The Humbling of a Computer Colossus

By THOMAS McCARROLL

Fighting back is a decidedly unaccustomed role for IBM. Other companies have to do it all the time, of course, but the Colossus of Armonk (N.Y.) is different. Overwhelmingly dominant in its industry for decades, IBM is used to swatting aside small rivals -- and they're all small by comparison -- with a brush of its hand. Now things have changed.

Last week was worse than most. With AT&T acquiring the computer maker NCR (for $7.4 billion), what had been little more than a bothersome competitor was suddenly part of a company as big as IBM. A new survey of customer satisfaction among business users of personal computers showed IBM out of the running, somewhere below 10th place and below average, its exact ranking not disclosed by the pollsters. Its stock is skidding along near a nine-month low. And at week's end, to underscore that the company is going through one of its toughest times in memory, it informed more than 10,000 employees that they would be taking a week's unpaid vacation in early July. Big Blue remains fearsomely strong (1990 revenues: $69 billion), but the days of Pax IBM may be over.

How could it happen? After all, the millions of Americans who have bought IBM stock or joined the company as employees were betting on a leviathan, a creature so big it couldn't be threatened. The answer is that while no killer shark is out there attacking this whale, thousands of relentless barracuda are taking bites out of it. Once the pre-eminent force in closet-size mainframe computers, IBM has watched its share of the world market dwindle from nearly 80% to 69%, as rivals like Japan's Fujitsu and Germany's Siemens score large gains with more powerful and less expensive machines. Its once commanding lead in personal computers has shriveled from 46% to 23%. Big Blue has stumbled so badly in such markets as home computers, portables and telecommunications that security analysts have started to doubt the company's high-tech superiority.

IBM has even lost favor with investors, who are still reeling from the company's first quarterly loss ever. True, the figure was mainly an accounting phenomenon, but its cause was far from heartening: The company was taking a $2.3 billion charge for the full estimated costs of paying 10,000 employees to quit voluntarily in the coming year. At its annual meeting last month, chairman John Akers told stockholders to brace for more bad news: "While we'd like to believe economic recovery is just around the corner, we have seen no evidence yet to indicate any improvement, and consequently the year remains uncertain." The IBM empire is striking back. In a marketing effort unparalleled in its 80-year history, the company launched an all-out offensive to retain current markets and recapture lost turf. The past 11 months have brought virtually nonstop announcements of new products, including a laptop computer, a home computer and a line of midrange computers costing an average of $500,000.

The company has also kicked off a $40 million campaign to rescue a struggling software system and beefed up its sagging mainframe business by signing an unprecedented deal with Tokyo's Mitsubishi Electric, marking the first time that IBM will sell its large computers under another company's label. Last week IBM upped the ante in a price war over workstations, number- crunching desktop computers used by scientists and engineers, by slashing prices as much as 60%. Analysts expect the company to make a similar move in personal computers next month.

Cutting prices usually means cutting costs, and in a six-year war on expenses IBM has reduced them by $1.8 billion so far. Advertising spending is down 10%, to $90 million this year. Known as a generous employer, IBM has scaled back benefits and perks.

Despite its famous no-layoff policy, IBM since 1986 has reduced its work force by 47,000 employees (10%) through attrition, early retirement and the sale of its typewriter and printer business. Even after this year's 10,000 are gone, say many security analysts, the company will still have 363,800 people on its payroll and will remain too fat to respond quickly to smaller rivals. Ulric Weil, a Washington consultant, says the company is likely to continue tolerating that disadvantage: "IBM doesn't have the stomach to make the cuts necessary to make the organization leaner and meaner."

Maybe not, but IBM has in many ways reshaped its corporate culture to fit the times. Gone is the imperious overlord that dictated to customers. Today the company is more user-friendly, with three fewer layers of bureaucracy so that managers can get "closer to the ground," as they like to say, and with 65,000 corporate personnel reassigned to sales and marketing positions. IBM has also dropped its hands-off policy on competing hardware. In the past, the company refused to help customers install or repair equipment (such as computers and printers) made by competitors. IBM quietly changed the policy about a year ago, after losing considerable business with FORTUNE 500 companies to outfits like Digital Equipment, AT&T and General Motors' Electronic Data Systems, all of which link machines of different makes and models.

