Corporate profit disaster at IBM

In the early 1990s, the world’s largest computer company, International Business Machines (IBM), suffered one of the largest profit disasters in corporate history. Essentially, its problems were rooted in poor corporate strategy. This case study examines how IBM got into such a mess. The case study at the end of Chapter 2 shows how IBM managed to pull itself around.

Over the period 1991–93, IBM (US) suffered a net loss of almost US$16 billion (half the total GDP of the Republic of Ireland). During this period, the company had many of the characteristics of a supposedly good strategy: a dominant market share, excellent employee policies, reliable products (if not the most innovative), close relationships with national governments, responsible local and national community policies, sound finances and extensive modern plant investment around the world. Yet none of these was crucial to its profit problems, which essentially arose from a failure in corporate strategy. This case study examines how this came about: see Table 1. The reasons for the major losses are explored in the sections that follow – clearly the company was continuing to sell its products, but its costs were too high and it was unable to raise its prices because of increased competition.

Table 1  IBM slips into disaster (US$ million)

Disaster and recovery strategies at IBM[/caption]

* The total market value of the IBM shareholding at the year-end; reflects stock exchange share prices.

Source: IBM Annual Report and Accounts 1993.

IBM market domination 1970–85

During the 1970s and early 1980s, IBM became the first-choice computer company for many of the world’s leading companies: it had a remarkable global market share – approaching 60 per cent. It constructed its computers to its own proprietary standards so that they were incompatible with other computers but helped to maintain the company’s domination of the market.

In essence, IBM offered large, fast and reliable machines that undertook tasks never before operated by machinery: accounting, invoicing and payroll. These major computational tasks were undertaken on large standalone computers in special air-conditioned rooms: they were called mainframe computers. Even though the capital costs of such machines were high – for example, over US$1.5 million for a medium-sized machine – IBM customers still made substantial savings in numbers employed, reliability and speed of processing. Above all, choosing IBM meant that risk was low for customers: ‘No one ever got fired for buying IBM’. Hence, IBM was the market leader and earned around 60 per cent of its profits from its mainframe machines. During these years, IBM remained profitable – see Figure 1.

Figure 1

In keeping with a large company, IBM had a policy of always maintaining shareholder dividends. Moreover, it had strong staff development and personnel procedures. For example, it was proud that it never made its employees compulsorily redundant. Reflecting its dominance of global computer markets, its culture was relaxed and it was supremely confident of its abilities and resources.

Because of its sheer size and global reach, the company was split into a series of national companies, each operating with a great degree of independence. This meant that central management control was limited with many key strategic decisions being taken at national company level. Often, central management did not even know what was happening in key product groups until the end of the year, when all the figures for the group were added up. For major new market developments, the initiative was often taken by IBM’s North American subsidiary. Throughout this period, IBM central HQ was content to rely on the success and profitability of its mainframe computer range and observe the rapid growth of another small but related market in which it had no involvement: the personal computer (PC) market.

Development of the PC market

During the late 1970s and early 1980s, small PCs with names like Osborne, Commodore and Sinclair were developed. Some of these were particularly user-friendly – for example, Apple computers. In these early years, IBM preferred to maintain a lofty technical distance. It took the view that the PC market was small and PCs would never handle the mainframe tasks. Some of these small machines were built around common computer chips and software. Although they did not have the capacity to handle any of the large computational problems of computer mainframes, the PC market was growing fast – over 100 per cent per annum in some years. In the late 1970s, IBM was exploring new growth areas and decided to launch its own small machine onto the market.

The launch of the IBM PC in 1983

Because IBM’s existing company structure was large and nationally based and its culture was so slow and blinkered, it chose to set up a totally new subsidiary to manufacture and market its first PC. Moreover, it did not use its own proprietary semiconductor chips and operating software. It acquired them respectively from the medium-sized chip manufacturer Intel (US) and from what was then a small software company called Microsoft (US).

IBM took the view that it was doing Intel and Microsoft and all PC customers a favour by making the IBM designs into the world standard. Indeed, IBM was rather proud of establishing the global benchmark in what was a small specialist market sector, as well as holding the lead in the much larger mainframe market. IBM finally launched its first PC in 1981 without tying either Intel or Microsoft exclusively to itself. The new PC cost US$3000 and, by today’s standards, was very small. Although the claim ‘IBM-compatible’ quickly became a common standard for most PCs, except Apple, these developments had two consequences for IBM:

1 its world-wide PC standard allowed competitors to produce to a standard design for the first time;

2 no restriction was placed by IBM on Intel and Microsoft supplying similar products to other companies.

IBM reasoned that these issues did not matter because it would dominate the small PC market just as it did mainframes. In addition, IBM judged that the small PC would never replace the large mainframe, so it posed no significant threat to its main business. As it turned out, the company was at least partially wrong on both counts.

