IBM's New Boss

Sam Palmisano has a tough act to follow. Here's what to expect

Samuel J. Palmisano was hopping mad. It was October, 1999, and he had just taken over IBM's (IBM ) $13 billion computer server business. But the computer giant's Unix machines--the technology of choice for the dot-com digerati and the backbone of corporate computing--were pricey and poky. Rivals Sun Microsystems Inc. (SUNW ) and Hewlett-Packard Co. (HWP ) were eating IBM's lunch, dinner, and breakfast. "They were killing us," says William Etherington, then senior vice-president of IBM's sales.

So Palmisano went on the attack. He devised a game plan he called "Project Pain." IBM was going to put the hurt on rivals. He assigned his top people to key bids and freed the sales staff to dazzle customers with discounts of up to 70%--untouchable by other computer makers. IBM would make up the lost revenue from the services and software sold along with the servers. And if it took big guns to close a deal, CEO Louis V. Gerstner Jr., Palmisano, and Etherington were ready to board the corporate jet.

The plan worked--a little too well. Fired up by Palmisano's take-no-prisoners approach and a line of powerful new servers, the IBM sales staff went into overdrive. In the first quarter of 2000, IBM hit Sun Microsystems like linebacker Ray Lewis during an NFL playoff game, claiming first place with a 25% share of the market, vs. Sun's 21%. Then IBM hiccuped. The company underestimated demand and didn't have crucial parts to build machines. Again, Palmisano stepped in. He started the coffee pot every morning at 7 for the managers who stumbled into his office to review the status of every single component--part number by part number. He hit the phone to hound suppliers to speed up deliveries. By the next earnings report, problem solved. "That was a defining moment for Sam," says Etherington. "He'll roll his sleeves up, and he'll just work the thing to death."

Palmisano may never have a chance to roll down his sleeves again. On Jan. 29, IBM's board named him the eighth CEO in the company's 91-year history. He officially takes over on Mar. 1, when Gerstner's contract expires. Managing IBM--bigger and broader than any other tech company--is perhaps the most challenging job in the industry. And while Big Blue is in its best shape in a decade, Palmisano steps in just as the industry is reeling. For the first time, PC demand is shrinking, economic malaise has dried up corporate spending, and tech players are scrambling to come up with the Next Big Thing that might spark a rebound. Is Palmisano, now IBM's president and chief operating officer, daunted? "The industry was tough last year, but we're spot-on with our strategy," says Palmisano. Gerstner will stay on as chairman until the end of the year, although he insists Palmisano "doesn't need to learn a lot from me."

Indeed, Palmisano may be just what Big Blue needs after Gerstner. Although he is an IBM lifer with 28 years under his belt, he's not the typical Big Blue exec. Instead of making safe bets, he has repeatedly challenged old thinking and taken risks. That brash style could be key when the upturn begins and computer makers refashion themselves to heed customers' demands. Palmisano's past may play to a turbulent future: In 1993, he questioned management's view that IBM's nascent services business didn't need to turn a profit on deals for several years. Not only did he make sure deals made money on Day One but he also insisted they be multimillion-dollar contracts. Last year, services contributed 50% of IBM's pre-tax profits. In 1999, he pushed for the company to exit the money-draining consumer PC business. And he has been the chief advocate behind IBM's $1 billion push into Linux software, a radical move away from IBM's tradition of selling proprietary operating systems.

Does Gerstner worry that Palmisano might be too bold for tried-and-true Blue? "I hope he throws out everything that I ever went for and he goes for a new strategy," says Gerstner, laughing.

Gerstner may be laughing, but Wall Street isn't. On Jan. 29, IBM's stock price dropped $5.15, or 5%, to $103 a share. That was on a day with a broad sell-off in stocks. It bounced back a bit the next day, hitting $105.55. Still, analysts worry that while Palmisano is an operations whiz, he may not be able to match Gerstner's skills as a strategic thinker. "Does he have the strategy chops to lead IBM the way Gerstner has?" questions analyst Steve Milunovich of Merrill Lynch & Co.

In the short term, that won't be put to the test. Palmisano says IBM's strategy of emphasizing services to help buyers cope with gaggles of complicated technology is a winner. Instead, his first order of business is tackling execution--namely, better managing IBM's three problem children: PCs, disk drives, and semiconductors. IBM's PC and printer business lost $153 million last year, while storage and chips hemorrhaged $374 million. One way to cut costs in PCs is to sell more machines over the Internet, doing away with costly sales teams. Today, about 50% of IBM's U.S. PCs are sold over the Web. "We've made good progress, but we need to go further," says Palmisano.

