IBM Needs to Reposition Itself for the Cloud Computing Era

Ginni Rometty needs to reposition the tech giant in a hurry for the cloud computing era
Illustration by 731

How’s this for bleeding edge: The average member of IBM’s senior executive leadership team started at the company in 1985, when the Internet was still a government project and Steve Jobs had just been fired from Apple. Chief Executive Officer Ginni Rometty joined IBM in 1981, two years out of Northwestern University’s engineering school, and has been there ever since.

That’s a deep and experienced bench. The question is whether the tech giant has the right managerial perspective for what confronts it in 2013. IBM finds itself on the wrong side of a major technology shift. In the cloud era, corporate clients can rent server capacity and processing power for far less than IBM charges to hire its consultants or buy its hardware.

Photo courtesy IBM
Rometty, who became CEO in January 2012, needs to pull off a strategic shift that enables IBM to be a dominant player in faster-growing markets like cloud computing, data analytics, and mobile devices. She’ll have to lead IBM out of a period of stagnation—revenue from its core businesses has been flat for five years—and deliver organic growth instead of the financial engineering and asset sales that have defined most of her tenure.

IBM is certainly capable of reinventing itself: In the early 1990s, as the company lost billions and shed jobs, it shifted away from large mainframe computers and toward servers, software, and technology services and prospered under CEOs Lou Gerstner and Sam Palmisano. Rometty, however, has been constrained by her predecessor in one respect: Palmisano promised investors and Wall Street analysts in 2010 that IBM’s annual per-share earnings would increase 74 percent, to $20 from $11.52, by 2015. So far, IBM is on track to nail that number (the Bloomberg estimate for 2013 is $16.72) through tens of billions of dollars worth of stock buybacks, spending cuts, business selloffs, and accounting adjustments—doing everything but investing aggressively in new businesses, says Credit Suisse analyst Kulbinder Garcha. He recently downgraded IBM’s stock to a sell rating. The share price is up about 1.5 percent so far this year; Standard & Poor’s 500-stock index is up 18 percent. “The way they’ve run the business for the last eight years, they can’t for the next few,” Garcha says.

Market researcher Gartner ranked IBM, which invented cloud computing in its labs, last among 15 cloud-services companies in terms of quality in an Aug. 19 report. Rometty is only just starting to invest in mobile-app development. IBM may be running out of easy ways to maintain earnings growth: Its last quarter beat expectations only after excluding a $1 billion charge tied to thousands of layoffs. “IBM has come to the end of the road with the optimization of their financial model,” says ISI Group analyst Brian Marshall.

To cut costs, IBM has been firing workers in droves—this year’s $1 billion tab for restructuring is up from $803 million last year and $440 million the year before. Rometty has forced U.S. hardware employees to take time off at one-third pay. The company has also exited low-margin businesses. On Sept. 10, IBM sold a $1.3 billion customer-assistance outsourcing business to IT services company Synnex for $505 million. At IBM’s annual investor day in February, Rometty justified the workforce cuts and asset sales, stressing the importance of profitable growth. “If we had not, we would be a much larger company, potentially a faster-growing company, but we would be a lower-margin company,” she said.

Rometty, who declined to be interviewed for this story, told investors that last year she met with 500 chief executives of clients to ask what they needed from IBM. That’s typical for Rometty, who quickly rose to a series of management positions after being hired as a systems engineer in IBM’s Detroit office. In public appearances she’s spoken about what tech will look like 20 years into the future, a time when the world will be run by computers that learn like humans. She usually evangelizes about cloud and mobile computing, yet IBM under Rometty isn’t making the kinds of investments needed to realize that vision. R&D spending has been flat overall since she took over, though IBM spokesman Michael Fay says the company has continuously invested for growth in new businesses.

IBM’s billions in annual R&D spending keep it at the top of the list for U.S. patent grants, but turning those inventions into commercially viable businesses remains a challenge for the company. “The drivers of the market are social, mobile, data analytics, and cloud, and they’re not a major player in those areas, even if their marketing says so,” says Ivan Feinseth, chief investment officer at Tigress Financial Partners.

The company has invested $6 billion in cloud acquisitions since 2007, most notably server hub SoftLayer, and says its cloud division will hit $7 billion in revenue by 2015. Most of that money, however, will be from business IBM already had but switched over to the cloud. In cloud computing, IBM lives in market leader’s vapor trail. This year, Amazon beat out IBM, a longtime federal contractor, for a $600 million CIA cloud contract. “I’ve competed with and partnered with IBM in the past, but today we don’t ever see them in our deals, ever,” says Tom Erickson, the CEO of website-management software maker Acquia.

IBM’s best prospects may be in its data analytics business, which has hired hundreds of scientists and invested to commercialize research projects such as Watson, the high-powered computer and Jeopardy! champion. IBM has boosted its 2015 revenue target for data analytics to $20 billion from $16 billion as it pursues projects ranging from health-care diagnostics to financial-markets analysis. To pull off the broad repositioning that IBM needs, Credit Suisse’s Garcha says it has to jettison Palmisano’s targets for short-term profit growth, forget about stock buybacks, and pour that money into products. Erickson goes further: In software, at least, he says, “Someone needs to come in with more current thinking.”