CASE STUDY. Defying Doom at IBM – Defying doom

CASE STUDY

Defying Doom at IBM

Inside IBM’s historic turnaround

Few business examples clearly show the successful turnaround of a large company. Much more abundant are the examples of large organizations that faced critical changes in their industry but were not able to produce a turnaround.

Lou Gerstner became a positive example for staging corporate turnarounds when, in just a few years, he was able to transform IBM. This global giant ended 1992 with a loss of over $5.0 billion, was heading for an even larger loss in the future and was facing the risk of becoming extinct. Gerstner’s book, Who Says Elephants Can’t Dance? tells the story behind the transformation of IBM and what it took to save the company and re-launch it to become a new global super-player in the IT and services industry.

In the following pages, I will extract specific components of IBM’s turnaround during the period from 1993 to 2002 when Lou Gerstner was CEO. All information is based on the book Lou Gerstner published telling his story about the turnaround.

To give a very practical example of everything described in the previous parts of this book, I have grouped the information around the different elements that I have developed in my framework: What’s the Story (urgency and vision for the future); Who’s on Board (the leader, top team and reaching out to everyone); and Execution. Consciously or unconsciously, Lou Gerstner made sure all of these elements were brought together and orchestrated in order to guarantee a successful turnaround.

Figure C.1 Defying Doom framework

1. IBM: What’s the Story?

1.1. A burning platform — IBM

IBM’s stock dropped from a high of $43 a share in 1987 to $12 a share on 26th April 1993. IBM’s sales and profits were declining at an alarming rate. The cash position of the company was very delicate, and the Board approved a new plan to authorize a credit line increase of $4.7 billion and to raise $3.0 billion through the issuance of preferred stock.

IBM’s main source of revenues in the past, Mainframes, had dropped its revenue from $13 billion in 1990 to a projected figure for 1993 of less than $7 billion. Prices were kept very high in order not to lose profitability with the tradeoff that they were losing customers instead.

The gross profit margin on hardware had dropped from 56 per cent in 1990 to 38 per cent in 1992. The pretax profit margin had declined from 18 per cent in 1990 to 6 per cent in 1992. The cost base was not adapting to the reality of the business. IBM had roughly a $7 billion expenses problem!

In the first quarter of 1993, revenues had declined by 7 per cent and the company had reported a loss before taxes of $400 million. In the same period the previous year the company had enjoyed a pretax profit of close to $1 billion. The only part of the company that was growing was the services sector, but it was a small segment and not profitable. Over the past 20 years, IBM had invested $20 billion in application development and acquisition with a negative rate of return of 70 per cent.

Information was very difficult to obtain inside IBM. Allocations between units and projects were constantly debated and changed during the year, making it impossible to understand what was really going on.

The company was suffering from a loss of customer trust, exacerbated by low customer ratings on quality. As a result, IBM was conducting more than 339 different satisfaction surveys and disparate methodologies made it impossible to get a single view.

Cross-unit issues were not being resolved quickly. They had become inefficient, stacking redundancy upon redundancy. There were 128 people with CIO titles, each running their own local systems architectures and funding homegrown applications. There were 266 general ledger systems. HR systems were so rigid that you actually had to fire an employee from one division for them to be employed by another. Even though internally more than $4 billion a year was spent on information systems, there was no correct information to manage the business.

There was little follow-up of implementation of projects. Deadlines to guarantee progress were almost unheard of, and when there were deadlines and they were missed, no questions were asked to understand the main reasons for failure or delay. Too much focus was placed on internal processes and too much energy spent in battles to define transfer pricing mechanisms between different units.

The geographic regions protected their turf and attempted to own everything that went on in the region. There was major tension in the company over who controlled marketing and sales processes. The power base of the company was very decentralized and lay in the hands of the country leaders when there were clear signals that they were competing in a global world and their main customers were becoming global as well. This created a lot of duplication in infrastructure overheads (for example, in the EMEA region 23,000 out of 90,000 employees were in support roles).

Other IBM employees (“IBMers”) practically had to ask permission to enter the territory of a country manager. Employees belonged to their geography first, while global IBM took a distant second place. It seemed impossible for IBM to take a global customer view or a technology view driven by customer requirements.

