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New Shades Of Blue

Friday, November 12, 1999

With a new e-business strategy, IBM is once more set to lead the high-tech pack.

Red Herring Feature Story on IBM
By Luc Hatlestad


Back in 1993, an engineer wrote a research paper called “Get Connected,” which outlined six principles of Internet-based communications and how they would help companies revolutionize their businesses. The engineer used this paper as a starting point for a grassroots effort that helped his company reorganize its entire focus around the Internet-an effort that has been extraordinarily successful by any measure.

The six principles were as follows: that electronic mail would become pervasive; that there would be a need for an email equivalent of directory assistance; that electronic messaging would enable a company’s minions to engage in open dialogue with their senior managers; that businesses would include their email addresses on all their printed material -advertising, press releases, and so on-to make them more accessible to customers; that companies would create online information repositories (Web sites); and, finally, that electronic commerce would soon explode.

If presented today, the paper would be considered laughably elementary, but back then it was as groundbreaking as if someone in the ’40’s had formulated a blueprint for space travel. The engineer we’re talking about was not some young entrepreneurial iconoclast fronting a no-name company. It was John Patrick, a 31-year veteran of IBM, possibly the furthest thing from a startup in the world of high technology.

International Business Machines is so venerable that its acronym is a household word. To your parents, it was high tech’s most important company. But despite its massive size and influence, it has been wildly derided over the last decade or so. In the dynamic climate created first by companies like Microsoft and Apple and later by Netscape Communications, Yahoo, and America Online, IBM has been viewed as a static, stodgy giant-unable to move quickly or to innovate.

But catalyzed by its reorganization around Internet-related products and services, and led by Lou Gerstner, a CEO whose success is fast becoming legendary, IBM is in the early stages of a turnaround that, if properly executed, would make it once again high tech’s most important company.


“We’re about five years into a major 30-year-long transformation,” says Irving Wladawsky-Berger, general manager of IBM’s Internet for e-business is about lots of little revolutions, not necessarily one big one, and they will continue at all levels. We’re just beginning to achieve a truly integrated commerce experience.”

The company, as its name suggests, is overwhelmingly focus on business. Although its research divisions devote considerable effort to consumer-bases areas, IBM’s reinvention’s built around wiring up business organizations for next-generation network computing. The company’s impressive financials suggest that it is taking the right approach.

IBM takes in $35 million per day in online business-to-business sales, with fiscal 1998 revenues totaling $81.7 billion (just $5 billion less than Microsoft, Intel, Cisco Systems, and Lucent Technologies combined); 25 percent of the company’s revenues now come from e-business, with annual growth rates in the upper teens. Its software generated $13.5 billion in 1998 revenues with gross margins of more than 80 percent. Since IBM bought Lotus Development in 1995, the Lotus Notes networking platform has increased from 2.2 million to 34 million seats. And fully 70 percent of all corporate data in the world is managed by IBM software residing on IBM servers, according to the company.

This entire operation is unified by IBM’s global services division, which will hire 20,000 people this year. A systems integration unit whose revenues have gone from $4 billion in 1991 to $28.9 billion in 1998, global services competes with the so-called Big Six consulting firms, none of which has IBM’s in-house technology resources. “IBM has a lot of good talent working in its services division,” says Aaron Zornes, an executive vice president at the Meta Group, an IT consultancy. “It’s just as good as any Big Six consultancy -not just in terms of sales, but in execution as well.”


Although IBM has never fallen too far out of sight, the company endured a fallow period of relative obscurity in the late ’80s and early ’90s. First it made the famously disastrous decision to license rather that buy the MS-DOS operating system from Microsoft, then had its competing OS/2 subsumed by Windows. Meanwhile, networkcentric companies like Cisco and, later, startups like Netscape and AOL began stealing the spotlight. IBM was for a time in serious danger of becoming irrelevant.

But with the arrival of Mr. Gerstner as CEO on April 1, 1993, a new era had dawned at IBM. His almost J.D. Salinger-esque avoidance of the media has contributed to the quasimythical aura that surrounds his tenure; because he seldom speaks to the press, he -much like Alan Greenspan- may be endowed with more power and influence than he deserves (or wants).

