How IBM Was Left Behind

By THOMAS McCARROLL

When it comes to dominating an industry, few companies have done so with the overpowering force of International Business Machines. From gigantic mainframes and tiny laptops to semiconductors and software, IBM ruthlessly called the shots for the entire industry after the computer became a commercial item about 40 years ago. So tight was IBM's market grip that it was practically impossible for any computer company to do business without being tied in some way to the Big Blue colossus.

How the mighty have fallen. While most of the industry is enjoying a renaissance, the world's largest computer company is being overwhelmed by an array of problems in one market after another. Its mainframe business, the core of the company, is being undermined by microchip miracles that make today's low-cost desktops as powerful as yesterday's closetfuls. Its lead in personal computers has evaporated. Its supremacy in computer chips is a mere memory. In software, upstart companies that didn't exist a little more than a decade ago are running rings around the 78-year-old behemoth. And even worse, IBM has been bogged down by endless rounds of painful restructurings and cutbacks. "IBM is no longer the monolithic monster that strikes fear in the hearts of competitors," says Ulric Weil, a leading computer consultant. "It has proved to be quite mortal after all."

! At a time when other computer companies, including Sun Microsystems and Compaq, have been reporting hefty profit increases and rolling out innovative products, IBM last week was announcing its most traumatic cutbacks to date. In the fifth major restructuring in the past seven years, it plans to shed more unprofitable and ill-fitting assets and slash its work force next year more than 8%, or an additional 25,000 employees. Only a year ago, IBM reorganized its operations into 13 semiautonomous units, called "Baby Blues." The latest round of cuts will include the first layoffs in the company's history and will lead to a $6 billion write-off for the fourth quarter. IBM is expected to post a net loss of about $4.8 billion for the year -- the second largest in American corporate history.

IBM also announced that it would pare its spending on research and development $1 billion, or 17%, a move that prompted President-elect Bill Clinton to comment while leading a two-day economic conference in Little Rock. Though he conceded that IBM's cuts reflect the irresistible pressures facing U.S. manufacturers, he expressed concern about IBM's decision to slash investment in research and development. That kind of expenditure, said Clinton, is "the exact thing we don't want them to be cutting."

The bad news echoed loudest on Wall Street, where IBM stock has been transformed from a darling into an ugly duckling in recent years. IBM shares went into a free fall after chief executive John Akers warned that the company may have to cut its rich yearly dividend of $4.84 a share as a result of the restructuring. "The reality of the environment we find ourselves in makes us less sure we'll be able to maintain that dividend," he said. "We must be frank with ourselves and honest with our constituents, including our shareholders." The company's stock plummeted 11 points last week to hit its lowest level in 11 years, wiping out $6.3 billion in shareholders' equity.

Although the company, based in Armonk, New York, has already taken several drastic steps to snap out of its prolonged slump, many industry analysts remain unconvinced of IBM's ability to re-emerge as a major force in the industry. The moves so far, they say, are little more than Band-Aid solutions that cover up deep financial and technological wounds. IBM's challenge is not just to shrink in size but also to remake itself completely into a nimbler and more market-oriented player, in much the same way that American Telephone & Telegraph reshaped itself after the breakup of the Bell System eight years ago. And even that would hardly be enough to restore IBM's dominance in an increasingly fast-moving and decentralized industry that is becoming less and less dependent on a single pacesetter.

IBM's corporate culture has been drastically altered by the radical changes under way. After years of enjoying the comfort of lifetime employment, IBM workers now labor under the threat of dismissal and the pressure of pay-for- performance. For many IBMers, the company's announcement last week that it may abandon its no-layoffs policy merely formalized what Big Blue has already been doing. Although IBM largely relied on attrition and early-retirement programs to reduce its labor force by 100,000 from a peak of 406,300 workers in 1985, the company began de facto layoffs last year through a new employee- evaluation process that grades workers according to internal goals. Those who haven't measured up have been fired.

Still, analysts insist that IBM must get even leaner -- perhaps paring at least 50,000 more jobs within the next two years -- if it is to meet the challenge from smaller and nimbler competitors. Says Bruce Lupatkin, an industry analyst: "There's still a lot of fat left." CEO Akers agrees that layoffs are necessary for the company's long-term survival. "Although it's a difficult step to take," he says, "it's one that, given the realities, if we must do it, we must do it."

