The Return of International Business Machines - Dissertation Example

The Return of International Business Machines Introduction It is irrefutable that the functioning of a business organization is highly dependent on its financial performance. The company’s health is often tied on how much it earns, profits, and manages its accounts. The financial aspect of a business entity often tells the managers and other stakeholders outside the organization on the current situation of a firm together with the problem areas which needs to be addressed. However, it should also be taken into account that quantitative analyses are not capable of telling the whole story. International Business Machines or the Big Blue gained its distinction as America’s corporate king as its financial performance peaked in the 1980s. It should be noted that IBM enjoyed double digit net annual profit of 10-15% during the 1950-1980. These profitable years were coupled with strong company growth. For a firm like IBM, this was remarkable as profits are ballooning with the company’s expansion (Duby 1995). This put IBM on top of other firms and became the most admired corporation in America. IBM is the envy of the corporate world as it enjoys an incredible culture of high performance and excellence. However, the early 1990s saw the downfall of the corporate giant. Iwata (2005) attributes the seeds of these failures top the big shifts in the Information Technology (IT) market and the key market changes and developments which were disregarded by IBM in the late 1980s. These problems triggered the financial catastrophe which was experienced during the 1990s. The downfall is indicated by the abrupt collapse in the firm’s profit margin, stagnation and decline of its revenue and huge net losses. The internal performance of IBM together with the speculations on the firm’s future slashed its stock price by almost half. The company also has to layoff 200,000 employs in four years (Iwata 2005). Amidst all these dilemmas, IBM managed to stand up and recover through various measures. The entry of Louis V. Gertsner, Jr. as the firm’s new CEO when it is in the deepest trouble had helped the company to regain its robust performance. This paper will tackle the downfall and recovery of IBM. The succeeding paragraphs will justify the importance of the IBM’s case in corporate finance. Another section will highlight the role and implication of innovation and changing technology to the business organization. In order to fully get acquainted with IBM, this paper will give a brief corporate profile of IBM together with the products and services it provides. The next section is an overview of the technology sector and the major competitors of IBM. A comparison of their financial performance is also shown. This paper will also give light on major issues faced by IBM and their causes. The last section will give a brief outlook for the company. Truly, the case of the Big Blue is very significant in the field of corporate finance. As with other business entities, the firm had experienced profitable years along with troublesome ones. The only difference that IBM shows is its capability of recovering after a great downfall. As a student, I believe that the downfall and recovery of IBM should become an imperative in a Corporate Finance course as it clearly shows the interdependence of the company’s financial health and the firm’s overall performance. The case of IBM also shows the mistakes that firms usually make. Through this, students who are trained to become financial executives someday are cautioned and trained on how to better handle decision-making processes. Another point which is highlighted by the IBM’s downfall and recovery is the great impact of a firm’s external environment. As mentioned above, the company’s downfall was triggered by its disregard of the changing markets and emerging trends. Thus, IBM teaches students that financial policies should take into account a firm’s external factors. It is equally amazing how IBM was able to cope and surpass all this financial pitfalls. The case of IBM is also an important part of corporate finance as it shows the essential steps in producing a total turnaround in a business organization. Truly, the fall of IBM has been detrimental to the whole IT sector but the company managed to improve by proper financial strategies. As future finance executives, this gives students a hope in reviving a financially dead business organization. As such, it is also a helpful source of information on the essential aspects of managing the financial area of a company. In Focus: International Business Machines Corporation International Business Machines Corporation (IBM), also known as the Big Blue is one of the largest players in the world’s technology industry. The company traced its roots in the early 1910s and was formerly known as Computing-Tabulating Recording Co. It was only in 1924 that it changed its name to International Business Machines Corporation. The firm is based in Armonk, New York but its international operation spans over 170 countries globally (International Business Machines 2006). IBM generally operates as an information technology company worldwide. Big Blue offers a wide array of IT services with its numerous business segments. The company’s major products and services are extended by IBM’s Global Services, Systems and Technology Group, Personal Systems Group, Software, Global Financing, and Enterprise Investments business units (IBM 2005). The company’s Global Services segment is engage in the provision of consulting services for application and systems integration, client relationship management, financial management, human capital. Business strategy and change, supply chain management, and transformation of business processes (IBM 2005). The Systems and Technology Group segment is involve in system and component design services, outsourcing of clients design teams, and technology and manufacturing consulting services. This business unit also provides