Who Says Elephants Can't Dance?: Leading a Great Enterprise through Dramatic Change (20 page)

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The Stack

Leaving Application Software

For most of its modern history, IBM made and sold hundreds of business applications, for customers in industries like manufacturing, financial services, distribution, travel, insurance, and health care.

These were important applications for important customers, yet we were accomplishing little more than losing our shirts. Jerry York conducted an audit that showed over the previous twenty years IBM

had

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invested about $20 billion in application development and acquisition, with a negative rate of return of around 70 percent!

This was—and is—a very specialized segment of the industry: everything from small-business payroll packages to software for automotive design or even the sophisticated software used to simu-late biological and genetic activities. It has always been dominated by entrepreneurial companies that bring obsessive focus to their specialties—such as sales force automation or financial services. Interestingly, nobody has ever succeeded in building a broad portfolio.

When I questioned why we stayed in this business, I was told that application software was critical to the total solution (which was true enough) and that our problems were of execution, and therefore fixable. So we changed executives, tinkered with the strategy, and studied whether we should just buy a few of the best firms in the field. The first candidate was going to be SAP.

Three years, a lot of activity, and a few billion dollars later, we still weren’t solution leaders, and we weren’t getting anything close to a decent return on our huge investments.

However, one thing we
were
doing exceptionally well was irritating the heck out of the leading application providers—companies like SAP, PeopleSoft, and JD Edwards. These companies were in a great position to generate a lot of business for us if they were inclined to have their applications running on our hardware and supported by our services. Why? Because customers often bought the application first, then looked to that software provider to tell them which hardware to run it on. As long as these companies saw us as a rival, we were driving them into the arms of competitors like Sun or HP.

One example: The segment of IBM that produced applications for distribution and manufacturing customers set a stretch goal to increase sales by $50 million (from a base of about $100 million). It ran ads and promotions and sales contests, and it hit its target. In the process, it alienated every software company in that segment of the market. Those companies, in turn, stopped recommending our hard WHO SAYS ELEPHANTS CAN’T DANCE? / 157

ware and contributed directly to a $1 billion decline in sales of one of our most popular products.

By 1999 we were finally ready to admit to ourselves that we could never be as single-minded as application providers that were in business to do just one thing—and do it better than anyone else. We exited application development but saved the very few pieces of software that IBM had successfully developed and marketed in the past. Thousands of software engineers were reassigned to other work, laboratories were closed, and investments were written off or sold.

Important as it was to stop deluding ourselves about our profi-ciency in this part of the stack, just as important was the message that we were prepared to work with the leading application software developers. What we said to them was: “We are going to leave this market to you; we are going to be your partner rather than your competitor; we will work with you to make sure your applications run superbly on our hardware, and we will support your applications with our services group.”

And rather than just having lunch with them and saying “Let’s be partners,” we structured detailed commitments, revenue and share targets, and measurements by which both parties agreed to abide.

The first company we approached was Siebel Systems, which had a leadership customer relationship management software package.

Its CEO, Tom Siebel, was understandably enthusiastic about the prospect of having IBM’s worldwide sales force and services organization marketing and supporting his product. But based on what he’d observed of IBM’s agility (or lack thereof), Siebel told us he doubted we could structure a deal on his timetable. He bet the IBM

team a bottle of fine wine that the whole process would break down due to what he called “cultural impedance mismatch” between Siebel and IBM.

Five days later Tom was picking out a fine Chardonnay. The contract was signed and we announced the relationship and the new alliance program. Over the next two years we signed 180 similar partnerships.

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In hindsight this looks like a no-brainer, given that it dramatically improved the economics of our business and was entirely consistent with our overarching strategy of being the premier integrator. Software companies that in the early 1990s viewed IBM as a major competitor are now very important partners. The amount of incremental revenue we realized is in the billions, and we achieved significant market share gains in 2000, then again in 2001.

The IBM Network

Some may think that the task of moving data from centralized computers to distributed computers, or from one manufacturing site to another, or from one country to another, would be the natural domain of telecommunications companies that had been providing voice transmission for nearly a century. However, until very recently telephone companies had minimal skills in data transmission, and voice services were based on a totally different technology. Moreover, the industry was nationalistic, monopolistic, and highly regulated.

Global telecommunications companies did not emerge until the mid-1990s.

So in the spirit of “If they need it, we will build it,” IBM in the 1970s and 1980s created multiple data networks to allow its customers to transfer data around the globe. We filled an important void.

By the early 1990s, however, the telecommunications companies were shifting their focus dramatically. Driven in part by deregulation, as well as by the revenue potential of digital services, all of the world’s major telecommunications companies were seeking ways to create a global presence, as well as digital capability. In the parlance of both the IT and telecommunications industries, they were talking about moving up the value chain. United States companies that had provided telephone service to customers only in a certain geographic sector of the country were suddenly investing in Latin WHO SAYS ELEPHANTS CAN’T DANCE? / 159

American telephone companies. European telephone companies were joining consortia and building wireless networks in remote parts of the world.

In a period of about twenty-four months, the CEOs of nearly every major telecommunications company in the world traveled to Armonk to talk with me about how their companies and IBM could team up to create digital services. The proposals presented to us ran the full spectrum—from modest joint activities to full-blown mergers.

However, affiliating IBM in one way or another with a telephone company made no sense to me. I saw little to be gained from a partnership with a regulated company in a different industry. Besides that, we had enough problems in IBM’s base business. I wasn’t inclined to take on additional challenges.

