In 1787, Empress Catherine II of Russia made an unprecedented six-month trip to Crimea, the “New Russia,” with her court and some foreign ambassadors. The area had recently been devastated by war. Amid fears of a new war, the purpose of the trip was to impress Russia's allies how prosperous the region had become as a result of rebuilding the region and bringing in Russian settlers.
The Empress was accompanied on the trip by the official who had been responsible for rebuilding the region and bringing in Russian settlers. The official, Grigory Potemkin, happily combined this official role with his unofficial function of bedroom companion and lover of the sex-hungry Empress.
Potemkin’s problem on the visit was that the reconstruction of the area was not as far along as desired. Not wanting to disappoint his demanding imperial mistress, and being an energetic fellow, he implemented an ingenious scheme. He had a team of workers develop some “portable villages.” Prior to the arrival of the Empress’s barge, Potemkin's men, dressed up as peasants, would show up at the site and assemble a village. At night, in the midst of the barren territory, the fake settlements with their glowing fires would comfort the Empress and her foreign entourage. Once the Empress’s barge had departed, the village would be disassembled and rebuilt downstream overnight for the imperial visit the next day.
Oil on canvas portrait of Empress Catherine the Great by Russian painter Fyodor Rokotov (Photo... [+]
The stratagem was a personal success for Potemkin. The Empress was sufficiently pleased with his multiple services that he solidified his hold on power. Strategically for Russia, however, it was otherwise. The visiting ambassadors detected the difference between the real and the fake buildings and Potemkin’s deception was in due course exposed by his political opponents. Shortly after the imperial visit, the region was once again plunged into a war between Russia and the Ottoman Empire.
IBM’s Potemkin prosperity
Fast forward a couple of hundred years to the troubles of IBM, the once-iconic technology giant, as its CEO, Ginni Rometty, struggles to convince a skeptical stock market that her tricks of financial engineering, share buybacks, tax gadgets, cost-cutting and hastily assembled acquisitions and innovation initiatives have put IBM on the path towards prosperity.
The problem is that after ten successive quarters of falling revenues, the pretense that everything is on track for the accomplishment of “Roadmap 2015,” in which IBM’s earnings would double to reach $20 per share, can no longer be maintained. Rometty announced last week what has been obvious for some time: IBM won’t hit the target after all.
She also announced that, rather than sell or shutter its chip division, it would actually pay GlobalFoundries $1.5 billion to take the division off its hands, while also taking a $4.7 billion charge.
“At the end of the day,” said Rometty in an interview with CNBC last week, “this is about returning value to shareholders.” Yet to many observers, the single-minded focus on returning value to shareholders is precisely what is killing IBM--and destroying real shareholder value.
IBM’s focus on boosting the share price has been built on a foundation of declining revenues, capability-crippling offshoring, fading technical competence, sagging staff morale, massive debt-financed share buybacks, pervasive non-standard accounting practices, tax-reduction gadgets, a debt-equity ratio of nearly 174 percent, a broken business model and a flawed forward strategy. Those Potemkin-style tactics can only work for so long, before the business reality becomes evident to all. With IBM’s stock down more than 10 percent over the last week, that day may have already arrived.
IBM’s staff speak
“We have a very clear strategy,” said Rometty last week, “about how to take this company to the future and more than a strategy, a whole list of bold actions we have taken, one after another this year. And when you're clear with your workforce and you engage them, that's how you move them swiftly.”
Among Rometty’s problems is the testimony of the staff and executives involved in the internal rejiggering of IBM’s affairs. If the anecdotal testimony of staff is to be believed, IBM’s workers are far from being engaged. Some recent examples of IBM staff views:
- “IBM is delaying and not paying out bonuses that engagement teams have earned. Example, it used to be when you won a deal, your bonus would be paid within 2 months or so. Today, folks that closed out an engagement back in January are still waiting on bonus payment. When management is asked about it, they keep repeating the party line, ‘They are still working on it.’ In another cost cutting measure, the 401K company contribution is now only paid out once per year (December 15).”
