IBM's 21st Century Transition Is Failing

By Peter E. Greulich :

Some investors attribute IBM's ( IBM ) poor 21st Century performance to a short-term technology lapse. They believe that if IBM can just get its technical mojo back - in areas such as cloud, security, data, analytics and mobile - it will recover. These investors are waiting on that one announcement that will make a difference: chip technology, medical acquisition or IBM's Watson. Unfortunately for these investors, the 20th Century IBM was never a centralized, one-trick technology pony. It was a decentralized, constitution-driven, independent-thinking corporation. As a $100 billion corporation, it will not find continual growth in a handful of technologies. A Hail Mary technology may postpone the predictable, but it will not prevent the inevitable. IBM needs execution. It needs constant invention, innovation and motivation from its 400,000 employees, not more directives from Armonk.

Other investors believe IBM's technology is its protective moat. But the substance of the company's moat mystifies those that were never employed by, or a customer of, the 20th Century IBM. Its moat was its culture. This cultural moat protected any cracks in IBM's technology walls - and there were always cracks. It was a culture of customer service; a culture of employee respect, enthusiasm and dedication; a culture of resolute, long-term minded investors; and a culture that society respected and supported. This moat has been drained by an unrelenting me-first and -only executive strategy that has failed all of IBM's stakeholders.

Let's summarize a few of these failures from my previous Seeking Alpha articles.

IBM's 21stCentury executives are...

...failing to provide an attractive return(for full article click here)

What have the last two Chief Executive Officers returned for a $1,000 investment in their leadership and strategy? How does that compare with an investment with less risk?

Sam Palmisano kept his investment community in suspense for almost a decade. After investing, on average, $10 billion a year every year in corporate stock, he finally managed - in his last year as CEO - to beat a simple large company stock index.

His ten-year record is one of consistent stock underperformance.

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It is difficult to put the word growth on Virginia M. Rometty's chart.

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She is retracing the steps of John F. Akers in the late '80s. John Opel, IBM's CEO in 1984, promised - as he walked out the door - a 100-billion IBM by 1990, and a 180-billion IBM by 1994. On those words, the company's market value peaked in 1985 at $96 billion, only to start a disastrous seven-year plunge to $29 billion. It was seven years of shareholder misery with Wall Street calling for the breakup of IBM into baby blues because "the pieces have more value than the whole." Akers' successor made the best intuitive call of his executive career. IBM still exists today because Gerstner refused to heed the hue and cry of Wall Street.

Sam Palmisano attained his 2010 Roadmap in 2009 - one year ahead of schedule. This is a salesman's tactic of "controlling expectations." Unfortunately, in May of 2010, he set an unachievable expectation in a second roadmap for his successor. As he walked out the door barely into the second full year of his 2015 Roadmap, he reiterated promises of at least $20 EPS in 2015. Mrs. Rometty finally abandoned his roadmap, but continues the same 21st Century strategy. She still prioritizes corporate paper over people, products and processes.

Every investor should hang in their home office, "Past performance does not guarantee future returns." Every CEO should hang in their corner office, "Investment insanity is repeating a losing investment strategy over and over again and expecting a different result."

Increasing shareholder risk(for full article click here)

IBM's percentage of goodwill from acquisitions is approaching 30%. Although its pace of acquisitions slowed in 2014, the percentage of goodwill associated with these acquisitions continued to rise. If revenue and assets drop again in 2015, or if the acquisition pace picks up, goodwill could conceivably go over the 30% mark.

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This acquisition activity not only competes with IBM's internal organic research and development, but also, more clandestinely, increases a long-term shareholder's investment risk. Shareholder risk has been trending the wrong direction for an extended period of time. If you are a short-term, play-the-market type, these are fun times - wager away. Just remember that when you place your bets, only a panhandler can manufacture food and drink from goodwill.

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Failing its business(for full article click here)

In 1964, the company's leadership bet the business and invested in people, products and processes. It was called the System/360 and it was more than a technology investment: it involved spending four times more per square foot on manufacturing space than the competition; it involved reorganizing, retraining, and reorienting its entire sales organization around an industry model; it meant building international communication networks between worldwide engineering teams before there was an Internet; and it involved creating new technology, some of which had to be invented along the way. The market rewarded IBM for its $5,000,000,000 gamble - an expenditure that was 9.50 times its 1966 net income.