Technological advance and branding in the later 1980s

Throughout this period, the state of the world’s economies had really very little influence on these developments. Computer markets were genuinely driven by innovation, new ideas and change to the extent that these overrode problems in individual national economies. In addition, competitors found the IBM-compatible standardisation was helpful in establishing a common technical platform that would allow open competition. The launch of low-cost computers from countries such as Taiwan and Singapore was made possible by the establishment of such common standards. New lower prices for
PC s fuelled further market growth.

Sales also continued to grow because of technological advances and aggressive marketing. In addition, innovative companies such as Sun Microsystems found ways to enhance the power of the small PC – the workstation and Unix computer networking were established. Computer chips had become more powerful and software more sophisticated. By the late 1980s, PCs were able to undertake the tasks formerly done by the smaller mainframe machines. By the mid-1990s, the same performance as a medium-size mainframe could be obtained from a computer costing US$30 000.

During the 1980s, another competitive advantage of IBM disappeared. All PCs became more reliable, so that IBM’s special reputation for quality and reliability became less important. This also meant that PCs could be sold, installed and repaired without the expensive and vast IBM service organisation. Indeed, they could even be sold by mail order with technical support from dedicated technical operators (Dell computers were innovators here). Such companies had even lower costs than IBM’s suppliers, fewer overheads than the large IBM organisation and the same quality. Because of their smaller size, they were also able to respond more quickly to market changes.

IBM and other computer companies continued to spend funds branding their products. However, their suppliers, such as Intel and Microsoft, also began to spend significant sums on advertising. Microsoft’s ‘Windows’ was launched in the late 1980s and Intel’s ‘Pentium’ microchip was launched in 1993. Both were destined to dominate their respective markets.

IBM slips into disaster 1986–93

In the late 1980s, IBM recognised the competitive threat from Microsoft and Intel. It launched its own propietary software, OS/2 Warp, in 1994 to counteract this and was negotiating with Apple to set up a new computer chip standard, the Power PC Chip, with the aim of attacking Intel. Although both initiatives had some innovations, they were too little and too late. IBM struggled on with the concepts, but the software made little headway against the established Microsoft and the chip was abandoned in the mid-1990s. The outcome was the profit disaster of the years 1991-93: see Figure 2.

Figure 2

By 1993, IBM’s advertising was forced into claiming that its PCs used the Microsoft ‘Windows’ operating system and its computer chips had ‘Intel inside’. The IBM PC was just one of many computers in the small-computer market. No one referred to a computer being ‘IBM-compatible’ any longer – all computers used the same or similar computer chips and the same software, except Apple. It should be said that other computer companies such as Olivetti (Italy), DEC (US) and Bull (France) were also hit even harder than IBM. They were all scrambling to find new strategies. But that was no use to IBM which had real profit problems.

New organisation structure: 1991

Recognising the need for change, the company began to develop a new organisation structure in 1991. Up to this time, the organisation had been centred on two central aspects of the company:

1 Products. The company provided the most complete range of products from mainframes to telecommunications networks, from PCs to computer software. Each main product group sold its products independently of other groups.

2 Country. The company was the leading provider in most countries with the ability to provide computer solutions tailored at national level for the particular requirements of that country. Each major country had its own dedicated management responsibilities.

While this provided strong local responsiveness, it meant that global and international company customers were not always well served through country companies and individual product offerings. In particular, industry-based computer issues that were common around the world were tackled largely by the national companies and individual product groups.

In the new 1991 restructuring, it was proposed that the major global industries such as banking, insurance, oil and gas, manufacturing, telecommunications companies and transport would be tackled by dedicated teams with a complete range of products on a national or world-wide basis: the new structure involved the development of Industry Solution Units (ISUs). Each ISU had its own dedicated management team and was measured not only on sales but also on customer satisfaction. However, the country and the product managers were reluctant to give up control to the ISUs, which often operated internationally across many countries. This resulted in confusion among customers and some internal political battles inside IBM.

Future IBM Strategy: 1993 strategic perspective

After the major profit problems of the early 1990s, IBM clearly needed a major shift in strategy. A new chief executive, Mr Lou Gerstner, was recruited from outside the computer industry, but he was faced with a major task. The conventional strategic view in 1993 was that the company was too large. Its real strengths were the series of national IBM companies that had real autonomy and could respond to specific national market conditions, and the wide range of good IBM products. But the local autonomy coupled with the large IBM product range meant that it was difficult to provide industry solutions. Moreover, there were problems for its central HQ and research facility to respond quickly to the rapid market and technological changes that applied across its global markets. The ISUs had been set up to tackle this but did not seem to be working. The most common strategy solution suggested for IBM was therefore to break up the company into a series of smaller and more responsive subsidiaries in different product areas – a PC company, a mainframe company, a printer company and so on.

© Copyright Richard Lynch 2021. All rights reserved. This case was written by Richard Lynch from published sources only.

Case questions

1 Use the five key elements of strategic decisions (see Section 1.1.2) to evaluate IBM’s corporate strategy. What conclusions do you draw for these and added value?

2 What are the strengths and weaknesses of IBM? And what are the opportunities and threats that it faces from the competitive environment surrounding the company?

3 What was the strategic significance of IBM’s decision to obtain supplies of computer chips and software from other manufacturers rather than make them itself?