- “The most recent (just this week) example of cost cutting measure designed to show profitability, is the selection of x number of employees that some executive (not your manager) has found to be lacking in skills essential to perform their job. They've implemented a 10 percent pay cut for 6 months so that those employees can dedicate up to one day per week to training. The logic is that since you will be dedicating only 90 percent of your time on your main job, you therefore deserve a 10 percent pay reduction. Keep in mind that this is not based on any performance deficiency and no mention of exactly what skills the employee is weak in. Keep in mind also that an average work week at IBM far exceeds 40 hours, it’s more like 60 to 70 hours when on an engagement. So telling someone that they will only spend 90 percent of their time on what they call real work is meaningless. But it's c'est la vie at today’s IBM.”
- “The company has imposed draconian measures to cut costs. As a manager you did your plan for the coming year and estimated the resources required. In the end you were given higher objectives and fewer resources. It was a purely financial game. The impact was exacerbated as the same game was repeated quarter after quarter.”
- “Today’s IBM is able to buy the right assets; but we have a very hard time to come up with great products ourselves. And why is that? It’s because the workforce is slashed all over the place. And the people that remain have to fight budget constraints and all kinds of crazy stuff, every other day in order to do the job they are paid for.”
- “Rometty only speaks to screened (and terrified) employee audiences and the rest of us are forced to watch videos of this.”
- “Execs are selling millions of shares and options, while rewards to the vast majority of employees are now given in the form of ‘Blue Points,’ which can be saved up and used to pick gifts out of a catalog. Employee morale couldn’t be worse.”
- “IBM has a ‘caste’ system.” Many of the executives are regarded as over-paid, damage-creating, unable-to-listen psychopaths. IBM is beyond cultural bankruptcy. When a company goes into ‘cultural bankruptcy’; you can start the countdown for the financial meltdown.”
- “So why are some of us still here? Because working for IBM was that good. We keep hoping things will get fixed but they aren’t. Lower and middle management are now powerless puppets who are forced to act as cheerleaders for the ‘new’ IBM. (The worst part is that the managers are bad actors.) It's sad. Really, really sad.”
Whether or not these statements are true in every detail or across the board is beside the point. The perception among staff that they are true has the same corrosive effect.
A broken business model
Some staff also question whether IBM’s business model is sound:
- “Where does IBM get its revenue numbers? Typically from the top 150 global accounts called Core Accounts. These are the largest corporations in the world who are heavily invested in their mainframe systems. IBM have a very elaborate deal-making process that locks these clients in for 3-5 years against their will and based upon the fact that zOS software is never owned by the customer. If you add to this license compliance actions (audits) you then have the bulk of their numbers.”
- “To be sure IBM does sell products into the Fortune 1000 and mid market, but the deals are few and far between, because IBM simply cannot compete. These are the markets where they are getting killed, where the reps are not nearly compensated at market rates.”
- “Finally, business partners are pulling back from IBM as IBM sells off its hardware lines and pulls back from customer data centers. They have their pricing strategy incorrect for the cloud. So there is a complete vacuum outside of the core accounts.”
- “IBM is facing an enormous set of hurdles within the next 2 years. As for the large IBM Core accounts who routinely are held for ransom? They are likely starting to wake up as cloud expands its role.”
- “I left IBM to be the first guy in a SaaS start up that was quickly acquired at our target buy-out. It was great to be in a scenario where you could actually sell and the customer could easily understand our value proposition.”
Rometty insisted last week that IBM’ has made “very bold moves” since she became chief executive— billions of dollars for data analysis software and skills, cloud computing, Watson artificial intelligence technology and so on. “The strategy is correct,” she said. “Now it’s our speed of execution that needs to improve.” But if the disaffected workforce doesn’t believe the strategy, implementing it won’t be easy.
The Buffett factor
The key to IBM’s game-plan in “delivering value to investors” has been “RoadMap 2015”, which promised a doubling of the earnings per share by 2015. “Roadmap 2015” is what induced Warren Buffett to invest more than $10 billion in IBM in 2011, along with many other investors, who were impressed with the methodical way in which IBM was able to boost earnings per share. (Buffett’s investment was striking because of his long-standing and publicly announced aversion to investing in technology, which he admitted he didn’t understand.)
“The best business returns,” says Buffett, “are usually achieved by companies that are doing something quite similar today to what they were doing five or ten years ago.” Put another way, “IBM had that stickiness and indispensability to many large corporate and government institutions worldwide.” The question is whether this way of doing business is coming to the end of its effective life. Today clients show signs of preferring flexibility to stickiness.
IBM is used to operating in a world where new versions of software come out every few years, making it difficult to get out of a license when company data depended on it. The emerging world of cloud computing will require greater agility.