A proposal was made to break up the company and sell its parts independently, because this might have been a better option for shareholders. Among other ailments, this was also a symptom of the lack of a clear strategy for the future. Many managers would have been glad to become an independent subsidiary, seceding from the union, and no longer being part of the larger IBM.

There was a general sense of panic as a consequence of many of the decisions that were being discussed. The company had lost its direct relationship and contact with its customers.

The company was very hierarchical: no one was supposed to address employees in other areas or employees that were two or three levels down in the organization. Central headquarters looked like an old government building, full of long corridors and closed offices with no indications that the building held a computer company! There was no computer in the CEO’s office.

IBM used to be proud and said out loud that they did not lay people off. However, the performance measurement system was very confusing. There was no alignment of management incentives with shareholders’ interests given that the internal HR bureaucracy did not think that managers should own the company’s stock. Relatively little was paid in bonuses, stock options or performance units. There was very little differentiation in the system. Annual increases were typically given to all employees except those rated unsatisfactory. Increases in pay were within a small band around the year’s average. For example, if the average increase was 5 per cent, all increases were between 4 and 6 per cent.

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

IBM placed tremendous focus on rigid procedures that added no value. The best example was the existence of a 60-page document to describe what was expected “On being the Administrative Assistant to W.E. Burdick, Vice President, Personnel, Plans and Programs”, explaining the color of the dress code and how to call a specific number on a daily basis to reset the exact time on three different clocks in the office!

In Lou Gerstner’s first meetings with customers, he realized most of them were angry with IBM because IBM was suggesting killing the Mainframe when every CIO needed them to run their business. He also received a lot of feedback on how difficult it was to do business with IBM given all the internal bureaucracy.

IBMers were battered, bruised and confused. Many had retreated into a self-protective shell.

IBM’s culture was strongly affected by a successful past with little competitive threat, high profit margins and a commanding market position where the usual live-or-die market forces simply did not apply. The company and its people had lost touch with external reality, because what was happening in the marketplace was essentially irrelevant to the success of the company.

There was a general disinterest in customer needs, accompanied by a preoccupation with internal politics. There was general permission to stop projects dead in their tracks, a bureaucratic infrastructure that defended turf instead of promoting collaboration and a management class that presided rather than acted. Any individual, team or division could block the rollout of an approved project with no questions or consequences.

One IBM division would bid against another division to win a customer, such that one single customer could receive more than one IBM offer. Teamwork was not valued, sought or rewarded.

Most energy around internal communication went into changes in the internal organization. Given the history of one very big antitrust lawsuit against IBM, any word referring to competition was literally banned and was not allowed in any communication within the company.

Value and profit margins where shifting away from hardware, which was becoming commoditized, toward software. Competitors in the Silicon Valley were leading the new industry, and IBM was not participating in this new game.

1.2. A clear vision of the future and the roadmap to get there — IBM

Lou Gerstner set five clear 90-day priorities:

  • Stop hemorrhaging cash
  • Become profitable for 1994 to prove to the investor community that they had stabilized the company
  • Develop a customer strategy to regain confidence
  • Finish the right-sizing process
  • Develop a medium-term business strategy

He also set a 30-day assignment for each unit head asking each one of them to prepare a 10-page report covering customer needs, product lines, competitor analysis, technical outlook, and both short- and long-term issues.

After the first 90 days, when a much better understanding of the industry had been grasped, a few key decisions were taken:

  • Keep the company together and not spin off the different pieces
  • Change the fundamental economic model
  • Reengineer the business
  • Sell unproductive assets in order to raise cash

Additional key decisions set the right vision for the future:

  • Reinvest in the Mainframe. Gerstner quickly decided to reposition the Mainframe when many people in the company thought its days were numbered. He did this with the best insights from customers who did not want to abandon it
  • Remain in the core semiconductor technology business
  • Protect the fundamental R&D budget
  • Make everything they did customer driven to turn IBM into a market-driven, rather than an internally focused, process-driven enterprise

All of these recommendations were clearly explained through the eyes of the customer and the industry dynamics.

