Struggling towards a world of services

IBM has endured some horribly bumpy patches over the past 20 years. Between 1985 and 1994 the firm that had practically invented the computer industry nearly halved its workforce as customers turned from its mainframe machines to the newly emerging PC. In 1992 IBM made a loss of $5 billion, the heaviest corporate deficit America had ever seen.

By comparison, the company's latest set of troubles must seem somewhat trivial. In April it announced that net profits for the first quarter were $1.4 billion, a little more than a year before, and that revenues were a tad below analysts' forecasts. Investors were taken by surprise and IBM's shares tumbled (see chart). And on Wednesday May 4th the company said that it would begin a restructuring that would see the departure of some 13,000 employees, around 4% of the total. But though these developments pale beside the dark days of the early 1990s, they are symptomatic of a wave of fresh competition for the iconic computer firm that could cause it just as much heartache.

IBM has not stood still in the face of this competitive threat. Over the past decade it has made sweeping changes to its business, shifting from selling computer hardware to providing computer services, which constitute anything from technology outsourcing and network design to consulting. Last year around a half of IBM's revenues of $96.3 billion came from such services.

Lately, however, the rate of revenue growth in this business has declined. Partly this is a result of the fall-off in demand after the bursting of the dotcom bubble, as companies reined in spending on information technology (IT). But suggestions that IBM's problems in the first quarter of this year were part of a more recent slowdown in IT spending appear wrong—for spending has in fact recovered of late. IDC, a research firm, recently lowered its growth forecasts for global IT spending in 2005, but spending is still expected to grow by 4.4% in Europe and by 5.5% in America. Clearly money is being spent, but less is going IBM's way. This suggests the firm's problems are largely of its own making.

IBM thinks the answer is, in part, to cut back its operations in western Europe, where growth is slow and costs are high. Such inefficient businesses are quickly exposed these days, since data can be sent rapidly anywhere in the world for processing. Competition has come not only from Indian outsourcing firms, such as Wipro and Infosys, but from closer to home: EDS and Hewlett-Packard offer competing services. And Dell Computer has made aggressive strides into services as it eyes areas of business that have higher margins and are quicker-growing than selling PCs. Last year a half of Dell's revenues came from PC sales but even its acclaimed direct-selling model is suffering from a market where margins are wafer-thin. IBM pulled out of the PC-making business altogether last December, selling its operations to Lenovo, a Chinese firm.

IBM sees its future in higher-end “business transformation” services rather than plain old data-crunching, payroll management or areas subject to heavy competition, such as maintenance contracts. The firm is increasingly moving into areas that will help improve its clients' profitability directly, such as redesigning supply chains or marketing systems. In 2002 IBM paid $3.5 billion for the consulting arm of PricewaterhouseCoopers to further these ambitions. It has also invested heavily in firms that make “middleware”, which connects large corporate systems and helps speed up business processes. Thus the firm is hoping to outflank competitors by marrying consultancy to its array of high-tech products and enviable research facilities.

The success of the services business is vital to the prospects of IBM's other offerings. As the firm moves increasingly into selling integrated packages of hardware, software and services, it must work harder to ensure that it gives customers exactly the kind of advice they need; if it fails to do this, they will take their hardware and software business elsewhere. In other words, more is now at stake.

Although the job cuts announced this week may boost IBM's profitability for a time, the real test for the firm will be whether reshaping its services business will help to attract enough customers for its high-end consulting as competition mounts in the area of more humdrum services. If it does not, IBM may face as testing a time as it did in the early 1990s.