How long Warren Buffett will stick with a losing business model remains a question. Some analysts speculated on CNBC’s Squawkbox last week that Buffett may already be selling some of his stake. If the share price continues to tank, he’s likely to pull out entirely.
The Palmisano factor
Rometty of course didn't invent “Roadmap 2015.” She inherited it from her predecessor CEO, Sam Palmisano, who retired from IBM with compensation estimated at $225 million, including the options, restricted stock, pensions, deferred compensation, bells and whistles.
Palmisano was, according to HBR in 2006, “a true-blue IBMer, who started at the company in 1973 as a salesman in Baltimore,” with “a visceral attachment to the firm.” He is “a results-driven, make-it-rain, close-the-deal sort of guy.” He also famously held a ValuesJam, in which thousands of IBM’s employees joined in an open debate about the very nature of the computer giant and what it stood for. At the conclusion, Palmisano declared IBM’s commitment to three values: “Dedication to every client’s success,” “Innovation that matters,” and “Trust and personal responsibility in all relationships.”
However critics—and many staff—suggest that what drove actual decision-making at IBM under Palmisano was not so much “clients”, “innovation” or “trust’, but a relentless drive to grow earnings per share, no matter what the cost.
Palmisano’s June 2014 HBR interview corroborates this diagnosis. In the long interview, Palmisano never once mentioned the word “client” or “trust”. He mentions “innovation” only once, and then to point out how little money it involves in the overall scheme of things. “Your innovation and long-term investments are a very small portion of the SG&A [selling, general, and administrative expenses] pot—maybe 4 percent.” Somehow IBM’s values got lost in the shuffle.
Many see Palmisano as the origin of today's problems. Far from valuing trust, IBM, under his watch, developed a culture of distrust, in which nobody dared to talk their mind. Executives just wanted to hear the "right" story. Rometty is simply following in Palmisano’s tracks.
Offshoring has been implemented with ruthless brutality. “US employees,” says one former executive, “were asked to train their successors and then fired. The offshoring was based on Palmisano’s ideology of the ‘Globally Integrated Enterprise’ (GIE) which claims that it does not matter anymore where you put your operations. You can stich the company together by information technology. This was used for IBM’s offshoring and customer projects where they took out cost by putting most of the resources in overseas call and competence centers. This was complemented by global processes that never worked properly. Through massive offshoring, IBM lost the ‘soul’ that it once had in days of Thomas Watson Sr.”
The “unprecedented pace of change”
“The pace of change,” said Rometty in her interview with CNBC last week, “is unprecedented.”
In the same interview, she also said, “At the end of the day, this is about returning value to shareholders.” In the interview, the client seems almost like an afterthought. By not putting the client front and center, the risk is that the pace of change will always be “unprecedented.” IBM will be continually surprised by what is happening in the marketplace.
Thus Amazon launched its cloud computing services in 2008. IBM only discovered the cloud in 2011 and has struggled to keep up ever since. After losing a lucrative CIA cloud project to Amazon—a deal that should have been a shoe-in for IBM, given its history and customer relationships—IBM acquired a small competitor, SoftLayer, to provide the services its customers were demanding, which IBM itself couldn’t provide. But SoftLayer itself was arguably already behind the curve and over-priced. And even if IBM ever does catch up in cloud-computing , the cloud is likely to be such a thin-margined industry that it won’t sustain the profit margins IBM is hoping to achieve.
Is it a surprise that Rometty reported last week that results were down because IBM’s clients were “not ready to make a decision”? Or another surprise: clients have been asking for “more flexibility in our software to deploy it for new workloads”? And surprise of all surprises in 2014: IBM has discovered that clients want “mobile.” Which century is IBM's management living in?
IBM is systematically playing catch-up in a world where catch-up is ultimately a losing game. Instead, IBM needs to answer Peter Thiel’s questions: what can IBM do that no one else is doing? What secret does IBM know that no one else knows?
Rometty’s attempted answer seems to be the very old response of Lou Gerstner back in 1994: we can help big firms integrate all this confusing technology stuff so that they just don’t have to worry about it: leave it to IBM.
“Playing to win on cloud,” said Rometty last week in her CNBC interview with David Faber, is what IBM is about. “We have always said there would be three things that would make a difference on cloud. It would be hybrid, meaning you would connect these new ideas, these new innovations to your existing systems. Data, it would matter it would really be about data. And security. All that is coming to be now. And that is exactly the strengths and exactly what we built for.”