2. IBM: Who’s On Board?

2.1. Willingness to change from the leader

LLou Gerstner was convinced of the need to turn around the company and took the challenge as much more than a personal responsibility. He knew the importance of IBM and the repercussions that its downfall could represent for the whole of the country. He did not delegate his leadership role to anyone else in the company, and took on the responsibility and the whole process with a great amount of passion. He was the first ambassador in delivering the bad and difficult news himself.

Gerstner had a very solid background thanks to his previous experience as a partner in McKinsey, a Senior Executive in American Express, heading the Travel Related Services Group, and later the CEO for RJR Nabisco. He joined IBM on 1st April 1993.

He was convinced that whatever hard or painful things he had to do, he had to do them quickly, and make sure that everyone knew what he was doing and why. In his meetings with his direct team, he openly shared how he felt and why he had taken the job. He also told the team that he counted on them since at his arrival he had no clear idea of what needed to be done. He showed that he was very human and realistic, openly recognizing that he was not a technology expert. The company and all of its employees needed strong leadership, a sense of direction and momentum.

He would not spend time trying to find out who was to blame for the decisions of the past. He needed everyone to look forward and keep a very strong “can do” attitude, looking for quick wins and long-term impactful victories. He was very clear in letting everyone know that they all started this new phase with a clean slate.

He shared all of the brutal information about what was going on. He laid out his beliefs and principles very clearly so everyone could understand the behaviors he expected to see in the company. He pushed everyone to solve problems and not to escalate everything up to him. He asked everyone to move fast and supported candid, straightforward conversations. He changed the dynamics of traditional presentations using overhead projectors. In an iconic move he stood up one day, turned the switch off and asked the presenter just to talk about the business.

He placed the customer at the center of all decisions and spent most of his time listening to and visiting customers. He still does this today.

He knew the only thing that would save IBM was execution. They had to stop looking for people to blame, and stop tweaking the internal structure and systems. He wanted no excuses.

In order to get people moving he knew that he had to create a great sense of urgency. He understood it was his role to define the crisis, its magnitude, its severity and its impact, and also to communicate how to end the crisis, adopt the new strategy, the new company model and the new culture. He recognized and understood very early on that the most difficult part of the transformation would be the cultural transformation. He also knew that he had to be the leader of the cultural revolution and needed to get his leadership team to join him.

Lou Gerstner catalogued what he had learned after being in charge of the company for almost a decade:

What it takes to run IBM

Energy

  • Enormous personal energy
  • Stamina
  • Strong bias for action

Organizational leadership

  • Strategic sense
  • Ability to motivate and energize others
  • Infectious enthusiasm to maximize the organization’s potential
  • Build strong teams
  • Get the best from others

Marketplace leadership

  • Outstanding oral communication
  • CEO-level presence and participation in the industry and with customers

Personal qualities

  • Smart
  • Self-confident, but knows what he or she doesn’t know
  • Listens
  • Makes hard decisions — in business and with people
  • Passion that is visible
  • Maniacal customer focus
  • Instinctive drive for speed/impact

2.2. Alignment in the Top Team — IBM

Apart from holding many group meetings, Gerstner spent many hours in the few first weeks meeting with each senior executive individually. He used these meeting to understand the problems each one was facing, how they were dealing with them and to make a quick assessment of the potential of each one of them.

He created a Worldwide Management Council to encourage communication among the businesses. It had 35 members and met four or five times a year for two-day sessions to discuss operating results and company-wide initiatives. The main reason behind this decision was to get the senior team working as one team with common goals.

When he discovered accidently that the European employees were not receiving his company-wide emails, he called in the head of the region and asked for an explanation. The regional head responded, “The messages were inappropriate for my employees and they were hard to translate”. He told that regional head that he had no employees, that all employees belonged to IBM and from that day on he should never interfere with messages sent from his office. The head of the region never adapted to the new global organization and left the company a few months later.

Everyone reporting directly to Lou Gerstner received an annual bonus based exclusively on Global IBM results. He needed them to work as a team.

During the first few months, several senior executives left the company. Generally, those who did so were people who could not adapt to working as part of a team. In Lou’s words, “Nothing can stop a cultural transformation quicker than a CEO who permits a high-level executive — even a very successful one — to disregard the new behavior model.”