data storage products, including disk, tape, and storage area networks as well as semiconductor technology and products, packaging solutions, and engineering technology services to original equipment manufacturer clients (IBM 2005). Its Software segment provides middleware and operating systems software. Middleware software enables clients to integrate systems, processes, and applications across their enterprises. It also offers collaboration and messaging software to engage in asynchronous communication and knowledge management (IBM 2005). The company’s Global Financing segment provides lease and loan financing to end users and internal customers (IBM 2005). IBM’s Enterprise Investments segment develops and provides industry-specific IT solutions supporting the hardware, software, and global services segments of the company. Its product lines include product life cycle management software and document processing technologies (IBM 2005). IBM and Innovation Innovation and technology has a huge role in shaping IBM. For one, the core business of IBM lays in the provision of innovative technology to the market. It is also irrefutable that the performance of IBM is highly determined by innovation and technology in its current market. IBM banks highly on its research and development. As stated earlier, the company’s business lies in discovering and developing technology which can be utilized in the market. Looking at the records, the company has been granted more than a thousand patents annually starting 1993. The largest number of patents granted to IBM is seen last 2003 where it is able to register 3,415. Since 1993 to 2004, the company has been granted 29, 021 patents (International Business Machines 2005). Technology and innovation has a great bearing on the company’s operation. Even the downfall of the company can be linked to innovation and market development. As the company’s businesses are becoming largely customer driven and market oriented, it is imperative that IBM takes into account the arising technologies in the industry. The Diversified Computer Systems Industry: An Overview IBM belongs to the diversified computer systems industry. This segment of the technology sector is comprised of players which specialize in the design, development, manufacture, and distribution of computers hardware and software. Aside from the aforementioned products, the industry also consultancy and business solutions services to a wide range of clients (Industry Center 2006). The following table shows some of the industry’s important figures. Table 1 Source: Yahoo Finance, 2006 Competitors & IBM’s position Currently, IBM rivals with 39 players in the industries where it operates though only three are considered direct competitors. These three large players in the Diversified Computer Industries are Dell Incorporated, Hewlett-Packard Corporation, and Microsoft Corporation. This portion will look at the corporate profile of these competitors and tackle their past and current financial situation. A comparison of these large industry players in relation to IBM will also be analyzed (Competitors 2006). Dell Incorporated Michael Dell, who is also regarded as the computer industry’s longest tenured chief executive officer, founded Dell Computer Corporation in 1984. Later in 2003, the company changed its name to Dell, Incorporated. The company is one of the most famous manufacturers of computer worldwide, which caters to the needs of individual and corporate clients with a very unique business concept (About Dell 2004). Dell Incorporated is headquartered in Rock Round, Texas. Dell, Inc. and its subsidiaries are actively involved in the design, development, manufacture, marketing, sale, and support of a range of computer systems and services worldwide. The main business activity of Dell is in the provision of products and services to customers, which enables them to establish their information technology and Internet infrastructures. Dell offers a wide array of products and services to its clients. The company’s broad product line incorporates enterprise systems which includes servers, storage, workstations, and networking products; client systems, such as notebook and desktop computer systems; printing and imaging systems; and software and peripherals, including titles, monitors, plasma and LCD (Liquid Crystal Display) televisions, MP3 players, handhelds, and notebook accessories (Dell Inc. 2005). Aside from these products, Dell also offers a wide range of services, including information technology management services; professional services in technology consulting, application development, solutions integration, and infrastructure design; deployment services; support services; and training and certification services. In addition Dell also offers financing alternatives, asset management, and other customer financial services for its business and consumer customer base in the United States (Dell Inc. 2005). Currently, Dell is the third largest computer manufacturer in the world. During 2004, the company generated a total net income of $41, 444 million. The company also generates employment for a total of 46, 000 employees. Hewlett-Packard Hewlett-Packard has been in the computing industry for 65 years. The company boasts of combining ingenuity, engineering prowess and customer focus in its line of business. The company is regarded as the largest consumer IT company, the world’s largest small and mid-sized business IT company, and one of the leading enterprise company (About Us 2005). HP offers a wide range of products and services. The company is engaged in the provision of infrastructure and business offerings that ranges from handheld devices to some of the world’s power supercomputer installations. It is also involved in the production and distribution of consumer products in the field of digital photography, digital entertainment and home printing and computing. HP’s products lines can be broadly classified in three: The Personal Systems Group; The Imaging