Big Blue's Bold Step Into China

Teaming with Lenovo spells opportunity -- if it can meet the big challenges ahead

It doesn't take a genius to see why IBM's (IBM ) sale of its $10 billion-a-year PC business to China's Lenovo Group Ltd. (LNVGY ) relieves a huge headache for Big Blue. The computer giant gets the barely profitable business off its books so it can expand profit margins and invest in more promising technologies. But there's an even bigger prize IBM executives have their eyes on. By lining up Lenovo as a strategic partner, IBM has a chance to rapidly enlarge its footprint in China, which could one day rival Europe as the world's second-biggest information technology market, behind the U.S.

The deal with Lenovo isn't your garden-variety sale. On Dec. 7, IBM unveiled plans to sell most of its Personal Systems Group to Lenovo for $1.75 billion in cash, stock, and assumed liabilities. Lenovo will relocate its world headquarters from Beijing to Armonk, N.Y., near IBM's home base, and it will be run by veteran IBM execs. Lenovo's new CEO will be Stephen M. Ward Jr., who now runs IBM's Personal Systems Group. IBM will take an 18.9% ownership stake in the new company, which will sell PCs under the IBM brand. "The rest of the PC industry is now competing with a Chinese company, with its aggressiveness on price, backed with the quality and services of IBM," says CEO Samuel J. Palmisano.

The transaction makes sense for both sides. IBM gets to keep selling PCs, which helps it market other products and services to corporations in packages. At the same time the deal removes an earnings drag. Lenovo, China's No. 1 PC maker, buys itself a global PC operation and instant entry into computing's big leagues. Combined, the companies have an 8.6% PC market share, No. 3 behind Dell Inc. (DELL ) and Hewlett-Packard Co. (HPQ ). "Lenovo gets what it wants -- a worldwide presence. And IBM gets what it wants," says analyst Phillipe de Marcillac at technology market researcher IDC. IBM, he points out, will still have a product offering for its large accounts without having to manufacture commodity machines.

THE DELL FACTOR

Of course, there's still plenty that could go wrong. Lenovo's new leaders will have to bridge not only the 6,800 miles from New York to Beijing but also immense cultural differences. Lenovo PCs will carry the IBM name for five years, and former IBMers will be among the product designers, but some corporate customers may not trust Lenovo to deliver the quality and innovation they have counted on from IBM. And tech combos far less complex than this one have been notoriously difficult to pull off in the past. Notes Dell Chairman Michael S. Dell: "When was the last time you saw a successful acquisition or merger in the computer industry?"

Of course, Dell is hardly an impartial observer -- he will remain the combined company's toughest rival. Indeed, while merging Lenovo and IBM's PC businesses will provide economies of scale, Dell, the No. 1 PC maker, still has a more efficient operation thanks to its direct-sales model. Even in China, Lenovo and IBM face a fierce competitor in Dell. It's already doing well in selling PCs to corporate customers, and Dell has also started to pick up some government business, a Lenovo stronghold.

The deal might turn out to be better for IBM than Lenovo. In the U.S. and Europe, Lenovo will "start off great, but gradually they'll lose share," predicts analyst Stephen Baker of NPD Group. "HP and Dell will be after the IBM accounts with all guns blazing." But IBM will have a chance to mine the Lenovo connection in China, the world's seventh-largest economy. IBM aims to sell more high-margin servers, software, and services to a market that has been snapping up PCs fast for half a decade but is just now developing a taste for more sophisticated stuff. The Chinese tech market is expected to double, from $24 billion last year to $47.9 billion in 2008, according to IDC. During the same period Chinese demand for services is expected to leap from $3.7 billion to $11.6 billion.

BRIDGING THE CULTURE GAP

IBM sees Lenovo as a good catch because it's the dominant player in Chinese computing. It has a 27% market share in PCs and remains strong in government and education markets. That's thanks in part to the Chinese government, which held a 57% stake in the company before the IBM deal and will now hold a 46% stake. IBM hopes to piggyback on Lenovo's influence and sales force as it targets Chinese banks, manufacturing companies, government agencies, and consumer-product outfits with its servers and services. Lenovo has been holding its own in PC market share while Dell and IBM have been gaining at the expense of other players. Lenovo and IBM hope they will be able to slow Dell and hold onto their combined 32% share. "We see a synergy of Lenovo leading with PCs and identifying opportunities for IBM, and IBM leading with solutions that will require PCs from Lenovo," says Ward.

Figuring out how to stay on top in China will be one of Ward's top priorities. IBM PC sales through the company's salesforce and thousands of resellers worldwide are running smoothly. That should free Ward up for frequent trips to China so he can learn firsthand about the market there and his new Lenovo colleagues in Beijing.

Bridging the culture gap will be key. Lenovo will be run day-to-day by Ward and, as chief operating officer, Frances O'Sullivan, who is now general manager of IBM's PC unit. The nonexecutive chairman will be Yang Yuanqing, now Lenovo's CEO, who will also work in New York. Clarence Kwan, managing partner at consultant Deloitte & Touche, thinks it will help that the PC business is by its nature global in terms of sourcing components, manufacturing, and product development -- so both sides already play by the same rules.

Even so, the culture clash and management challenges will be daunting. Can Lenovo and IBM pull it off? An icon of Western capitalism is teaming up with a company that's partly owned by the Chinese government to tap into the fast-evolving global marketplace. How the world has changed.

By Steve Hamm, with Pete Engardio in New York and Frederik Balfour in Hong Kong

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