Guild Companies--international Business (machines)

The top brass of IBM held their semi-annual audience with the Wall Street analyst community two weeks ago. For as long as I can remember, IBM has invited me to this event, presumably because I do a lot of financial reporting about Big Blue, outside of Guild Companies. I decided to attend in the hope that something interesting would happen. It did. I learned a few things, which I would like to share with you and ponder a little further.

The one person who did not go to the meeting was Chairman and CEO Sam Palmisano, who appeared at a customer event with 100 customers in San Francisco a several weeks ago with Jeff Immelt, CEO of General Electric, Meg Whitman, CEO of eBay, John Chambers, CEO of Cisco Systems, and Linux guru Linus Torvalds, among others. At the meeting with the analysts, IBM played a clip of these people all talking about IT and business. It was probably only four minutes long, but it made me motion sick because it had so much data and it was spliced up so much. I prefer textual data.

The top executives of IBM's various business units spent the next three hours presenting their vision of the future of computing. There was a lot of talk about business process engineering and consulting, a lot of talk about on-demand hardware, software, and services. We all know that computer vendors like to talk, usually about themselves, but sometimes they are on to something.

John Joyce, IBM's chief financial officer, showed an interesting chart that actually explained why IT buying patterns are changing and why the sales cycle is elongating. In 1999, during the dot-com boom, about 22 percent of IT purchasing decisions were, according to Joyce, the result of IT organizations pushing for piece parts and technologies inside their organizations; another 33 percent of decisions were driven by top-down initiatives from the board room or business line managers, which IT organizations had to absorb. About 45 percent of decisions were driven by collaborations between business managers and IT managers. In 2003, only four years later, and well on the other side of the boom, pure IT-driven decisions about IT products account for only 9 percent of transactions, and business-driven acquisitions of IT products account for only 4 percent of transactions. The remaining 87 percent are collaborative decisions involving both sets of teams.

This is a big change, and it's the direct result of decades of poor IT spending habits. You might even call them rich habits, since IT organizations tended to behave like money was no object, and managers (both business and IT managers) thought that IT projects would deliver expected results. Companies are smarter about figuring out the return-on-investment for IT projects, thanks in large measure to the economic downturn of the past three years. But it is more than just calculating ROI. More people are involved in IT business processes, which slows things down, but it probably also keeps companies investing in better and more sustainable ways when it comes to IT. If this change hasn't happened to your IT organization, then brace yourself. Change is coming.

Bruce Harreld, IBM's senior vice president of strategy, presented an economic overview of IT and demonstrated statistically that some kind of transformation is occurring in the IT and business market. "You can call it anything you want," he said, in obvious reference to the many names that IT vendors have given this change they are predicting, "but it is happening." IBM calls it on-demand, Hewlett-Packard calls it the adaptive enterprise, Sun Microsystems calls it N1, and so forth. Harreld put up a chart that plotted IT spending as a percent of U.S. capital equipment spending, which shows a rising step function curve from 1960 through 2010. It's a pretty consistent step function with a 15-year cycle.

Between 1960 and about 1970, IT spending rose from nothing to two or three percent of capital spending, and then it hit a plateau. This is when industry bought and learned how to use mainframes to automate back-office functions that used to be handled by people. In the late 1970s and through the mid-1980s, companies absorbed this technology, as well as the advent of the PC desktop computer, and IT spending rose to about 7 percent of all capital spending in the United States. These two technologies spawned the automation of departmental computing and personal computing, which fused in the late 1980s to spark the client/server era. The logical end of the client/server era is the Internet and all the connectivity it entails. In the mid-1990s, IT spending rose rapidly again, hitting about 11 percent of all capital spending. Harreld's curve showed IT spending compared with all capital equipment spending growing steadily again between 2005 and 2010, and if you extended the curve, probably a year or two beyond that. This is the "on-demand" era to IBM. And this is where International Business Machines is going to transform into international Business (machines).

IBM doesn't want to change, any more than any of us do. IBM was a genius creator of electromechanical computing equipment, and continues to be an excellent supplier of top-notch electronics components. But the profits are moving away from hardware and software and toward services. Harreld compiled statistics of the biggest 117 publicly traded IT suppliers, and looked at where they are making their money now, where they made it a few years ago, and where they will likely make it in the next few years. Profits are migrating away from hardware components, complete systems, and even software components and toward deep consulting, business process engineering, and other esoteric services. Take a look at the following table, which shows operating profits by category: