwide, lifting its payroll above 330,000 for the first time since 1991. I.B.M. says it will spend $800 million this year on employee education. "This is a human capital business," Mr. Palmisano said.
Left unsaid is the sometimes wrenching fact that the human capital market is as global as I.B.M.'s business. Sixty-two percent of I.B.M.'s $89 billion in revenue last year came from outside the United States, and 57 percent of its work force is abroad.
If Mr. Palmisano's overhaul of I.B.M. proves successful, Big Blue could gain a long-term competitive advantage, as it did from big bets of the past, like its pioneering mainframe computers in the 1960's. For I.B.M., the strategy also moves the center of gravity in its relationships with corporate customers further from its traditional mainstay, the mainframe, and closer to business consulting services.
THE mainframe business is still a lucrative legacy for I.B.M., and an estimated two-thirds of the software sold by the company runs on its mainframes. But that franchise will surely erode further over time, and I.B.M. needs a new basis for securing and maintaining its relationships with big corporate customers, many of which spend hundreds of millions of dollars a year on I.B.M. offerings.
Mr. Palmisano's answer is to use the business consulting arm of I.B.M. Global Services to cement customer relationships. That, in turn, will pull in plenty of hardware and software sales - or so goes the thinking.
Some large customers who have watched the new game plan unfold are impressed both by its scope and its early impact. "Sam Palmisano took a real gamble with a strategy that changes how I.B.M. does business," said Raymond E. Gogel, chief information officer of Xcel Energy, the nation's fourth-largest oil and gas utility, serving millions of customers in 11 states.
Xcel, based in Minneapolis, is a big I.B.M. customer, spending more than $100 million a year, and Mr. Gogel met with Mr. Palmisano three times in the last year. "You talk to Sam and you feel the passion he has to return I.B.M. to its halcyon days, but in a new guise," Mr. Gogel said.
Mr. Palmisano likes to say that his plan is bold but not really risky because I.B.M. is just following customer demand. Companies are less enamored of technology itself than in what technology can do for them - the practical benefits, or solutions, he says. That is certainly true, but the strategy is still a gamble, industry analysts say.
One risk is technical - specifically, that I.B.M. can accomplish as much with software as it has set out to do. The development and spread of Internet-based software standards in recent years has opened the door to greater efficiency and cost-cutting opportunities in computing. Software using these standards can be thought of as the geeky glue that allows proprietary systems to talk to one another, sharing data and workloads. It helps make corporate data centers more nimble and flexible, and it is a crucial technology behind I.B.M.'s new ability to offer corporate data processing as a pay-for-use service, much like an electric utility.
That is the easier part of what I.B.M. calls its on-demand strategy, and all of its rivals - Microsoft, Hewlett-Packard, Sun Microsystems and others - are employing these Internet software standards to help corporate customers cut costs. But I.B.M. wants to go much further by trying to capture in software some of the things businesspeople actually do - like sifting and analyzing information - and automate it. This is where much of the I.B.M. research effort comes into play and involves sophisticated text analytics, modeling, simulation, mathematical optimization and the like. And for this to really pay off for I.B.M., the ideas and techniques developed for one customer have to be useful for an entire industry or several industries.
I.B.M.'s research gurus are confident that they can deliver on the promise to bring this kind of clever technology out of the labs and into the marketplace. "The on-demand strategy has fairly crisp technical roots," said David McQueeney, a physicist and former head of the company's lab in Zurich, who is now vice president of technology assets in I.B.M.'s services unit. "It wasn't dreamed up by the marketing guys."
For his part, Mr. Palmisano acknowledges the ambition of his design. "We have the capability," he said. "Now we've got to make it real for the client. That's hard. I understand it; that's the challenge of this thing."
The other risk for I.B.M., analysts say, is that its timing may be a bit off. The company, they say, is promoting adventurous new uses for technology services at a time when corporate customers are still engaged mainly in cutting costs. "I.B.M. is ahead of the trend," said Thomas Bittman, an analyst at Gartner, the research firm. "The problem I.B.M. has is that they've focused mostly on the part customers aren't so interested in yet."
So why not take a more cautious, step-by-step path? "Not for me!" Mr. Palmisano replied emphatically.
With business technology spending finally showing signs of picking up, and I.B.M. reporting strong quarterly results two weeks ago, Mr. Palmisano's vision seems less an against-the-grain bet than it did when the company trotted out its notion of on-demand computing in the fall of 2002.
Back then, the PwC Consulting deal had just closed, and Mr. Palmisano wanted to explain to customers and others where he thought I.B.M. and the industry were headed. Inside the company, he sought to communicate that I.B.M.'s recent moves signaled not only a shifting of its portfolio of businesses but also a new direction.
In an e-mail message to his senior management team on Oct. 29, 2002, Mr. Palmisano wrote: "While they share many attributes, there is one thing that sets all great companies apart - they define and lead the agendas for their industries. This has been a hallmark of I.B.M. throughout its history.''
"We now see an opportunity to set the agenda again," he added. He concluded: "I am confident that we are on the verge of the next great opportunity for our company, and for the entire information technology industry."