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The 21st Century cloud-centric environment is the reassertion of technologies that IBM - at one time - dominated: centralization of processing power, centralization of storage, manipulation of data, security-first architectures, fail-safe networking and analytics. The company just needed to keep advancing its legacy core competencies but it couldn't because IBM's leadership was starving the business. Instead of following Watson Jr.'s example, IBM's 21st Century leadership spent $158,000,000,000 on paper - an expenditure of 9.59 times its 2013 net income. IBM's leadership did not miss the cloud, it walked away from it in pursuit of the wrong priorities - shareholder-first and -foremost. A billion here and a billion there will not get the company its technology leadership back.

Louis V. Gerstner, as CEO, wrote to the IBM shareholders in 1998 and 1999 that market value is, "the most important measure of progress to investors." It is the market's trust and confidence index. The following chart is a sixteen-year, investor-driven, public appraisal of IBM's leadership:

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IBM's market value is down by twenty percent since 1999 but, ironically, it is actually higher now than five of the ten end-of-year market valuations under Sam Palmisano. The stakeholders - shareholders, customers, employees and society - have been speaking. But IBM's top leaders and the board of directors have not been listening. Instead they have been trying to compensate with share buybacks. Additionally, since 2002, the number of individual stockholders in IBM has plunged by a third - 32.6%.

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Although many individual investors now get their exposure to IBM through mutual funds, they get it by default. There is no direct vote of confidence in the corporation. One has to go back a half century to find fewer direct investors in IBM - 359,495 in 1967. Even in stocks, basic economics applies: reducing the supply of stock is of little benefit if demand is weak. The problem with IBM's value in the marketplace is the individual investor's lack of confidence in it as a safe haven.

What would best support IBM's stock price is not less inventory but more demand.

Failing its customers and employees(for full article click here)

Finally, IBM's executive leadership has failed their customers and employees. It is impossible to find a time when Tom Watson Sr. addressed IBM's shareholders and did not talk about their customers and employees. On his way to the 1948 shareholders' meeting, he and his wife traveled 6,500 miles by car and personally shook the hands of 15% (2,850 employees) of the IBMers in the United States. What he learned on these excursions with his corporate-family he discussed with his shareholder-family.

In contrast to the Watson style, IBM's current leadership is avoiding this discussion. In 2010, it promised a "more contemporary approach" in gathering employee morale information. In 2011, it removed all auditable, externally-assessable data on employee morale from its Corporate Responsibility Report. In its place, the management offered the platitude that it "must hire, support and retain great employees." Shareholders must accept the blame for not requiring this promised information. And they need the information as the board of directors are evidently not watching out for their interests.

Customers and employees are tightly woven together into the fabric of a successful corporation. If the employee does not accept a personal ownership for customer satisfaction, it will always be an issue. IBM's 20th Century first-line sales managers told their sales reps, "Do what is right by the customer and we [first-line management] will do what is right by you." Ultimately, everyone knew that their paychecks and promotions depended on customer satisfaction; and first-line managers were empowered to do what it took to preserve it.

IBM faces deteriorating employee and customer satisfaction because it acknowledges nothing detrimental and over-centralizes everything.

The best news is net income. Unfortunately, the bigger they are...

The company is profitable, so it does not have to suffer the same transition pains as in past years. But history shows that disasters can strike quickly.

In 1921, Watson Sr. experienced his disaster. To avoid bankruptcy, he implemented layoffs and stopped product development. Following this near-death corporate experience, he ran a fiscally conservative corporation. He did stretch the company during economic downturns though. He established two hallmark recessionary traditions: maintain performance-based full-employment and double-down on research and development. In 1964, Watson Jr. made a high-risk bet on the S/360, and because of sloppy inventory accounting, faced his worst nightmare. He was within weeks of missing payroll. As he wrote in Father, Son & Co ., he "unexpectedly" sold $370 million of IBM paper to keep moving forward. And his resilient, long-term shareholders were ready to buy.

In 1991, John Akers' disaster found him. In the previous eight years, IBM had averaged $5.5 billion in net income. It was a cash machine that faltered in 1991 - to the tune of $9 billion. Over the next few years, as he lost confidence in his supporting culture, the company again came within weeks of not making its payroll.

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But after a leadership change, the business recovery was swift. The cultural moat may have been weakened, but it was still a thing of beauty - providing an $11 billion swing back to profitability in one year.

