Who Says Elephants Can't Dance?: Leading a Great Enterprise through Dramatic Change (13 page)

From what I can tell, there was little benchmarking of IBM’s practices vis-à-vis other companies. In a sense IBM
was
the benchmark and decided on its own what it wanted to do.

Basically it was a family-oriented, protective environment where equality and sharing were valued over performance-driven differentiation.

I was well aware of the strong commitment IBM held for its employees long before I joined the company. However, as good as it might have been during IBM’s heyday, the old system was collapsing amid the financial crisis that preceded my arrival. Tens of thousands of people had been laid off by my predecessor—an action that shocked the very soul of the IBM culture. The year before I arrived, limits were put in place on future medical benefits, setting the stage for cost sharing by employees and retirees—another very difficult break with the past for IBMers.

The old system was not only out of touch with the realities of the marketplace, but it was unable to satisfy the paternalistic underpinnings of the historical IBM culture. Consequently, it made fixing the WHO SAYS ELEPHANTS CAN’T DANCE? / 95

company very difficult and made employees sad and cynical. We needed a whole new approach—and we needed it fast.

Pay for Performance

We made four major changes to our compensation system, and I’ll describe them in a moment. Behind all of them was a fundamentally different philosophy than what had been followed in the past, best described in this list:

OLD

NEW

Commonality

Differentiation

Fixed rewards

Variable rewards

Internal benchmarks

External benchmarks

Entitlement

Performance

This was all about pay for performance, not loyalty or tenure. It was all about differentiation: Differentiate our overall pay based on the marketplace; differentiate our increases based on individual performance and pay in the marketplace; differentiate our bonuses based on business performance and individual contributions; and differentiate our stock-option awards based on the critical skills of the individual and our risk of loss to competition.

Let me comment now on a few of the specific changes we made.

Stock Ownership

Have you ever wondered where the Watson family fortune is?

Certainly Mr. Watson, Sr., who started at the company in 1914, and his son, who was CEO during the great growth phase of the company (with both of these tenures added together, they ran the company for

96 / LOUIS V. GERSTNER, JR.

fifty-six consecutive years), had the opportunity to amass a net worth on the order of the Fords, Hewletts, and Waltons. Surely there could have been a Watson Foundation as powerful as the Ford Foundation or the Hewlett Foundation. But there was no such aggregation of wealth!

Why? It appears that both Watsons had strong views that limited their ownership of IBM stock. Tom, Sr., never owned more than 5

percent of the company and refused to grant stock options to himself or other executives. He liked cash compensation and was paid a salary plus a percentage of the profits of the company.

Tom, Jr., started a stock-option program in 1956, but it was limited to a very few executives. Regarding his own ownership, in his book,
Father, Son, and Co.
, he stated that he stopped taking options in 1958

(he was CEO until 1971), believing that his $2 million worth of options at that time would be worth tens of millions of dollars in the future.

Apparently he felt that was enough.

It appears that for Tom Watson, Jr., stock options were intended solely to reward executives—and not to link executives to the company’s shareholders. In fact, in the aforementioned book, he stated that “the model corporation of the future should be largely owned by the people who work for it, not by banks or mutual funds, or shareholders who might have inherited the stock from their parents and done nothing to earn it.”

While I think Tom Watson and I share a lot of common beliefs (in particular, our passion for winning), here we part ways.

I wanted IBMers to think and act like long-term shareholders—to feel the pressure from the marketplace to deploy assets and forge strategies that create competitive advantage. The market, over time, represents a brutally honest evaluator of relative performance, and what I needed was a strong incentive for IBMers to look at their company from the outside in. In the past, IBM was both the employer and the scorekeeper in the game. I needed my new colleagues to accept the fact that external forces—the stock market, competition, the chang

WHO SAYS ELEPHANTS CAN’T DANCE? / 97

ing demands of customers—had to drive our agenda, not the wishes and whims of our team.

However, beyond their role as a connector to the outside world, stock options played an even more important role in my early days at IBM. I had made the decision to keep IBM together. Now I had to make that decision pay off. I just told you about the role that organization and branding decisions played in supporting this integration strategy. Nothing, however, was more important to fostering a one-for-all team environment than a common incentive compensation opportunity for large numbers of IBMers—an opportunity that was heavily dependent on how the overall corporation performed. I repeatedly told my team that we don’t report software profits per share or PC profits per share—only IBM consolidated profits per share. There was only one financial scoreboard, and it was the stock price reported every day in the media. People had to understand that we all benefited when IBM as a whole did well and, more often than not, lost out when we functioned as a disjointed operation.

Consequently, we made three big changes to the IBM Stock Options Program. First, stock options were offered to tens of thousands of IBMers for the first time. In 1992, only 1,300 IBMers (almost all high-level executives) received stock options. Nine years later, 72,500

IBMers had received options, and the number of shares going to nonexecutives was two times the amount executives received.

I want to emphasize that the decision to make options widely available to employees is not a general tenet of my personal management philosophy. In fact, I am not a fan of corporate plans that promise a minimal grant of options to every employee in a company.

Most employees view such options as nothing but a delayed form of salary. As soon as they can, they cash them in.

However, IBM is different—perhaps from any other company in the world. As I said earlier, it has, for the most part, a single class of knowledge workers. Second, it does not have multiple businesses.

It has one gigantic, $86 billion business.

Engineers, marketers, designers, and other employees around the 98 / LOUIS V. GERSTNER, JR.

globe had to act in sync if we were going to pull off the integration of IBM. I had to have all these people thinking as one cohesive unit, and granting stock options to thousands of them would help focus attention on a common goal, a common scorecard of performance.

