Lou Gerstner Unveils His Battle Plan

A year ago, when IBM's directors recruited Louis V. Gerstner Jr. to be the crippled giant's chief executive, it looked like a signal for radical change--a clear break from the ancien regime. In many ways, the outsider lived up to those expectations. Instead of dragging out the torture of downsizing the bloated company with another annual cutback, Gerstner engineered a massive--and he says, final--bloodletting that resulted in an $8.9 billion loss. He brought in outsiders to head finance, human resources, and the critically important IBM Personal Computer Co. And he set about obliterating some of Big Blue's most self-defeating traditions. "We have been too bureaucratic and too preoccupied with our own view of the world," he writes in the just issued annual report. Also, he notes, the company had earned a reputation for arrogance, "but it's not going to happen on my watch."

Gerstner was set to round into the second year of his watch by addressing a standing-room-only briefing for securities analysts on Mar. 24. His plan is to summarize his accomplishments and sketch out a six-point plan for IBM's future. It still is not the sweeping "vision" that many customers and IBM-watchers have been clamoring for since Gerstner's arrival. Rather, it is, in Gerstner's words, a statement of the half-dozen "strategic themes" that will guide the company. Broadly, they call for IBM to push its core technology across more product lines and to sell more components such as chips to outsiders; become a player in so-called client/server computing; offer network services to large companies; reengineer the sales force to cut costs; jump into new geographic markets, particularly in Asia; and leverage IBM's size and scale.

Barring a last-minute change in the script, Gerstner's plan won't be a radical departure over what had been well under way during the tenure of John F. Akers. Indeed, after a year of criss-crossing the country, learning the computer business, studying IBM's methods and markets, and generally getting a handle on the struggling colossus, Gerstner confronts a depressing truth: No amount of strategic brainstorming will produce a simple solution to IBM's most fundamental problems. Nothing in IBM's portfolio of businesses can quickly pull the company out of the morass into which its huge computer-hardware business has sunk. "This is now Nixon's war," says a former IBM executive. "Remember, there was a point where the Vietnam war passed from being LBJ's to Nixon's. What used to be Akers' problem is now Gerstner's problem."

"OFF A CLIFF." The problem is simple. Despite efforts to diversify, too much of IBM's revenue--49%--comes from computer hardware. And virtually every IBM hardware market is marked by eroding prices and profits. Between 1990 and 1993, a total of $14 billion in hardware profits simply evaporated. And there are no signs of a profit rebound. In fact, there is an alarming slide under way in IBM's core large-computer businesses--the products that deliver the highest profits and, equally important, secure IBM's hold on corporate customers and generate other revenues from software, leasing, maintenance, and other services. Sales of mainframes skidded 50% between 1991 and 1993, to about $6.6 billion, and are expected to keep sliding despite new models due out in April.

Minicomputers, which have been delivering the biggest chunk of hardware profits lately, could be the next trouble spot. Revenues from AS/400 minicomputers dropped 10% in the fourth quarter, a dip that IBM blamed on the slow European economy. But some analysts believe that this is the start of a long-term spiral--akin to what's happening in IBM mainframes. Says Charles H. Ferguson, consultant and co-author of Computer Wars: "The pressure is going to gradually increase for another year or so, and then somewhere between one or two years from now, we think it's just going to go off a cliff the way mainframe sales are."

On the other hand, sales of personal computers are soaring. In 1993, they hit $9.7 billion--just shy of the $10 billion generated by mainframes and minis. But that doesn't help the profit picture. Indeed, PCs, workstations, and computer services are all growing rapidly, but they yield less than half the profit margin of big computers. As a result, concludes Morgan Stanley & Co. analyst Steven M. Milunovich, Gerstner may still be a long way from a turnaround in Year Two. "There's no obvious answer," he says. "The fact is they still have to find higher growth areas with better margins."

Gerstner's strategy is to do the best he can with the cards he has been dealt. One trump card, in his estimation, is IBM's base technologies such as microprocessor chips and disk drives. Part of his new plan is to turn IBM into a technology boutique--offering everything from microprocessor chips to object-oriented software to disk drives. At the same time, Gerstner is insisting that the company use its core technologies--its ultrafast PowerPC chips, for example--throughout its product line. Says Gerstner: "Despite superior technology, we failed to exploit that strength in both our products and by marketing technology as a product in its own right."

CRUCIAL CHIPS. Gerstner has good reason to hope that IBM can become a major supplier of base technology throughout the computer industry. By the end of 1990, Akers had decided that selling IBM chips and disk drives to other companies would help sharpen IBM's skills, according to William R. Bowles, the general manager who has been cranking up sales to other computer makers. Bowles says that sales shot up to $3 billion last year, from $300 million in 1990. But analysts worry that the business provides profit margins that are too low and wonder if the goal isn't simply to keep IBM factories busy when business slows. Gerstner, however, says the business is profitable and he's "not doing all this just to keep our plants humming."

At the analysts' briefing, Gerstner also intended to lay out his plans for what may be the company's single most important technology in coming years--the speedy PowerPC microprocessor. That chip architecture, which is now used mainly in RS/6000 workstations, will spread throughout IBM's line. The company is already marketing a large-scale scientific computer, using dozens of chips. And in 1995, it is expected to bring out new AS/400 minicomputers based on PowerPC technology. In addition, IBM is working on PCs based on the new chip for later this year.

