Slimming Down for Future Growth

Few corporations endure for 100 years, so IBM‘s centennial should make this year an occasion to learn from what has carried the corporation so far for so long. One of the key lessons lies in how Big Blue has moved into new-growth markets while at the same time exiting businesses it no longer saw as key to the future.

Such moves are often unpopular at first. Back in 2004, when IBM revealed that it was divesting its personal computer unit, the business world was skeptical. After all, the PC and ThinkPad had become IBM’s signature products. The decision to shed $11 billion in revenue and transfer 10,000 employees to the then-largely unknown Chinese manufacturer Lenovo was seen by some as an iffy maneuver. When the deal was announced, the smart money picked Dell Computer as "the big winner."

Skip ahead seven years: IBM’s investors have no more reason to miss PCs than they did punch cards. Big Blue’s stock has doubled since the divestment. Meanwhile the price of shares in the formerly winning Dell has been roughly cut in half. (The Standard & Poor’s index of 500 stocks has remained roughly flat since then.)

Conventional wisdom has been to divest what is not core to your business. This makes sense—most of the time. Sometimes it is parts of the core that you most want to divest. For IBM, the computer business gave way to a more ambitious definition of its new core in what Chief Executive Officer Samuel Palmisano calls "high-value businesses." By this, he means solving big problems by selling business analytics software and "smarter planet" solutions. Big Blue now derives more revenue from both its software segment and services segment than it does from hardware.

Divest When Old Winners Still Sell

Many companies wait too long to spin off businesses with declining profits. General Motors, for instance, had been under pressure for years to divest lagging brands such as Oldsmobile. By the time the company got around to it, however, there was no market for the unit’s assets; GM simply shut Olds down in 2004. Then in 2009, during its brief bankruptcy, GM was forced to close or sell at distressed prices such additional businesses as Hummer, Saab, and Pontiac.

The moves were painful but helped position the company for the future. "New GM" is better able to focus on fresh opportunities to innovate in such areas as electric vehicles, via the Chevy Volt.

Eventually, today’s breakthrough products will become commodified, or markets will be disrupted by cheaper or more effective solutions. Johnson & Johnson, for instance, realized that its drug-coated stent business—a $600 million product line—was losing ground to rivals in an increasingly crowded market. Rather than face years of declining market share and squeezed profits, J&J decided to close the business and redeploy resources toward higher-value opportunities.

How to Evaluate Core Units’ Futures?

To that end, companies should ask a set of five key questions to determine how to evaluate their core business to allow next-stage innovation to flourish:

1. What kinds of storms do we face? Will new technologies and business models now on the periphery of our industry disrupt or commodify our business? Are we overshooting what our customers want by providing too many complex features? Can we innovate ways to deliver cheaper, simpler, or faster solutions?

2. Where is our future growth? How will our core business change in five or 10 years? Which product lines or business units will no longer be engines of growth but instead, drags on innovation?

3. How much should we shed? Do we need a series of small cuts or do we need to get rid of a large operation?

4. What’s our capacity for innovation? How strong is our culture of innovation? How robust is our new product and service portfolio? What new products and services have the greatest potential to take the place of pruned businesses?

5. Who would want to buy our assets? Which new owners might see our divested businesses as fresh growth opportunities?

For IBM, the answer to the fifth question turned out to be Lenovo. The $1.75 billion IBM PC deal made strategic sense for the Chinese manufacturer, which gained the use of the IBM and ThinkPad brands and established a presence in the U.S. in a single bold stroke. Lenovo’s share price has also doubled since 2004. It is now the world’s fourth-largest PC maker.

IBM asked itself all the above questions. Palmisano often speaks of his 10-year plan to remake the company—a strategy he launched in 2001 that is now largely complete. The sale of the PC unit was only the highest-profile divestiture. IBM replaced the revenue with organic growth, as well as growth through a series of 116 acquisitions of smaller companies. During this span, net income has more than doubled, which explains the company’s stock price.

As always, the challenge to IBM and other companies is figuring out what’s next. Since growth must never stop, the pruning and trading of old assets for new ones must also never stop.

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