But the greatest challenge facing IBM is apparent in a pair of simple facts: the technology in which it leads the world, mainframes, is fading in importance, while the technology in which it is falling back, personal computers, is exploding. Mainframe sales have slowed dramatically in recent years, as Big Business customers have increasingly shifted data processing to less expensive but powerful workstations and PCs. That is especially painful to IBM and other manufacturers like Unisys and NCR because profit margins on desktop systems are as thin as a silicon wafer compared with those offered by mainframes.

While IBM is a force in workstations -- it sold $1 billion worth last year -- the company has resisted pushing them as a low-cost solution for fear of cannibalizing its bread-and-butter mainframe business, which accounts for 60% of sales. "Downsizing poses a worldwide threat to IBM," says Rick Martin, an investment analyst at Prudential Securities. Although IBM is expected to maintain its leadership in the market, the strategic importance of large systems will continue to diminish.

Which leaves PCs, IBM's most important and competitive business after mainframes. Personal computers accounted for 5% of IBM's total revenues in 1985, 20% last year, and they should reach 40% by 2000. Yet because the market is growing so much faster the company's influence is shrinking. IBM is using every weapon in its well-stocked arsenal to restore its lost supremacy. In March it introduced a state-of-the-art laptop computer (price: $3,800). Trouble was, the machine was a very tardy entrant in computing's fastest- growing segment. James Cannavino, head of IBM's personal-computer division, & concedes that lack of a laptop was a major reason for the company's 17% drop in hardware sales in the first quarter. Says he: "We couldn't catch the demand because we didn't have a horse in the race."

When IBM entered the market in 1981 with much fanfare and a $2,600 machine called the PC, the personal computer was still struggling for legitimacy. Arcane operating commands made IBM's bulky box difficult to use, but because the company could open doors in the all-important FORTUNE 500 market, the PC and its operating software became a technological standard. An entire industry grew up around the machine, supplying everything from add-on memory boards to printers to game programs. IBM sold 15 million PCs, capturing more than 45% of the market at its peak in 1983. But low-cost copycats, such as Tandy and Leading Edge, and more innovative machines, such as Compaq's (which are IBM- compatible) and Apple's (which aren't), soon began to chip away at Big Blue's overwhelming share.

IBM fought back with a new line of computers, called Personal System/2, and new control software, called Operating System/2. The system is commanded by graphics rather than text and is easier to use. But because it is not completely compatible with the old PC, customers have been slow to accept it.

Their underwhelming response has left the industry without a standard- bearer. As a result, analysts see the market splitting into several competing camps: IBM, Apple and loose federations of smaller manufacturers. Is that good or bad? One school of thought holds that fragmentation could hurt everyone by blocking innovation and growth as manufacturers worry about choosing the winning camp (and covering their bets) instead of advancing an agreed-upon technology. "The market is up for grabs," says Cannavino, who believes buyers and sellers are begging for leadership. "The industry wants to be led out of the confusion. It would be happy for someone to point the direction." That beacon, Cannavino insists, will be IBM.

Others refuse to worry about IBM's decline from dominance, at least in PCs. IBM's basic standard has already been so widely adopted, says Compaq president Joseph ("Rod") Canion, that "it's not IBM's standard -- it's the industry's standard." The remaining question is how it should be applied, and Canion favors letting a thousand start-ups bloom to create myriad programs that would all work in IBM-compatible machines, if not necessarily with one another. | "Customers want freedom of choice," he says, "and don't want any one company to dominate the standard again."

Utter dominion over an industry, which IBM enjoyed from the 1960s to the 1980s, rarely lasts so long. Now that it is waning, perhaps the company should be congratulated for maintaining its role as long as it did rather than criticized for letting it finally diminish. And before anyone organizes a benefit dinner, remember that IBM was America's most profitable industrial company last year, earning more than $6 billion. Its profit will likely decline this year, but the company remains huge, powerful and full of talent. In the realm of computers, it is not what it was. But underestimating Big Blue always proved a mistake in years past and probably still would be.

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[TMFONT 1 d #666666 d {Sources: Forrester Research; Ulric Weil}]CAPTION: SINKING

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CREDIT: TIME Charts

[TMFONT 1 d #666666 d {Sources: Forrester Research; Ulric Weil}]CAPTION: SHRINKING