A day later, Mr. Palmisano announced the on-demand campaign to an audience of corporate customers, industry analysts and journalists, at the American Museum of Natural History in Manhattan. Next, I.B.M.'s huge advertising budget - $500 million a year - began promoting "e-business on demand."
Initially, rivals heaped derision on the marketing campaign. Then most of them mimicked it. These days, Hewlett-Packard speaks of its corporate offerings as its "adaptive enterprise initiative"; Microsoft says its offerings will make companies "agile" businesses; and Computer Associates simply copied the "on demand" phrase.
In late January 2003, I.B.M. held its annual worldwide management committee meeting at a company conference center in upstate New York. At the two-day session, there was a lengthy discussion of how to harness the company's resources around the on-demand vision - until Mr. Palmisano cut it short. "I was listening very patiently, and they were very sincere," he recalled. "These are some very good people." But all the discussion was about internal moves.
So he told everyone to go out and talk to customers about their most nettlesome business problems, and to try to figure out how I.B.M. might be able to help solve them. "If they got out there and actually solved the problem with the client,'' he said, "they would understand what we needed to do."
They found that a team approach was required, typically involving the sales executive in charge of a corporate account, a representative from the services division, a person in the software unit and, increasingly, someone from the research labs. At I.B.M., this team approach is called "four in a box." Previously, the common pattern had been "two in a box": a sales manager and a services person.
THE reorganization of the company's software around 12 industry groups grew out of those meetings with clients. The hardware systems business is following suit, tailoring its server computers with specialized features for specific industries like telecommunications and banking.
"So once they all got into the marketplace, they all saw it and it just took off," Mr. Palmisano said. When the management committee holds its yearly meeting this week, internal organization, he noted, will not be on the agenda. "For us to deliver the value of on demand, we had to reintegrate I.B.M.," he said. "That's really what we've been doing for the last 15 months."
His guiding of the changes inside I.B.M. illustrates his management style. "I know a lot of C.E.O.'s like to say, 'I'm driving this,' " he said. "Well, with 316,000 brilliant people in 165 countries, I ain't driving much. I just try to lead them and get them to come together around a common point of view."
How does that point of view translate into reality in the marketplace? Consider the case of FinnAir, the Finnish airline. I.B.M. sold mainframes to it for decades and has run its data center operations since 2001. Last spring, I.B.M. began going further: its services and research labs started working with FinnAir on a project to use mathematical modeling and optimization algorithms to try to increase customer loyalty, reduce marketing costs and improve response rates among members of its frequent-flier program - the 10 percent of its travelers who account for more than half of the airline's revenues.
The program involves processing huge amounts of customer data and using sophisticated math techniques developed by I.B.M. researchers to predict how the frequent fliers behave. FinnAir is pleased with an initial project involving half of its frequent fliers. Eero Ahola, senior vice president for business development and strategy, says the technology has reduced marketing costs by more than 20 percent and improved response rates by up to 10 percent.
"That can be huge money in the airline business," Mr. Ahola said. "And it's done with mathematical modeling. We could never do it ourselves."
Such work, he added, shows another step in the evolution of FinnAir's relationship with I.B.M. "They've gone from being a supplier to our data center to a partner," Mr. Ahola said. "It's a totally different relationship."
The praise is nice, but a company of I.B.M.'s size needs a lot of wins to generate growth. Indeed, the central question asked on Wall Street is whether Mr. Palmisano's services-led strategy has the growth potential of a conventional technology business when its products are selling well.
When I.B.M. announced solid quarterly results 10 days ago, the services division - which now accounts for about half the company's sales, doing everything from repairing machines to advising chief executives -reported that its revenue slipped by 1 percent, if you ignored the currency gains from a weak dollar.
Not to worry, I.B.M. said, pointing to strong gains in signing up customers for the kind of research-dependent deals, like the one with FinnAir, that should begin to really drive growth this year and next.
Lou Gerstner brought I.B.M. back from the brink. It was a fight for survival and relevance in the industry, helped by shrewd decisions and boom times in the late 1990's. Sam Palmisano, who rose from sales representative to run most of I.B.M.'s major units, has a very different mission and style. He has made some huge bets in the midst of the technology slump, trying to position the company for long-term strength. He has harked back to the old team values of I.B.M, going so far as to put half of his bonus last year, about $4 million, in a pool to be shared by the company's other senior managers.
LAST summer, Mr. Palmisano asked I.B.M. employees to share their thoughts online about what the company's future values should be. The results were distilled to three: customer relationships, innovation and trust. Mushy stuff, cynics say, but they touch on a home truth of the technology business: Corporate customers don't so much buy technology products, since the technology changes so fast, as invest in a relationship with a trusted supplier.
Mr. Palmisano's strategy is to make I.B.M., more than any other, that company. I.B.M. will probably never return to anything like its days of dominance in the 1960's and 70's. Yet if Mr. Palmisano succeeds, his I.B.M. could be one that enjoys prosperity for years. |