4 How big a part did the change in computer technology play in IBM’s problems? Could this have been predicted by IBM? What is the significance of your answer for corporate strategy?

5 What was the significance of IBM’s suppliers spending marketing funds to brand their products? What strategic significance does this have for the late 1990s in computer markets?

6 What strategies would you have adopted in 1993 to turn round the situation at IBM? When you have made your choice, you might like to turn to the end of Chapter 2 and see what the company actually did.

First case Study: Indicative Answers to the Case Questions

Disaster and recovery strategies at IBM

Over the last twenty years, there have been few companies that have equalled the profit disaster that befell IBM during the early 1990s. However, it should be recognised that the seeds of the problem were sown during the 1980s and were not simply the fault of the management at the time when the difficulties were declared.

Important strategic mistakes were made at IBM during the 1970s and 80s. Even though some of them had been recognised, it is not always possible in corporate strategy to provide instant solutions: large corporations develop conflicting interests that are not always easy to reconcile and cannot make rapid changes because of the size of the organisation. For example at IBM, there was a conflict between the need to preserve the highly profitable mainframe computers and the need to develop the smaller machines that might steal business from the larger models. Moreover, with a very large company, it takes time to discuss and agree any changes that need to be made.

1. What was the strategic significance of IBM’s decision to obtain supplies of computer chips and software from other manufacturers rather than make them itself?

This allowed the suppliers to develop their business on the basis of the reputation of IBM. The mistake made by IBM was not to buy in supplies, but to allow their suppliers to sell the same goods to competitors of IBM. As IBM established the market, it was developing a common standard – the IBM compatible computer – that was ready-made for its suppliers to use as the basis of developing their business.

2. How big a part did the change in computer technology play in IBM’s problems? Could this have been predicted by IBM? What is the significance of your answer for corporate strategy?

Computer technology was one of the major problems that IBM faced during the 1980s: small computers were becoming more powerful and more easily able to compete with at least some of its products. Technology may be difficult to predict where it is revolutionary. However, in the case of IBM, it was essentially evolutionary so might have been predicted. Where something such as technology cannot be predicted, it makes it difficult to develop rigid corporate strategy for many years ahead. Prescriptive approaches may be impossible in fast changing environments.

3. How important was the decision of IBM’s suppliers to spend marketing funds on branding their products? What strategic significance does this have for the late 1990s in computer markets?

It has proved vital: value added has shifted from the assembler of computer components such as IBM to the supplier of exclusive, branded supplies such as Intel and Microsoft. Branding has been a method of delivering that exclusivity: the Pentium chip and Windows 95 have locked customers into Intel and Microsoft respectively and provided real competitive advantage.

4. Can you think of any reason why companies like Hewlett-Packard continued to make profits during this period?

They had differentiated products that could not be easily imitated by their competitors. They were also more innovative and used this to reduce costs, increase value for money for their customers and provide genuinely new products.

Importantly, Hewlett-Packard were more adaptable as a company. The company was able to change with the market more easily than IBM. Moreover, H-P was less arrogant than IBM and more willing to work to improve its products as a result. It is important to realise that IBM’s problems were partly the result of its culture and style, just as much as technology and marketing.

5. Use the five key elements of strategy to evaluate IBM’s corporate strategy. What conclusions do you draw for these and added value?

• Sustainability: the company’s strategy was only partially sustainable over time. It worked well at the mainframe level but not for smaller computers.
• Distinctiveness: the small computers had no distinctive features beyond being branded and sold by the largest computer company in the world. This gave them some advantages but they were not technically as advanced nor as cheap to produce as their competitors.
• Competitive advantage: this was in decline over the years.
• Exploitation of linkages between the organisation and its environment: IBM never really exploited the linkages that it undoubtedly had in earlier years with, for example, its suppliers and its customers. It allowed others to muscle in and take share.
• Vision: the IBM vision was very clear in earlier years but seemed to be one of catching up during the 1980s. By contrast, other companies had a much clearer sense of their direction and purpose.

It has to be said that the above comments are made with all the wisdom of hindsight. They were not so easy to identify at the time, which is why corporate strategy is not always so easy or straightforward.

© Copyright Richard Lynch 2021. All rights reserved

References for IBM Case: Cases compiled by the author from the following published sources: Heller, R (1994) The Fate of IBM, Warner Books, London (easy to read and accurate). Carroll, P (1993) The Unmaking of IBM, Crown, London (rather one-sided). Financial Times: 7 Aug 1990, p14; 5 June 1991, article by Alan Cane; 8 Nov 1991, article by Alan Cane and Louise Kehoe; 5 May 1993, p17; 29 July 1993, p17; 14 Mar 1994, p17; 26 Mar 1994, p8; 28 Mar 1994, p15. Economist, 16 Jan 1993, p23. Business Age, Apr 1994, p76. Note that this case simplifies the IBM story by emphasising the PC aspects. There are further parts to the story that can be read in the references above.

Finally, the cases use material developed from the annual reports and accounts of IBM, Microsoft and Intel for various years.