IBM’s financial renaissance certainly dates from Mr. Gerstner’s arrival (see charts, right). Moreover, his lieutenants, especially company veterans, heartily applaud the leadership of “the great Communicator,” as he is sometimes called around IBM. “Since he arrived, there’s been not just a convergence of technologies, but a top-down convergence of the leadership with the rest of the organization,” says Mr. Patrick, author of the celebrated “Get Connected” paper and now IBM’s vice president of Internet technology. “Lou has done all the turnaround stuff that a good CEO should do, but his real magic is that he saw the potential of the Internet instantly. He asked the right questions. He’s not watching the transformation-he’s leading it.” (AT&T’s leaders are attempting a similar reinvention; see “Reading the T Leaves,” page 121. )

To illustrate his point, Mr. Patrick recalls a 1994 meeting at which his division showed the prototype for the first IBM home page to Mr. Gerstner. As the presentation concluded, Mr. Gerstner’s first question, to Mr. Patrick’s astonishment, was where the page’s Buy button was. “E-commerce didn’t exist yet. He was asking questions in 1994 that other people didn’t ask until years later,” Mr. Patrick recalls. “He saw the Internet as a business-to-business commerce tool right away and got involved with our efforts.”


The other key decision that Mr. Gerstner made early on was to keep IBM’s business units together instead of dividing them into separate companies, a move that many in the media and investment communities were proposing. “We seemed to be on a path toward breaking up when Lou joined, but his decision to move to an ‘e-solutions’ focus helped keep us together,” says Ben Barnes, general manager of IBM’s global business intelligence unit. “IBM always had great products and services, but it didn’t always put together unified solutions. We researched large-scale decision-support programs and concluded that we needed to create business intelligence as an entrepreneurial unit -to lead with total solutions instead of just products. The whole industry is evolving this way as underlying technology becomes secondary to the service you can provide with it.”

Since 1996, the company’s business intelligence unit has grown from virtually nothing to more that $4 billion in annual revenues, and its focus on end-to-end solutions-meaning the company can supply everything from the servers running the network to the desktop PCs running the applications, and all the plumbing in between-has permeated the entire organization. And although the company has yet to become known for pushing the technology envelope, it has maintained its age-old image of sturdiness and reliability. “IBM still needs to establish the impression that it’s on the modest cutting edge, and its tools aren’t perfect for every company, but it’s always a relief to use IBM products because the stuff just works,” Mr. Zornes says.

He adds that, unlike companies that routinely pitch far-off scenarios to their customers, IBM consistently delivers on its promises. “I have to discount about 40 percent of what companies like Oracle and Siebel Systems tell me, because they’re selling so far into the future that they’re effectively lying,” Mr. Zornes says. “IBM sometimes looks like the dullard, but the company is telling the truth because it’s selling what it can deliver now.”


High praise, but perhaps the type of accolade, in which the company takes only mild pride. After all, IBM’s vast research wing has filed more U.S. patents by far than any other organization for the past six years (see “Labs of Steel,” page 126). But the general consensus in the industry, supported by most media outlets -including Red Herring-is that commercialization of innovation simply doesn’t happen at large organizations, because they are too focused on maintaining their market share to bother fiddling with novel technologies of unknown promise.

In truth, IBM has become quite cutting-edge-but more in its philosophical approach that in this actual nuts-and bolts- operation. Rather than creating new devices from the ground up to replace old standbys like the RS/6000 supercomputer and its bread-and-butter AS/400 servers, the company has repurposed the machines to capitalize on the Internet opportunity. Mr. Wladawsky-Berger says that it was when he and his colleagues saw some of the early Internet business applications-like tracking Federal Express packages and managing frequent flyer accounts-that they were inspired to create a new strategy around their existing technologies. “It became clear that we had to build a whole new infrastructure that combines the best classical networking protocols-like security, stability, and industrial strength-with the best of the internet, including connectivity, reach, standards, and ease of use,” he says.

The success of this philosophy contrasts starkly with that of IBM’s struggling competitors, past as well as present. Companies like Hewlett-Packard, Silicon Graphics, and Digital Equipment (which was broken up and sold to Compaq Computer in 1998) at one time all possessed technology on a par with IBM’s but each has failed to execute on its strategic dissemination. And these companies are furious about it. “HP is incensed that this historically stodgy company has become viewed as the dynamic market leader because of its services,” says Matthew Nordan, an analyst with the IT consultancy Forrester Research.