I needed to convince IBMers they were better off working as a singu-lar enterprise—one team and not separate fiefdoms. If I could not do that, my entire strategy for turning around the company would fail.

The second decision regarding stock options involved executives, and it was far more straightforward: We made stock-based compensation the largest element of executives’ pay, downplaying annual cash compensation relative to stock appreciation potential. This is part of my management philosophy. Executives should know they don’t accumulate wealth unless the long-term shareholders do the same.

The third, and final, decision regarding options was also based on a view I hold very strongly. Executives at IBM were not going to be granted stock options unless they concurrently put their own money into direct ownership of company stock. We established guidelines that effectively said: “You have to have some skin in the game.” No free ride.

E X E C U T I V E S T O C K O W N E R S H I P

G U I D E L I N E S

The value, in U.S. dollars, of the IBM stock you are expected to own is determined by your position and a multiple of your combined annual base salary and annual incentive at target: POSITION

MINIMUM MULTIPLE

Chief Executive Officer

4

Senior Vice President

3

Other Worldwide Management

2

Council Member

Other Senior Leadership Group

1

Member

WHO SAYS ELEPHANTS CAN’T DANCE? / 99

Every executive had to be in the same position as a shareholder: stock up, we’ll feel good; stock down, we’ll feel pain (real pain—not the loss of a theoretical option gain). I bought stock repeatedly on the open market in the early days, because I felt it was important to have my own money at risk.

A Distasteful Necessity

One historical footnote on the subject of stock options: In 1993 I used options in a way I find personally distasteful, but which was necessary because of our financial crisis. I realized that I had no holding power over key technical and managerial talent at IBM and that our competitors were systematically raiding us to grab our best people. I knew that at the time it was important to reduce our overall number of employees, but in a crisis it was even more important to retain our most promising people.

I looked around for choices, one of which would have been to introduce new stock options for key people. However, no shares were available under the existing stock-option plan, and the only way to get them would have been to call a special shareholders’ meeting.

After the contentious Tampa shareholders’ meeting, imagine my asking IBM shareholders for yet another meeting solely to approve more stock for management!

I decided to offer the people we most wanted to retain an opportunity to turn in their basically worthless existing options for new, lower-priced options. I loathe doing this because rewriting the rules halfway through is not the way to play the game, but I was able to overcome my personal bias by setting very specific terms that I believe, in light of the dire circumstances, made this a viable and appropriate program for shareholders at the company at that time.

And we excluded senior executives. They had played a role in creating our prob

100 / LOUIS V. GERSTNER, JR.

lems. They had to keep their old options at the old prices and work to solve the problems.

This was a very important and successful program. I can’t give specific numbers, but I know it helped to retain a lot of important people who had been tempted to join competitors but are now in leadership positions at IBM. Also, it sent a message to everyone—including the executives who were excluded—that we really intended to tie our performance to share price and that we wanted to align our interests directly with those of the shareholders. And, finally, it sent a message, the first of many to follow, that compensation at IBM

was going to be performance-based, not simply length-of-employment-based.

Other Changes

I’ve described in detail the changes made to the stock-option program principally because I wanted to underscore my belief that you can’t transform institutions if the incentive programs are not aligned with your new strategy. I’ll conclude this chapter with a description of several other changes we made to bring the compensation system in line with the new IBM.

Prior to my arrival, bonuses were paid to executives based solely on the performance of their individual units. In other words, if your operation did well but the overall corporation did poorly, it didn’t matter. You still got a good bonus. This encouraged a me-centered culture that ran counter to what I was trying to create at IBM.

Therefore, beginning in 1994, we instituted a huge change. All executives would have some portion of their annual bonus determined by IBM’s overall performance. The most unusual part of this plan involved the people who reported directly to me—the highest-level executives, including those who ran all our business units.

From then on, their bonuses were to be based
entirely
on the company’s overall performance. In other words, the person running the Services

WHO SAYS ELEPHANTS CAN’T DANCE? / 101

Group or the Hardware Group, had his or her bonus determined not by how well the unit performed, but by IBM’s consolidated results. Executives at the next level down were paid 60 percent based on consolidated IBM results, 40 percent on their business unit results.

The system cascaded down from there.

Of all the changes I made in 1993 and 1994, nothing else had the impact that this move had in sending a message throughout the company: “We need to work together as a team. Gerstner’s not kid-ding. He really wants us to make integration the centerpiece of our new strategy.”

We made a similarly bold statement to our employees. In the mid-1990s we introduced “variable pay” globally across IBM. This was our way of saying to all IBMers that if the company could pull off its turnaround, each and every one of them would share in the rewards.

Over the next six years, $9.7 billion was paid out to IBMers worldwide (with a few exceptions in countries where this program was not permitted by law).

The variable pay amounts were also tied directly to overall IBM

performance to ensure that everybody knew that if they worked hard at collaboration with colleagues, doing so would pay off for them.

The final change we made was the least strategic but the most controversial: paring back the paternalistic benefits structure. We did not undertake these changes because we thought the highly generous support system was bad per se. Believe me, I would have loved to continue the employee country clubs and the no-cost medical plans. We cut back on these plans because the company could no longer afford the level of benefits. The high profit margins of the 1970s and 1980s were gone—forever. We were fighting for our lives.

None of our competitors offered anything close to the IBM benefits package. (Even now, after all the changes we made, IBM benefits programs are among the most generous of any United States-based multinational corporation.)