and Printing Group; and The Technology Soultions Group (About Us 2005). At the end of 2004, HP is Fortune 11 company having $86billion in total revenue. The company generates employment for 150,000 employees who are deployed in more than 170 countries around the globe. The company is headquartered in Palo Alto, California (About Us 2005). Microsoft Corporation Microsoft is undoubtedly the most popular competitor of IBM. Microsoft Corporation was founded by Bill Gates and Paul Allen in 1975. Microsoft Corporation engages in the development, manufacture, license, and support of software products for various computing devices worldwide. The company is known at the world’s largest software corporation recording almost $80 billion in total revenue for the fiscal year 2005. Microsoft Corporation employs 60,000 employees in 85 countries it operates in (Microsoft Corporation 2006). The giant company has three core business divisions: Platform Products and Services Division which also includes the Windows Client group, Server and Tools Group, and MSN Group; Business Division which includes the Information Worker Group and Microsoft Business Solutions Group; and Entertainment Divisions which includes the Home and Entertainment Group and the Mobile and Embedded Devices Group (Microsoft Corporation 2006). Table 2 shows the performance of the three large industry players in relation to IBM. It can be seen that in terms of market capitalization Microsoft leads with $293.15 billion followed by IBM ($126 billion), HPQ ($86.72 billion) and Dell ($68.86 billion). It can also be noted that all the players are way above the industry average of $623.35 million. HP employs the largest number of employees with 150,000 compared to the industry average of 2.42 thousand. IBM leads in terms of revenue. During 2005, the company recorded $91.13 billion from all its business units. Tagging behind is HPQ with $86.70 billion, while Dell is a far third cornering $54.18 billion. Microsoft recorded the lowest revenue at $40.34 billion. It should also be noted that all as the three competitors of IBM posted positive year on year growth with Dell recording an impressive double digit growth of 11.30%, IBM posted a slump in its revenue to as high as -11.0%. Table 2 Source: Yahoo Finance, 2006 Though smallest in terms of total revenue, Microsoft proved to have a superior cost management through cost minimization. This is evidenced by the huge percentage of gross margin relative to sales (85%) and operating margin (42.19%). The company also records the Earnings Before Interest, Taxes, and Depreciation (EBITDA) and net income amidst its relatively smaller revenue. On The Recovery of IBM The recovery of IBM from the company’s collapse in the 1990s necessitated some adjustments in the company’s way of doing business. Certain measures were implemented in order to achieve for the much desired turnaround. This portion will discuss the important moves taken to revive IBM. It will also tackle the current situation of the company and the moves that different moves it does to sustain the recovery. The near-death of IBM in the 1990s necessitated a new CEO to lead IBM. Louis V. Gerstner (2002) on his talk entitled “IBM’s Transformation,” attributed the company’s recovery to a total change in culture. He states that “The thing I have learned at IBM is that culture is everything.” IBM is known for its “sales-centric” and “sales-oriented” business culture. This culture has become an identity of the corporate giant. Many of its executives and general managers chosen were always on the sales force. In addition to this, IBM’s middle and top management were often enlisted to give direct support to salesmen in the process of making sales to the firm’s important customers (International Business Machines 2005). Louis Gerstner describes the company’s culture as the “most dynamic sales cultures in the world.” He described the IBM’s sales force as “very good, very focused,” and “very individualistic.” Aside from this, the company also has the culture of hordes of administrative assistants and the culture of “individuals with a capital ‘I.’” IBM’s decentralized and individualistic culture which worked for the company in the previous years was replaced with a more “integrated” approach. This culture was reinstated with the company’s culture of shared technical plans and common technical standards (Lagace 2002). Another move which was initiated for the recovery of the company was IBM’s strategy of focusing on the customers. Instead of just creating fancy technology, the company has moved to creating technology which provides value and solutions to the company’s market (Lagace 2002). These measures were the key factors utilized in bringing IBM back to shape. According to Gertsner (2002), IBM’s turnaround can be wholly attributed to a “cultural transformation.” Through this the new CEO made the company “respectable and financially stable again.” Currently, IBM has recuperated from the crisis it went through in the 1990s. Though the company is presently the technology sector’s largest player in terms of market capitalization, IBM has not yet regained its former strength. The company has yet to overcome all the numerous problems it currently faces in order for it to earn the reputation and muscle it once had. Alongside, the measures taken by the company are numerous issues which need to be addressed. Outsourcing Labor Business process outsourcing is one of the growing trends in the global economy. Through technological breakthroughs, companies are able to source services from foreign workers in order to cut cost and focus on their core activities. IBM took advantage of this trend as it started to outsource some of its back-office operations in foreign countries. This strategy is expected to generate $168 million in savings as programming jobs are outsourced from China, India, and Brazil. The company slashed 14,500 jobs during the first quarter of 2005 and is outsourcing cheap labor from India (IBM to Save $168M 