2.3. Reaching out to engage everyone

Gerstner spent most of his time talking to customers and employees to share all of the decisions he was making. He knew that if employees did not believe there was a crisis, they would not make the sacrifices that were necessary for change.

He spoke in plain, simple, compelling language that resulted in conviction and adherence throughout the organization. “Clearly what we have been doing has not been working — we lost $16 billion in three years. Since 1985, more than 175,000 employees have lost their jobs. The media and our competitors are calling us a dinosaur. Our customers are unhappy and angry. We are not growing like our competitors. Don’t you agree that something is wrong and that we should try something else?”

In some cases he was forced to go and speak directly to employees in a unit whose leader felt strongly about controlling communications with “his people”. He also frequently used the internal email system to address all employees and share in an open manner what was going on, how he personally felt and what he expected from everyone. He spoke to industry analysts and media reporters to share the plans that were underway and what he was doing.

On 27th July (only three months after taking over) he held a very large press conference in New York. He was very clear and direct, and maintained a very pragmatic approach. It was at this meeting that he made one of the statements that became famous: “The last thing IBM needs right now is a vision”. He went on in a very pragmatic way, “What IBM needs right now is a series of very tough-minded, market-driven, highly effective strategies for each of its businesses”. In essence, he was trying to say that what the company needed was a good toolkit to turn around quickly! The challenge at that time was to give some direction and get the company out of its state of paralysis.

He continued announcing IBM’s priorities:

  1. Restore the company to profitability
  2. Win the battle in the customer’s premises
  3. Move more aggressively into the client/server arena
  4. Continue to be the only full service provider for their customers

3. IBM: Execution

Fixing IBM was about Execution.

Lou Gerstner placed all of his focus on transforming the core business instead of trying to enter totally unknown territories. “Lack of focus is the most common cause of corporate mediocrity. History shows that truly great and successful companies go through constant and sometimes difficult self-renewal of the base business. They don’t jump into new pools where they have no sense of the depth or temperature of the water.”

He worked to eliminate bureaucracy fast. He decentralized decision-making as much as possible, and balanced it with a clear central strategy and widespread customer focus.

IBM launched a massive program of expense reductions that reached $8.9 billion in total. It included big lay-off programs, reducing employment by 35,000 people in addition to the 45,000 people whom his predecessor had already laid off in 1992. Thousands of software engineers were reassigned to other jobs, labs were closed and investments were written off or sold. Common HR processes were rolled out on a global basis in order to move talent quickly and effectively wherever it was needed.

He aligned managers’ incentives with shareholders’ incentives, not through risk-free stock options but through the process of putting their own money on the line via direct ownership of the company. He replaced fixed rewards with variable rewards, and internal benchmarks with external benchmarks when setting salary levels, and the concept of performance-related pay. All executives were given clear guidelines on the amount of stock they were expected to hold as a multiple of their annual salary. Other benefits geared towards lifelong employment were replaced.

He set his own travel agenda in order to be able to listen to customers and employees very early in the whole process. He launched the “Bear Hug” program to revert customer satisfaction trends. Each of the 50 members of the senior management team would visit five of the top customers during the following quarter.

He changed the pricing strategy behind the Mainframe to return the product to a competitive position in the market.

The Management Committee was eliminated. This formal mechanism to decide on proposals had become a waste of time because instead of having open debates, everything was worked out previously by corporate staff from all divisions, who ended up presenting consensus-built proposals that usually contained too many compromises.

He banned all press releases around changes in the organization, placing all focus on the external market instead of what was going on inside the company. He turned away all of the investment bankers who were proposing to sell different assets of the company. A huge reengineering program for all processes was launched, in which 128 CIOs were replaced by one CIO and 31 internal communication networks were replaced by one. A big project was launched to sell buildings and other real estate to reduce the real estate division, which was employing 240 people. Unproductive assets were sold to solve the cash flow situation. Most of the corporate airplane fleet was sold. In 1995, most of the art collection that the company held was sold at an auction at Sotheby’s for $31 million.

IBM’s Federal System Company (which mainly carried out projects for the United States government) was sold to Loral Corporation for $1.5 billion. IBM sold its global telecoms network in a bidding process to AT&T for $5 billion at a time when most of the market was betting on the merger of telecoms and IT players. Instead, IBM opted for focus over breadth.