Again, much of IBM’s Internet strategy sounds obvious enough today, but in 1995 and 1996 it was borderline revolutionary. And as IBM has moved forward, it has not been without trepidation. “Back then, not many people said that the Internet wasn’t important, but we were way ahead of everyone in saying that it was important for business,” recalls Mr. Wladawsky-Berger. “We felt that we were onto the right things, but when you’re out in front, slashing your way through the jungle with a machete, you have to be very arrogant not to have fear.”

Another popular impression of the “new” IBM is that the turnaround was engineered by an infusion of entrepreneurial Gen Xers. There have been distinct efforts to recast the company with a younger sheen-most notably with its highly successful e-business branding campaign and with the creation of divisions like the AlphaWorks Java unit. In fact, though, much of the brainpower behind IBM’s reinvention came from veterans like Mr. Patrick and Mr. Wladawsky-Berger, both of whom have been with IBM for several decades. “The Internet is cool and appealing to many young people, but it’s always been associated with the university and research communities,” Mr. Wladawsky-Berger says. “You can’t exactly say that DARPA [the Defense Advanced Research Projects Agency, the Defense Department’s central research and development organizations] represents the youth movement of America.”


IBM’s Internet division now acts as an incubator for the rest of the company -a hotbed where technologies get created and then farmed out to the divisions that can deploy and market them most effectively. Such was the case with the server that IBM built for online ticket sales to the 1996 Olympic Games. The server eventually evolved into Net.Commerce, a system that helps companies develop virtual storefronts.

With products and services like these, IBM fulfills its goal of being a leading e-business systems developer rather that a company like Microsoft or AOL that leverages its technology to enter ancillary businesses like media and banking. “Our strategy is to help our customers become great e-businesses, rather that becoming huge e-businesses ourselves in other areas,” Mr. Patrick says.

The Internet’s future is all about branding, reliability, and customer service, and IBM has prospered by doing those things well, just as it has always done. While there may be many young pups nipping at IBM’s heel, this old dog still has plenty of new tricks.



IBM’s research facilities generate an annual torrent of patents.

Although often identified as high tech’s eternally slumbering giant, IBM is about as innovative as possible for such a large company. Perhaps it doesn’t get recognition because its inventions focus less on slick new devices than on the brains and plumbing that run them. But the truth is, IBM has long been the industry’s most productive creator of new technologies.

In 1998, for the sixth year running, IBM was awarded more U.S. patents than any other organization in any industry. Its total of 2,658 for the year well eclipsed its old record of 1,867 and outdistanced that of the next company, Canon, by 38 percent.

IBM has eight labs worldwide, employing a total of 3,000 researchers whose discoveries generated $1.3 billion in licensing revenues last year. The brilliance of the labs is not just in their discoveries, but in how the company implements them. While acknowledging that IBM is not seen as a producer of envelope-pushing technology, Paul Horn, the company’s senior vice president for research, says, “we’re absolutely cutting edge in terms of time to market. Much of our focus is on speeding the process of moving new technologies into the marketplace.”

IBM achieves this by eliminating barriers between research and development groups and making them more of a joint venture, according to Mr. Horn. “The development side is highly disciplined, with a lot of checkpoints, test, and milestones,” he says. “The research side is the exact opposite; it’s much more freewheeling.”

He cites IBM’s work on giant magneto-resistive (GMR) heads for hard disks as an example. First developed by French scientists in 1987, the heads could store vast amounts of data, but only when kept at extremely cold temperatures. IBM researchers found a way to change that conditional parameters so that the heads worked at room temperature. The upshot: in August IBM announced the first-ever 25-Gb hard drive. “We got it into our products first because our labs have the resources and connections that other research organizations don’t,” Mr. Horn says. Technologies like GMR contribute to IBM’s efforts in its “pervasive computing” research group, devoted to creating technologies that can store, retrieve, and send data from any device anywhere. And in May IBM established the Deep Computing Institute (named after the Deep Blue computer that beat chess grand master Garry Kasparov in 1997) with a budget of $29 million and a staff of about 120 researchers. The institute will explore ways that complicated computations can help make business decisions.

Other IBM labs are researching display technologies, cryptography, user interfaces, and silicon manufacturing. IBM also got patents last year for an e-business sales-promotions systems that uses neural networks to dissect customer purchasing patters. As IBM gets more deeply into e-business, Mr. Horn says, it may ramp up its efforts to buy needed technologies form outside the company. “But because we have such a strong technology base, we tend to generate lots of our ideas from within, ” he says.

Indeed, a stronger, broader base may not exist.