When to consider investing again

A leadership change

The next opportunity for a significant upward change in IBM's stock price will come with new leadership. Looking at the market's reaction during IBM's 1993 leadership change, there appears to be no need to "catch the bottom" or buy its stock before a change is announced. the company's early '90s short-term market gyrations flatten out in the expanse of a six-year road trip back from the brink.

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IBM's 21st Century return will probably take longer this time as it requires a rejuvenation of its culture. IBM has lost its institutional memory. It no longer remembers what made it one of the 20th Century's greatest capitalist institutions: a work family of employee-owners - guided by a corporate constitution - who made every day decisions as if they carried the owners' burden. It will take a new leader with a new philosophy to change IBM, and he or she will need the right stuff.

The board of directors need to realize that today's IBM is the IBM of 1914, not the IBM of 1993. What Watson Sr. said of the 1914 IBM, he could easily say of the 2015 IBM: there is little enthusiasm. It will require a leader with an internal fortitude and dedication only surpassed by his or her willingness to recognize and share credit. Lou Gerstner could not turn around today's IBM as its internal social structure, its morale, and its personal reward system are a mess. Ultimately this is the long-term fruit of his cultural changes - extended to their logical conclusions by his successors.

A strategy change

Louis V. Gerstner implemented a strategy that added IBM's knowledge worker to its list of interchangeable components. Starting in 1999, a decentralized, performance-based, human- relations system that retained the best and brightest for decades, was gradually replaced with a centralized, financially-based, human resources system that encourages experience to stand near an exit door. Its profit model is based on human interchangeability and expendability, regardless of position. Programmers, technical writers, product and market managers, product testers, systems engineers, salesmen, architects, first-line managers, low-level executives and distinguished engineers are all replaceable. If the financial organization doesn't like the price of human capital in Raleigh, it moves the workload to Ireland. If it doesn't like the price of human capital in Ireland, it moves the workload to Kuala Lumpur. If it finds cheaper human capital in Africa, it moves the workload out of Kuala Lumpur.

IBM's financial organization, using human resources as its blunt instrument, shifts workloads worldwide for quick financial gains - ignoring long-term corporate costs such as deteriorating product quality and falling customer and employee satisfaction. The Chief Executive Officer and the Board of Directors of the last two decades display a complete lack of understanding of the value of the individual - especially their knowledge workers. Lose the knowledge worker and, eventually, you lose your intellectual capital, energy and enthusiasm. This is the long-term cost of IBM's 21st Century strategy.

Even with new leadership, until there is a clearly-articulated, externally-accountable strategy that puts people, processes and products first, invest skeptically.

IBM's 21st Century transformation is failing

IBM is failing all its stakeholders. It will continue to fail until its leadership once again understands basic human motivation. Tom Watson Sr. and his son built the 20th Century IBM by understanding what motivates a person beyond a paycheck. It was these human motivations that Peter F. Drucker captured in The Concept of the Corporation : a corporation is a social institution and a community, and it needs to be managed as such. Peter Drucker, if he were alive today would call IBM a "social mess." Although corporations can change quickly, human beings evolve; so what worked just a few decades ago will still work today.

IBM's 21st Century leadership is a failure in every respect except one: enriching the top-level executives at the expense of all other corporate stakeholders - customers, employees, long-term shareholders and society. Until IBM has a new strategy that invests in people, products and processes; until it displays the desire and the ability to rebuild a positive corporate culture; and until the company's leadership abandons its shareholder-first and -only strategy, it will be unable to refill its moat or rediscover its technical mojo.

Wait for a leadership change; wait for a social change; then IBM will be a long-term investment again. With these two changes, IBM can come back. It will come back.

It just needs a driven, selfless, business-focused 21st Century leader - much like the ones that took charge in 1914 and 1956.

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Peter E. Greulich is an author, publisher and public speaker. He has written two books on IBM and three essays on Thomas J. Watson Sr.'s leadership during the Great Depression. His latest book,A View from Beneath the Dancing Elephant: Rediscovering IBM's Corporate Constitution is a sweeping historical look at IBM that puts a spotlight on its current human-resource practices in light of IBM's time-tested human-relationship achievements. All of Pete's perspectives are from beneath the dancing elephant - the perspective of an employee-owner. It is a different perspective from Louis V. Gerstner's Who Says Elephants Can't Dance.

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The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

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