Equally important will be the effort to convince other computer makers to adopt the chip. Apple Computer, IBM's partner along with Motorola in developing the chip, has just introduced a line of Macintoshes based on PowerPC. IBM also has deals to supply chips to Japan's Canon Inc. and to Ford Motor Co., which plans to use them in onboard computers. And it's building PowerPC TV converter boxes for Bell Atlantic and Canada's Groupe Videotron. Gerstner says IBM is negotiating with more than 130 companies to use the technology.

But establishing the PowerPC as an alternative to Intel Corp. chips in the PC market will be much harder. So far, makers of IBM-compatible PCs have expressed little interest. The big hang-up is software. Says Safi U. Qureshey, president of $1.4 billion PC maker AST Research Inc.: "It's up to Apple and IBM to make the market, not us."

Complicating the picture are mixed signals from IBM. Its PC division is still the world's biggest customer for Intel chips and has not introduced any PowerPC-based products. IBM's chief strategist, Senior Vice-President James A. Cannavino, says PowerPC is not a short-term strategy. "It's not something we're going to use to hustle a few PCs." Once PowerPC-based models are established, IBM may have conflicts, "but we're nowhere near that yet."

A far more pressing problem, says Gerstner, is getting IBM back on track in client/server computing. This technology--using powerful "servers" to feed data and programming to desktop "clients"--is what makes it possible for customers to scrap their old IBM mainframes and minis. "To be blunt," Gerstner says, "the failure to capitalize on this sea change in our industry is the single most important mistake IBM has made in the last decade."

How's IBM getting back on course? In addition to ordering up better server hardware, Gerstner is pushing IBM's programmers to develop critical software. Some of IBM's mainframe software, such as its database technology, has been adapted to run on RS/6000s. At the same time, Gerstner has decided to push an ambitious, chameleon-like software environment called Workplace OS, which can assume the "personality" of other operating systems such as IBM's OS/2, Windows, or Unix. Such an all-purpose operating system would make it simpler to create client/server setups and, company insiders say, could save IBM millions of dollars in development costs--eventually. For now, however, the client/server market will continue to be dominated by others such as Hewlett-Packard Co.

BLUNT WORDS. Those companies will continue to snag longtime IBM customers who want to "downsize"--which will keep the pressure on Big Blue's mainframe business. Already, Chief Financial Officer Jerome B. York has warned analysts that IBM's mainframe revenue could melt an additional 50% by the end of 1995, plunging sales of the big computers to $3.8 billion--a mere fraction of PC sales. York's candor with Wall Street, during an analyst meeting in January, makes it clear that management does not have very high hopes for two big computers that are on the launchpad.

In a few weeks--around the time of the 30th anniversary of the System/360 mainframe that cemented IBM's dominance of the computer market--the company will begin an important shift in its large-systems business. It plans to roll out two mainframes based on a parallel computing scheme using multiple processors. First, the company will bring out machines built around a new microchip deploying the same low-cost technology used in the mass-production PowerPC chips but capable of running the software of current IBM mainframes. Customers say they expect the new machines to cost as much as 40% less than conventional IBM mainframes.

While the first effort is aimed at holding on to existing customers, the second could secure a badly needed beachhead in large-scale open systems. Headed by Irving Wladawsky-Berger, general manager of the Power Parallel Systems, the effort exploits the PowerPC technology. It will use AIX, IBM's version of the Unix operating system and compete with large-scale servers from the likes of Hewlett-Packard and Sequent Computer Systems. Those machines have emerged as a significant alternative to IBM's conventional mainframes. The powerful systems, first used in engineering and technical jobs, are sought after by customers who want the power to analyze corporate data--to spot market trends from a flood of sales data, for example.

It's a far cry from the old mainframe business. Because it's rooted in the same microprocessor technology of personal computers and workstations, the new business has the same price pressures and slender margins of those businesses. As a result, says Wladawsky-Berger, he has modeled his business on that of IBM's no-frills workstation operation. "Right now, we are very sensitive to being extremely efficient," he says.

SHUNPIKE BOUND. Does Gerstner have any opportunities that are both high-growth and high-profit? The closest thing could be the nascent area of network services and equipment. To do business electronically across the globe, companies need ultrareliable, high-speed networks. IBM has been tight-lipped about its plans for the Information Highway, but Gerstner planned to tell analysts--and later, a group of consultants at a meeting in Orlando--that IBM is not about to chase an unidentified consumer market. IBM is building set-top boxes and video servers for the new interactive cable systems. But Gerstner says his big strategic bet will be in helping businesses create advanced networks--the industrial version of the Information Highway.

It's an opportunity that plays to IBM's strengths. Not only does IBM make some of the most critical parts, it also has legions of sales people and technicians to sell, install, and maintain the complex setups.

Before Gerstner can begin capitalizing on this opportunity, however, he will continue to tinker with the sales force. The former McKinsey & Co. partner is overseeing an effort to upgrade 30,000 sales reps to act as business consultants, selling IBM and non-IBM "solutions" to corporations.

How will the second-year plan play? On the eve of the Mar. 24 meeting, IBM stock was rising from the mid-50s, where it had lingered for months. Wall Street has applauded the cost-cutting moves and is primed to hear more concrete details of a turnaround strategy. With IBM's intractable hardware problems, however, "the window is getting narrower, the upside is getting lower, and room for maneuver is getting less," says consultant Ferguson. And now it's Gerstner's war.

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