What did occur to me was that we had an asset that most of these companies would be seeking to build over the next five years. And if the world was moving in the direction we anticipated—toward a glut of many networks (the Internet wasn’t even an important consideration at the time)—then the value of our network would never be higher. So we chose to auction it off to the highest bidder. We thought we’d be doing well to get $3.5 billion. But the frenzy eventually produced a bid of $5 billion from AT&T; that was an extraordinary price for a business that produced a relatively tiny percentage of IBM’s profits.

This doesn’t mean it wasn’t a good transaction for AT&T. It allowed AT&T to leapfrog its competitors. But for IBM it was a strategic coup.

We got out of a business whose value was going to deteriorate very quickly, as massive capacity was added around the globe. We avoided the huge capital investment to maintain the network. And we exited from another part of the stack that was not strategically vital.

To say there was heavy resistance inside parts of IBM understates the point. People argued, passionately, that we were shortchanging our future. They simply couldn’t see the logic in jettisoning a global 160 / LOUIS V. GERSTNER, JR.

data network when we all believed we were on the brink of a networked world. Once again there was the “Do it all to be the best”

argument. And once again we opted for focus over breadth.

The PC Dilemma

Perhaps the most difficult part of the business that needed to be overhauled during my tenure at IBM was the PC segment of our portfolio. Over the course of nearly fifteen years, IBM had made little or no money from PCs. We sold tens of billions of dollars’ worth of PCs during that time. We’d won awards for technical achievement and ergonomic design (especially in our ThinkPad line of mobile computers). But at the end of the day it had been a relatively unprofitable activity. There were times when we lost money on every PC

we sold, and so we were conflicted—if sales were down, was that bad news or good news?

The single most important factor in our overall performance was that Intel and Microsoft controlled the key hardware and software architectures and were able to price accordingly. However, we weren’t innocent bystanders as they had achieved those dominant positions. We had entered the business in the 1980s with a lack of enthusiasm for the product, as I’ve already noted. We had consistently underestimated the size and importance of the PC market. We had never developed a sustained leadership position in distribution, vacillating between company-owned stores at one time, to dealers, to distributors, to telephone sales systems. Finally, we couldn’t manufacture PCs in a world-class manner in respect to cost and speed to market.

Despite this unacceptable performance, we were never prepared to get out. There were many reasons for this, some more applicable in the early 1990s than they are today. But suffice it to say that, at that time, the PC represented a lot of revenue and critical customer mind-share. In very real ways, a company’s PC drove the company’s image in

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the industry. There were raging internal debates about this, but ultimately we felt we couldn’t abandon the PC completely and still be the integrator we needed to be for our customers.

So we adopted a strategy of playing to our strengths, primarily in mobile computing and in the market for systems that connected other PCs and helped them function in an integrated way. We waited too long to do it, but we finally abandoned the more commodity-like segments, ceasing to sell to consumers through retail stores and shifting more of our consumer business to direct channels such as ibm.com and telesales. Later on we turned over the development and manufacturing of most of our PCs to third parties, lowering our exposure to this segment even further. Still, it’s a spotty record at best, and I am not terribly proud of it.

There were many other steps taken to withdraw from parts of the stack and focus our portfolio. We exited network hardware. Even though we had invented this business, we simply failed to exploit it over the subsequent fifteen or twenty years. We exited the DRAM

business. As mentioned earlier, it is a commodity-based, notoriously cyclical market. Midway through 2002 we agreed to divest our hard-disk-drive business through an agreement with Hitachi. As I write these words, other candidates are under active review. This process of selecting markets and competing on the basis of a distinctive, sustainable competency is essential to the new IBM, and I know it will be an ongoing challenge.

Fallacies and Myths and Lessons

As that work proceeds, it is my hope that the company’s new leaders keep sight of some of the higher-level lessons that resulted from these decisions.

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With os/2-the fallacy that the best technology always wins
.

I can understand why this one, in particular, was hard for IBM to accept. In the early days of the computer industry, systems failed frequently and the winner was usually the one with the best technology. So we came to the OS/2 v. Windows conformation with a product that was technically superior and a cultural inability to understand why we were getting flogged in the marketplace.

First, the buyers were individual consumers, not senior technology officers. Consumers didn’t care much about advanced, but arcane, technical capability. They wanted a PC that was easy to use, with a lot of handy applications. And, as with any consumer product—from automobiles to bubble gum to credit cards or cookies—marketing and merchandising mattered.

Second, Microsoft had all the software developers locked up, so all the best applications ran on Windows. Microsoft’s terms and conditions with the PC manufacturers made it impossible for them to do anything but deliver Windows—ready to go, preloaded on every PC they sold. (Even IBM’s own PCs came preloaded with OS/2

and
Windows!) And in the mid-1980s, the Windows marketing and PR machine alone had more people than IBM had working with software partners or distributors. Our wonderful technology was whipped by a product that was merely okay, but supported by a company that truly understood what the customer wanted. For a

“solutions” company like IBM, it was a bitter but vital lesson.

In the case of application software-the myth of “account control.”

This was a term used by IBM and others to talk about how a company maintained its hold on customers and their wallets. It suggests that once customers buy something from a company, then train their people on that product and get familiar with how to support it, it’s very hard for them to move to a competitor.

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