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New focus at IBM

Sunday, April 23, 2000

Cleveland Plain Dealer
By Zach Schiller

For a month now, FirstEnergy Corp. has allowed its electricity customers to pay their bills online.

Thinking it might make a big acquisition last year, National City Corp. simulated whether its computer systems could handle a doubling of their regular volume of transactions.

Working with Neoteric Solutions Inc., an electronic-commerce company in Hudson, Lehman’s Hardware in Kidron upgraded its Web site to make its catalog for non-electric appliances and other goods more appealing and easier to maintain.

What do these local business moves have in common?

International Business Machines – its technicians, its testing center, and its software for conducting business on the Web, respectively.

Increasingly, this is what IBM wants to be, on a global scale: A seller of services and software, focused especially on helping customers conduct business electronically. That’s what Chairman Louis V. Gerstner Jr. will undoubtedly stress at the company’s annual meeting at the Renaissance Cleveland Hotel downtown on Tuesday.

The company moves its meeting around to different cities to allow more shareholders the opportunity to attend.

This year, it meets amid turmoil in the financial markets that has blown a hole in the strategies of many Internet start-ups. While that has made giant, profitable IBM look solid by comparison, the world’s biggest information technology company has been traveling a pretty bumpy road itself as it tries to lead the way into electronic business.

Gerstner was an early convert to the importance of the Net for companies to operate their businesses. “He was singing the Internet song well before many were singing it,” said James E. Bennett, senior executive vice president at KeyCorp, who worked at the consulting firm McKinsey & Co. when Gerstner was there.

Still, Big Blue has yet to prove it can grow consistently at something approaching the industry rate of 11 percent to 13 percent a year.

Belted by a Year 2000 spending slowdown, lately it hasn’t been able to come close to its goal of increasing revenues in the high single digits. Analysts disagree over whether it will be able to do so long-term.

While top rivals such as Sun Microsystems managed major sales gains in the first quarter, IBM saw its revenues fall 5 percent, to $19.3 billion.

Central to its woes is the computer hardware business that made it famous, but sales of software and services also were level with the year-earlier quarter.

IBM’s revenues flattened in the third quarter of last year. In October, it warned that it would see weaker sales and earnings for two quarters because of customers putting a hold on purchases while they made sure they could cope with possible Y2K problems. And its stock fell 9 percent last Wednesday, the day after it reported higher earnings but lower sales in the first quarter.

The company attributed slow sales to the same lockdown of customer computer systems. But it also cited two other factors: a set of moves it took to improve its long-term position in various hardware operations and an unexpected slip in its business selling hard disk drives.

IBM boosted its profits 3 percent in the quarter, especially by chopping administrative and sales costs. And Chief Financial Officer John R. Joyce told Wall Street analysts last week that the company was “well positioned for double-digit revenue and earnings growth in the second half” of 2000. He counseled them not to change their estimates for the full year.

J. Bruce Harreld, senior vice president for strategy, is enthusiastic about the fast growth in many of IBM’s e-businesses, which now account for something like a quarter of its sales. “I like our hand [there],” he said.

Gerstner injects discipline Though IBM means computers to most people, more and more it also means multiyear service contracts like those at Bank One and Sumitomo Metal Industries, where the company has taken over running computer operations. IBM also means software, such as its WebSphere, which KeyCorp is considering to help build systems such as Internet banking and online brokerage. And it means chips and disk drives it sells to other computer and electronics companies.

That’s the strategy fashioned by Gerstner, the brand man who left the top job at RJR Nabisco to take over a reeling IBM in 1993. “Many people said at the time the IBM job was not doable,” said KeyCorp’s Bennett.

Since Gerstner arrived, shareholders of the Armonk, N.Y., company have done fabulously: Shares have risen eightfold. Gerstner, 58, also has been well rewarded, cashing in options worth $87.7 million last year.

Gerstner peeled off nonstrategic businesses, beefed up the company’s software presence and services sales, reorganized its sales effort and reoriented the company around building computer networks for the big corporate customers that had always been its bread and butter.

Purposeful and demanding, he injected new discipline into IBM. Bennett knew him as smart and intense. “He’s not a warm and cuddly guy,” Bennett said.

At first, Gerstner also hacked away at jobs, cutting employment by tens of thousands before more recent increases. “We have a total focus on all aspects of cost,” CFO Joyce said last week.

Moving to the Internet

One way it’s doing so is by going to the Net itself. IBM bought products worth $13 billion over the Internet last year. It has saved $9 billion since 1995 through online procurement, chopping paperwork, inventories and the time it needs to forecast demand.

That’s not the only way it’s integrating the Internet into its own business. Last year, IBM sold $14.8 billion of its products and services over its Web site http://www.ibm.com/us/en and elsewhere on the Net. Click a button on the site, and someone will call you back in five minutes, a popular feature for those with only a single phone line.

The company is busy digitizing the flow of information around IBM so that salespeople meet in two-way e-meetings, and employees can enroll for medical benefits online.

“We’re eating our own cooking,” said John R. Patrick, vice president of Internet technology.

According to Patrick, people are only using the Internet for 2 percent or 3 percent of all the things they will eventually be able to do online. “We haven’t seen anything yet, compared to what we’re going to see,” he said.