He understood that he needed to create a global and integrated IBM if he wanted to be the integrator for the customers. He declared war on the geographic fiefdoms and decided to organize the company around global industry teams. Building the plan was easy. Getting it done was the difficult part because it required massive shifts in resources, systems and processes. They were only able to move to an integrated customer view when they stopped creating profit and loss statements for each region.

Traditional levers of power were redirected. This meant making changes around who controlled budgets, who signed off employees’ salary increases and bonuses, and who made final decisions on pricing and investments.

He introduced “one voice — one agency”, replacing all independent brand agencies across the company with one: Ogilvy & Mather. To do this, he had to remove all advertising budgets from the different divisions. All media buying was also centralized.

He clearly articulated the new behaviors he expected from his executives and simplified the IBM leadership competencies down to three: Win, Execute and Team.

Figure 6.1 Required behavioral changes

From

To

Product out (I tell you)

Customer in (in the shoes of the customer)

Do it my way

Do it the customers’ way (provide real service)

Manage for morale

Manage for success

Decisions based on anecdotes and myths

Decisions based on facts and data

Relationship driven

Performance driven and measured

Conformity (politically correct)

Diversity of ideas and opinions

Attack the people

Attack the process (ask why, not who)

Looking good is equal to or more important than doing good

Accountability (always move the rocks)

United States (Armonk headquarters) dominance

Global sharing

Rule driven

Principle driven

Value me (the silo)

Value us (the whole)

Analysis paralysis (100%+)

Make decisions and move forward with urgency (80%/20%)

Not invented here

Learning organization

Fund everything

Prioritize

3.1. Win

“It was required that all IBMers understand that business is a competitive activity. There are winners and losers. In the new IBM, there would be no place for anyone who lacked zeal for the contest. Most crucially, the opponent is out there, not across the Armonk campus. We needed to make the marketplace the driving criterion for all of our actions and all of our behavior.”

3.2. Execute

“This was all about speed and discipline. There would be no more of the obsessive perfectionism that had caused us to miss market opportunities and let others capitalize on our discoveries. No more studying things to death. In the new IBM, successful people would commit to getting things done — fast and effectively.”

3.3. Team

“This was a commitment to acting as one IBM, plain and simple.”

4. The rebirth of IBM

In Louis Gerstner’s own words:

“Before I stepped away in March 2002, we were number one in the world in IT services, hardware, enterprise software (excluding PCs), and customer-designed, high-performance computer chips. The IBM team had staged comebacks in multiple markets where we’d previously been getting sand kicked in our faces. We revamped and reinvigorated traditional product lines, launched new growth businesses and jettisoned several others that were vestiges of the old era.”

“At a higher level, we had articulated and then led the future direction of the industry — a future in which business and technology would not be separate tracks but intertwined; and a future in which the industry — in a remarkable about-face — would be driven by services, rather than hardware or software products — We’d coined the term ‘e-business’ and played a leadership role in defining what was going to matter — and what wasn’t in a networked world.”

“The IBM workforce increased in size by about 100,000 people. Our stock split twice and increased in value by 800 percent. Our technological community ushered in a new golden age of IBM research and development and earned more United States patent awards than any company for 9 years running. We even connected supercomputing with pop culture when a machine named Deep Blue defeated chess grandmaster Garry Kasparov.”

The IBM Global Services unit revenues increased from $7.4 billion in 1992 to $30 billion in 2001. During 1996 IBM acquired Lotus for $3.2 billion.

Figure 6.2 Summary of IBM’s operational and financial performance for the years 1992–2001

1992

1993

2001

Revenue

($ in billions)

64.5

62.7

85.9

Net profit

($ in billions)

-5.0

-8.1

7.7

Earnings per share —

diluted ($)

-2.17

-3.55

4.35

Cash flow

($ in billions)

6.3

8.3

14.3

Employees

(in thousands)

301.5

256.2

319.9

Stock price (1)

($)

12.72 (1)

14.12

120.96

(1) Stock price adjusted for splits: May 1997 and May 1999

(2) Stock price on 3/3/1993