Palmisano aims to drive costs down across the board at IBM. He's hoping to do that by tapping further into the power of the Web, using it to buy and sell, link with suppliers, and develop products--saving time and money. Last year, IBM purchased about $45 billion of its good and services--some 90%--over the Net, saving $400 million. But only 25% of IBM's products and services were sold online, saving $500 million. "You will see us continue to drive our productivity and effectiveness" through the Web, says Gerstner.

Palmisano must contend with concerns over the quality of IBM's earnings. Critics say that IBM's earnings have been puffed up by booking nonoperating gains from stock buybacks, an overfunded pension fund, and the sale of assets. Molly Tool-Reed, director of corporate ratings for Standard & Poor's, however, says that IBM is financially sound because it oozes cash and has a conservative balance sheet. Last year, IBM generated more than $7 billion in free cash flow, a measure of operating cash flow minus capital expenditures.

Then there's IBM's perennial growth problem. When Gerstner arrived at Big Blue in 1993, the company had suffered through three years of declining revenues. He dumped manufacturing plants, closed offices, and focused on services. Over the next eight years, IBM grew, on average, 5% a year. Under Gerstner's tenure, if an investor had put $10,000 into IBM it would be worth $73,400 today. But IBM has slowed with the times. In 2000, it grew 1%, while sales declined 3% last year. That's better than most rivals but nothing to be proud of.

Palmisano must get the engine revving again. The emphasis will be on software and services, potentially high-growth sectors. IBM's $13 billion software business grew, on average, 3% a year over the past decade. That's measly compared with Oracle Corp. (ORCL ) and Microsoft Corp. (MSFT ), which have achieved growth rates of 20% to 30%. To reach those heights, Palmisano will have to grab more share in markets such as databases and fix the ailing Lotus Notes business--collaborative software that customers say doesn't work well on the Web. "They are not a dominating force," says Hasso Plattner, CEO of rival SAP (SAP ).

Where IBM is dominant is in tech services. The hallmark of Gerstner's remarkable turnaround of IBM was his decision to take the company away from its roots as a hardware maker. Now, services is the business that's most crucial to the tech giant's future. Today, the $35 billion Global Services unit does everything from consulting on the design of corporate systems to running tech operations for AT&T. IBM's service-heavy business model is the envy of the industry. Services account for 40% of IBM's revenue, compared with 17% for EMC and 20% for Compaq. "I'm jealous," confesses Compaq CEO Michael Cappelas. "Have you noticed that they've skirted through the downturn?"

Skirted, but not skipped. In the most recent quarter, services revenues declined for the first time due to the recession, to $9.06 billion, down from $9.19 billion in the year-ago quarter. Worse, services is people-intensive, which means if the downturn is protracted, IBM's 150,000-person services organization is vulnerable.

Palmisano isn't worried about that possibility. Instead, he's preparing IBM's services group to take advantage of computing's next wave: delivering technology over the Internet much like a power company dishes up electricity to its customers. In tech parlance, it's called "computing on tap." IBM is investing in technologies that automatically find and fix flaws on the Net so tech services are not disrupted. "Even in the tough environment we had in 2001, we continued to invest in those future growth businesses," says Palmisano.

Experts say Palmisano's priorities are right, but much depends on execution and how quickly customers move to computing on tap. "We're coming into a period where it's about growth," says Neil Isford, CEO of Web consultant Plural Inc., who worked for Palmisano at IBM. "Sam's completely suited to that. The guy is a salesman at heart."

The IBM Palmisano inherits is more solid than it has been in years. In 2001, it earned $7.7 billion on sales of $85.9 billion. Revenues fell 3% last year, but IBM looks like granite next to rivals such as Sun, whose sales tanked 25%. "They are fantastically positioned for the future," says Rosabeth M. Kanter, a professor of business administration at Harvard Business School.

What gives Palmisano a leg up is that he helped put IBM in this cushy spot. He joined Big Blue out of college and has managed every major division save software and microelectronics. Like pre-Gerstner CEOs, Palmisano rose through the sales and marketing ranks. But in the past eight years, he has managed PCs, servers, and services, which was by far his greatest success. He further sharpened his management skills after becoming president and chief operating officer in September, 2000. "Sam has demonstrated that he's able to manage a whole spectrum of technology companies," says G. Richard Thoman, a former Xerox CEO who has worked with Palmisano at IBM.

The new IBM CEO is a hands-on guy who eschews the trappings of rock-star CEOs. He doesn't believe in big staffs or executive perks. He has never had an executive assistant and he answers his own e-mail. Until he became president, Palmisano insisted on driving his own car to work from his home in Southport, Conn., refusing a comfy ride in one of the Lincoln Town Cars made available to Gerstner and other IBM brass.

Palmisano also channels his temper differently than his boss. While Gerstner telegraphs disgust by ignoring or shutting people out, Palmisano speaks his mind--sometimes at high volume, with table-pounding. But the storms pass as abruptly as they arrive. "He can get up in your face and then afterward, put an arm around you and forget about it," says Plural's Isford.

One thing to bet on: Palmisano will shake up the troops. When he took over daily operations, one of his first moves was to make the monthly sales forecast meetings weekly. This was no easy switchover. IBM had to build a new sales-management system for Palmisano's stepped-up schedule. Now, IBM collects sales data every day, and Palmisano gets weekly reports. One trick he uses to make managers squirm: He'll ask for a list of deals they plan to close in the next week. Forget monthly or 90-day sales forecasts. He wants a follow-up e-mail in seven days. "I watched guys just get shattered," says Etherington. "You can hide in a 90-day forecast. You can't hide in a weekly discussion."

Palmisano gets the tough work ethic from his father, who owned an auto-repair shop in Baltimore. Friends and classmates remember him as a popular, outgoing, and happy kid who excelled in the classroom and on the football field. Palmisano was an "A" student and played a mean center. While playing football at Calvert Hall College High School, a private Catholic boys school, he got hit in the nose and was bleeding profusely. Instead of asking to leave the game, Palmisano stuffed cotton in his nose and kept playing, says Tom Bateman, the freshman football coach. In his senior year, he was named the school's scholar-athlete in the National Football League banquet.

Palmisano entered Johns Hopkins University in 1969, at the height of the antiwar movement. But he was no rabble-rousing lefty; he was there to get an education and play football. At graduation time, Palmisano wasn't sure what he wanted to do. He passed on an offer to try out for the Oakland Raiders. "I came to the conclusion that I wasn't going to make my mark running into people who were twice my size," he says.

That left business. He joined IBM in August, 1973, as a marketing trainee associate in the data-products unit in Baltimore. The division handled IBM's Big Iron mainframes and other servers. The first sign that Palmisano would be an IBM standout came in 1988. He was working on the launch of a new computer, the AS/400. At the time, Digital Equipment Corp. was clobbering IBM. Digital had a solid following among software developers who wrote programs for DEC machines. Until the AS/400, IBM would unveil a new machine by throwing it over the wall and praying for the arrival of developers. Palmisano and the AS/400 team decided it was time for a change. He went into high gear, meeting with software companies until he signed up 1,000 developers to create applications for the computer before it was rolled out. "It was one of the most successful product announcements that IBM ever had," says William O. Grabe, then vice-president for marketing at the data-products group and Palmisano's boss.

That success put Palmisano on the radar screen. In the spring of 1989, then-CEO John F. Akers asked Palmisano to become his executive assistant. Palmisano was now officially an employee with high potential--a "hi-po" in IBM lingo. Recalls Akers: "He handled [the job] better than anyone else had done it for me."

In 1992, Palmisano got the call that changed everything. Dennie Welsh, a senior exec who was pushing IBM into services, asked him to become president of Integrated Systems Solutions Corp. (ISSC), the group that became the core of Global Services. Welsh is credited with creating IBM's services business. But it was Palmisano who figured out how to make the business grow--profitably. "He sat us down and said we had to change the way we paid people," recalls George Samenuk, CEO of Network Associates Inc., who sold IBM's outsourcing services to the banking industry. At the time, IBM paid sales commissions based on a deal's size. Palmisano decided to base pay on how profitable the deal was. From 1993-96, when Palmisano was president of ISSC, revenues grew from $14.9 billion to $22.9 billion.

The services stint catapulted Palmisano to IBM's upper echelons. Until now, Palmisano has had every key job except chief strategist. That won't come until Mar. 1. Thanks to Gerstner's powerful vision of selling technology solutions to customers, Palmisano can afford to gaze into his crystal ball for the time being. Soon, he'll have to make some hard choices and craft his own game plan. He'd better start planning.

By Spencer E. Ante and Ira Sager in Armonk, N.Y.

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