Though attention focused earlier on companies that sold to consumers over the Web, it has become clearer in the past few months that the biggest part of the Internet’s growth will come between businesses. “It will happen behind the scenes,” Patrick said. “Most of it won’t even involve people interacting with Web sites, but Web sites interacting with Web sites.”

Forrester Research Inc. estimates that by 2004, businesses will buy and sell $2.7 trillion with each other that way – 17 percent of all their transactions. Though the recent gyrations of stock prices for technology companies have signaled that many dot-coms may flounder, few question that over the long-term businesses can improve their efficiency using the Net.

IBM’s giant base of computers at the world’s biggest companies gives it a natural position for leveraging as those companies scramble to develop Net strategies. The $3 billion in e-business services it sold last year, said Susan Miranda, president of IT Services Advisory LLC in Hillside, N.J., was twice that of its top rival, Andersen Consulting.

“That’s for good reason,” said Miranda. “Look at their installed base. Every one of their customers is coming into some kind of e-business platform, and IBM is right there to help them.”

Big Blue as integrator IBM looks to advise big companies what their Internet strategies should be, help craft the solutions, offer hardware and software to make them work and run the systems for them through its Web-hosting centers, where row upon row of computers allow Web sites to accommodate millions of hits an hour.

“I would say what’s unique about IBM is that we are the integrator,” Patrick said. “We know how to put the pieces together and make it work. … The hardware, software, consulting, the systems integration planning, financing, education for the user … we do all those things.”

Big Blue has scored some notable successes in building its e-business services. One example: Web hosting. “It’s a $1 billion business for us and growing rapidly,” said Jim Grant, vice president in charge of it.

For instance, IBM built and now runs the Web site for the New York Stock Exchange, which can comfortably accommodate 9 million hits an hour.

Grant’s biggest challenge, he said, is “getting enough floor space to meet customer demand over the next three or four months.”

But IBM also has fallen behind in some fast-growing businesses. A collection of competitors old and new is trying to win the same lucrative consulting business. And though the Y2K spending turndown is over, IBM’s profitable mainframe business remains under pressure because falling prices are more than offsetting the growing demand for computer capacity.

Company lags rivals

Hardware looms as the immediate problem.

IBM fell behind Sun in selling midrange servers used by companies to power their Web businesses. “IBM with Gerstner has been doing a lot of positioning around e-business to get their machines up to spec, but when it comes to stable, reliable systems, Sun has a little bit of an advantage,” said Bob Rickert, a former IBMer and chief technology officer at KeyCorp.

Harreld said that back when IBM was having financial problems, it didn’t upgrade that product line. In the past two or three years, the company has made a major commitment to do so, he said, and is winning back customers with one new high-end server.

Recently, though, the company fell behind the competition in another product line – hard disk drives – which cost it $350 million in revenue in the first quarter. Joyce said a new product will be out shortly but won’t be shipped in volume until the second half of the year.

Meanwhile, IBM is losing oodles of money from its personal-computer operation. The company last fall announced that it would stop selling its PCs to consumers through retailers in the United States and that it would chop up to 10 percent of its PC work force. It is moving to more efficient direct sales, which competitor Dell uses.

These and decisions to get out of some other businesses cost IBM sales in the first quarter, but they improved profits and will continue to do so, Joyce said.

IBM also is looking to bolster its position by backing Linux software, a free operating system that allows different companies’ hardware to be used together. “It may break down some of those barriers people have created in their mind about IBM being a proprietary company that was only trying to steer people to their platforms because they can control them,” said Steve Josselyn, research director for commercial systems and servers at International Data Corp. in Framingham, Mass.

Developing growth strategy

Amid the hardware problems, questions also remain about IBM’s growth strategy.

Despite its emphasis on services and software, much of IBM’s profits still depend on its big-ticket computers, said analyst Thomas Kraemer of Morgan Stanley Dean Witter. “IBM in lots of ways is very well positioned, but just because e-business is going to take off doesn’t mean the mainframe does.”

Kraemer sees an improving outlook for the company but pegs long-term annual revenue growth at no more than 5 percent.

To succeed with its e-business strategy, IBM will have to do a better job of selling to start-up Internet companies. IBM was a latecomer selling to these customers. “We started taking it very seriously last year,” said strategist Harreld.

It is building a sales team that calls exclusively on Internet start-ups and is pouring support into financing and other business initiatives to cultivate them. One example: a recently announced venture with Qwest Communications to build Web-hosting centers, aimed in part at building IBM’s position among the dot-coms.

A decade ago, said Harreld, “We had this notion that we served large customers and that we did it all ourselves. If you go forward 10 years, you’ll see an IBM with a myriad of partnerships. Other people are a lot better at other portions of our value chain … and they can be great partners of ours.”

The company has formed alliances with a string of other companies. Among them is one with Ariba and i2 Technologies to develop electronic marketplaces that which Gerstner and others foresee shaking up the dynamics of whole industries.

Crucially, IBM also is trying to build innovative technologies for the e-business world. The company has been the top U.S. patent generator for the last seven years. “We have an extraordinary research capability which has been focused on the subject of e-business,” Patrick said.

For instance, IBM is bringing together its language translation and instant messaging technologies. A customer could ask a question in Spanish; the software would route it to the person at the company best able to answer the question, who might answer in it Chinese; and the answer would be converted back into Spanish.

No company, IBM included, will dominate future technology markets the way the Big Blue of old did, Gerstner believes. What he has to prove is that IBM can grow at a rate close to that of its industry.