2004). Outsourcing can really do much in strengthening the financial position of IBM. Outsourcing jobs offshore saves IBM much needed finances which could be invested in more profitable ventures. However, this move is met with resistance from labor groups as it means less jobs for IT workers in the United States. CEO changes Last March 1, 2002, Gerstner steeped down as IBM’s CEO and was replaced by Sam Palmisano. Although, there are no political issues in the replacement analysts say that this move is very timely. There are a lot of reasons why Gerstner’s resignation was timely. True enough; the CEO has done an amazing job of minimizing costs and returning the company to profitability. However, Gerstner is IBM’s worst CEO in terms of revenue growth rate. During his leadership, the company managed to grow at only 2.5% from 1996-2000. This is even worse than during the IBM’s near death (Djurdjevic 2002). Acquisitions The past two years marked numerous acquisitions by IBM. During 2004, IBM acquired Maersk Data and DMData, Logicalis Australia and Logical CSI New Zealand, Candle Corp., Daksh eServices, Alphablox, Cyanea Systems, Venetica, and Systemscorp. The year 2005 marked the acquisition of Corio crio, Ascential Software, Gluecode, PureEdge, DWL, and Data Power (International Business Machines 2005). Selling PC Division On May 2005, the deal was closed between IBM and Lenovo, a Chinese PC maker which is partly owned by the government. The Personal Computer division of IBM was transferred to Lenovo who bought the segment for USD650 million in cash and USD600 million in stock. IBM owns 19% of the Lenovo’s ownership (International Business Machines 2005). The sale of PC division, IBM reveals, is due to the segment’s unprofitable operation for three years. IBM claimed that losses continued even if it tried to cut cost by outsourcing. The company further revealed that the PC division recorded net losses of $258 million, $171 million, and $397 million in the years 2003, 2002, and 2001, respectively and added that the business has a history of recurring loses, negative working capital, and accumulated deficit (Gardner 2004). Workforce Issues Aside from outsourcing issues, IBM’s employees are not satisfied by the company’s policies. Last January, Big Blue was sued in US District court for allegedly not paying overtime to its rank and file employees. Employees reported that the company forced them to work for than 40 hours a week and were even called to work for weekend without being paid (IBM Sued 2006). Drop in Share Prices IBM’s stock, as any other company is affected by the company’s financial performance and speculation in the stock market. Currently, IBM’s stock price is plunging due to the numerous issues that the company faces. For one, the company records negative revenue growth for the past two quarters. The issue of company’s profitability also pushes the stock prices down. This, together with the case filled by its employees worsens the perceived profitability of investing in IBM’s stock. IBM’s Future: What Lies Ahead The future of IBM is strongly tied to its current performance, its plans and the external environment. This section will tackle what the company plans to achieve its objectives, battle the issues it faces, and the products and services that it plans to launch in its market. IBM plans includes regaining the financial strength and stability that it once had by launching different strategies. IBM’s future rests on how the company plans to revive itself. Currently, IBM’s future is in business-performance transformation initiative launched by the Big Blue. Business-performance-transformation-services (BPTS) is a mix which comprises IT and business process outsourcing coupled with an intelligent software and consulting services. Ginny Rometty, managing partner of IBM business consulting estimates that business-performance-transformation represents a $5000 billion market and explains that BPTS is utilized to help customers reengineer and streamline their SG&A (selling, general, and administrative) processes (McDougall 2005). Sam Palmisano also made a statement on 2004 that IBM’s future will be on demand. This strategy’s core is on innovation. The company is positioned to give more flexibility to customers by the on demand business model which offers more innovative and value adding products. One of the most important innovations that IBM is going to launch for its future business is called the Store of the Future. Part of this is the installation of Shopping Buddy, a wireless, touch-screen computed attached to a shopping cart that allows shoppers to scan items that they place in their carts. Another is the Everywhere Display which uses projectors, mirrors, and software to turn any retail store surface into a “virtual, interactive touch-screen.” In addition, the Store of the Future also features a Personal Assistant shopping cart which harnesses radio frequency tags and global positioning system technology. This feature alerts customers about promotions and personalized discounts (Inside IBM’s Store of the Future 2005). There are a lot of speculations on IBM’s future performance. IBM was able to beat the analysts growth forecast of the company during the fourth quarter of 2005. During the period, IBM was able to record 13% rise in quarterly profit amidst lower forecasts. This somehow helped the company to gain rosier forecasts for 2006. The company’s Chief Financing Officer Mark Loughridge stated that IBM hopes to surpass the analysts average earnings forecast for 2006. IBM is still focused in attaining its goal of double-digit growth in the long run (Gollner 2006). Analysts David Grossman said that IBM is still in the stage where growth can be improved. However, Harry E. Blunt wrote that he sees an “increasingly cloudy outlook for services bookings going forward.” He further added that trends in certain servers as well as semiconductors are very solid (Earning Preview: IBM 2006). 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