Job reductions alone, however, will not be enough to restore IBM's competitive edge. Distracted by endless rounds of cutbacks, the company lost sight of the ball. IBM fumbled in market after market: it fell behind in computer-chip technology, and it engaged in a self-destructive battle with software powerhouse Microsoft over the direction of desktop-computer programs. Even worse, IBM began losing money and market share in two of its vital markets: mainframes and personal computers. Here IBM is faced with a double quandary: it remains the world leader in the market for mainframes, but the large systems are fading fast in importance. Meanwhile, personal-computer systems have been growing in strategic value just as IBM has lost its technological virility.

For four decades, the mainframe was the queen bee of office computing. The gigantic machines often served as host for an army of white-collar workers, who were linked together in a single network of as many as 10,000 "dumb" ( desktop terminals. The market for these behemoths regularly grew 15% a year, but sales have slowed to 4% since 1990 as customers have turned to less expensive but powerful personal computers and linked workstations. Many manufacturers of large systems have already fallen victim to this irreversible change. In August, Wang Laboratories was forced to file for bankruptcy. Unisys, the by-product of the merger of Burroughs and Sperry, nearly went under after it suffered $2.5 billion in losses in 1989 through 1991. Huge losses also nearly claimed Digital Equipment, whose board ousted founder and president Kenneth Olsen earlier this year.

For years, IBM stubbornly attempted to ignore the trend away from big mainframes. Instead of adapting, it tried to protect its base: the computing dinosaurs account for 42% of IBM's revenues and about 60% of its profits. Margins on large systems were as high as 70%, although recent price competition has reduced margins to about 50%. But with sales slowing and price pressure mounting, IBM has finally faced up to the trend. Last week Akers signaled IBM's intention to shift away from its mainframe business, which is down 10% this year. Most of the $1 billion reduction in R. and D. will occur in mainframe development. IBM, he said, will rely more on workstations to serve as the central host for PC networks. "The computer industry is in a time of fundamental transition," said Akers. "Customers more and more prefer smaller computers."

IBM, however, is seeking to gain strength in a market where it is at its weakest. Personal computers accounted for 20% of IBM sales of $63 billion last year and are expected to make up 40% by the year 2000. But IBM's growth in PCs lags far behind that of the rest of the industry. IBM is the only one of the top 10 PC vendors whose market share has declined this year. In fact, IBM's PC business is in the red.

By contrast, Apple Computer -- which has surpassed IBM as the leading PC maker for the first time ever -- is having a spectacular year, largely on the success of its laptop PowerBook. Apple and Compaq are reaping the benefits of huge demand sparked by aggressive price cutting. Workstation manufacturers, such as Sun Microsystems and Hewlett-Packard, are also enjoying strong demand for their machines. IBM is still catching up in workstations. Although it developed superb technology years ago, the company sat on it out of fear that it would cannibalize IBM's bread-and-butter mainframe business.

; To prevent being passed by the PC parade, IBM has rolled out several new products as well as a new marketing strategy. In October the company launched a line of computers called PS/ValuePoint, with prices starting at $1,300 for the entry-level model. The PS/VP, which is compatible with IBM's original PC line, is the company's answer to Dell and Compaq, which both sell machines by mail order as well as through retail channels. The strategy is starting to pay off. IBM expects to ship 1.5 million PCs this quarter, 50% more units than it has ever shipped in any quarter in its history. The shipments include the company's five-year-old PS/2 models as well as its brand-new line of laptops. While its new assertiveness has been praised by analysts, IBM can at best hope only to stem its losses rather than to reclaim its lost glory in PCs.

The days of Pax IBM are over. Rather than dictate to the industry as it did in the past, a humbled IBM must now accept its role as just another player. To its credit, IBM appears to be doing exactly that. Although it is coming off what can best be described as an annus horribilis, rivals would be mistaken to underestimate this company in the future. If it can overcome the enormous challenge of becoming leaner and more responsive to shifting demands, and if it can anticipate the next technological wave rather than resist it, Big Blue still has the potential to be a market monster once again.