Huddled together on a sinking ship
Yet implicit in Rometty’s summary is a philosophy of business as usual. It involves a set of “core accounts”, namely, big firms who don’t understand software and who are scared to death of everything that it is doing to their businesses. They are hoping that IBM can somehow protect them by providing a safe and stable environment and they are willing to pay a premium if IBM can do it. That will supposedly enable them to get back to their “real business” of pushing products at customers and making money.
One problem is that when IBM itself is moving so slowly, with such a disaffected workforce, and with no apparent mastery as to what is going on, let alone any clear vision as to what is coming next, the safety and security that IBM promises to its fellow mastodons constitute an illusion. IBM is just as out of touch as they are. When there are much cheaper and more flexible solutions, the option of switching looks ever more attractive, as the pressures mount on all the big firms to deliver “better, faster, cheaper, light, more mobile, more personalized and more convenient.” In this environment, the extravagant premiums that IBM is hoping to extract for sticking with IBM look ever more fragile.
The reality is that IBM and its core accounts are huddled together on sinking ship that is basically out of touch with the marketplace, with an obsolete approach to management (maximizing shareholder value and hierarchical bureaucracy) and frightened of the future. They had all hoped that by jacking up their share prices through Potemkin-style tricks of financial engineering, share buybacks and free government money, no one would notice their real underlying problems. But change is coming, inexorably.
The problem they face is that technology isn’t any longer something that can be kept locked up in some back room, overseen by IBM. Whether these firms like it or want it or will admit it, all organizations are now software organizations. All of these firms’ systems run on software. The customers of all these firms want fast, convenient higher quality mobile solutions that only software can provide. There is no safe space where software can be contained, no back room where the glacial progress of IBM’s mainframes can reign. “Software,” as Marc Andreessen quipped in 2011, “is eating the world.”
In this emerging software-driven world, a new kind of management is required. It focuses customer delight as the new bottom line of the firm’s business. It delivers greater shareholder value, not as the goal but as the result. IBM will have to learn how to disrupt its own cash cows and rapidly develop new products that have not even been heard of. Innovation will need to happen on a continuous basis.
For a certain period, the tricks of financial engineering could fool some of the people some of the time that the ship wasn’t taking on water or losing velocity. But the moment of truth is fast approaching for IBM, just as it is for IBM’s core clients. The future is rapidly evolving software. All organizations will need to learn to live with it and master it. There is no safe haven. IBM can’t provide it. That era is over.
Potemkin-style financial engineering won’t save these firms. Maximizing shareholder value by jacking up the share price won’t help for long. Nor is the “corporate cocaine” of share buybacks the solution.
Does IBM have a future?
Yet the case isn’t hopeless. Despite the profound problems IBM now faces, the firm still has tremendous resources and knowledge, in particular in R&D. It enjoys a huge base of customers who are losing patience but who have not yet given up on IBM. The firms that constitute the Global Accounts have long-term relationships with IBM and would prefer to stay with IBM if IBM could be a viable partner in the new world. They see IBM as one of the few companies that can actually run big complex data centers. IBM also has immense strengths in the field of High Performance Computing. Even critics concede that IBM still has the most secure and reliable software for mainframe systems and middleware.
IBM needs to build on its strengths. IBM was once a great company that respected and rewarded its employees and served its communities and society. It's a company that still has the power to change the world if only it would choose to.
Yet it’s hard to see how it can accomplish this with the current management team or the current board and their obsolete management philosophy. It has been evident for some time that IBM has been heading down the wrong path. Why did they just watch and not act? According to Nick Summers at Bloomberg BusinessWeek, IBM’s leadership has been “like a driver obeying the commands of a GPS system even as passengers shout that the car is clearly headed toward a ditch.”
It’s time to get back to Tom Watson Sr.'s philosophy of putting the customer first among stakeholders and earning a real living again, but in a very different context with a very different approach to management.
IBM has made other major transitions in its long life—last time with an outside CEO.
Maybe it’s time for leadership with a different vision?
And read also:
Why Software Is Eating the World
The Origin Of The Dumbest Idea In The World
The Copernican Revolution in Management
The five surprises of radical management
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Follow Steve Denning on Twitter at @stevedenning.
