IBM to Cut Up to 13,000 Employees, Mostly in Europe

by Timothy Prickett Morgan

As expected after its surprise to Wall Street a few weeks ago where it did not meet its profit targets, IBM said late last Wednesday that it would cut up to 13,000 employees from its corporate payroll as it seeks to streamline its management and get more power into the hands of the sales people who are making the deals these days. The cuts are in line with the Street's expectations, so the company will not be faulted for not cutting deep enough.

IBM had about 329,000 employees as 2004 came to a close, and it says it will use a mix of voluntary and involuntary layoffs to reduce its payrolls by between 10,000 and 13,000 employees. That works out to between 3 and 4 percent of its current payroll. However, IBM has about 100,000 employees in Europe, and the cuts will be a lot deeper there. Europe could lose anywhere from 6,500 to 9,100 employees, and that is from 6.5 to 9 percent of its workforce. The impact of the cuts on other regions, comprising 229,000 employees, will therefore be on the order of a fraction of a percent to as high as 2 percent, depending on how many cuts IBM ultimately makes. IBM's operations in Germany, Italy, France, and the United Kingdom will bear the brunt of the layoffs. IBM says that the diminished economic growth and the low level of employee attrition for the past few years is what is forcing it to do layoffs at this time.

The immediate cause of the layoffs was the shortfall in sales and profits that IBM had as the first quarter came to a close. IBM's sales in the quarter were $22.9 billion, up 3.3 percent, and the company brought $1.4 billion to the bottom line, an increase of 2.9 percent over last year's first quarter. That worked out to 85 cents a share, and because of IBM's share buyback and other financial engineering, earnings per share increased by 7.6 percent. However, analysts polled by Thomson/First Call had been expecting, on average, for IBM to rake in 90 cents a share on sales of $23.65 billion.

But IBM's problems in Europe, which it has not discussed, apparently go deeper than one quarter. The fact that the U.S. dollar is so weak has helped IBM Europe post decent growth in sales and profits in dollars, but at constant currency (mostly in pounds and euros), growth has been a lot less than IBM would like. So IBM is restructuring to get more people selling and fewer people managing--or, at the very least, fewer people managing.

IBM said it was going to restructure its European operations, where each country has had its own Baby Blue fiefdoms for decades and where IBM Europe (commonly called IBM EMEA, for Europe, Middle East, and Africa) had what amounted to a top layer of upper management akin to that in its U.S. headquarters. This organization is a legacy leftover from when Thomas Watson, IBM's founder, had to give his two sons, Tom and Dick, more or less equal pieces of the business to run. IBM said it plans to reduce the bureaucracy in slower growth countries in Europe and create management and sales teams that can span regions, which obviously makes sense for an IT vendor that sells products across a unified (at least economically) European Union. IBM also said it would be consolidating the centers from which it provides services. Prior to the European Union, IBM and other transnational companies often had to have complete operations in each country, for political, cultural, and economic reasons. No one who wants IBM service in one European country is going to make a fuss if that service is derived from another country these days. IBM no longer manufacturers computers or creates software in every country, either. Neither does any other IT vendor.

Because the European operations of Big Blue will bear the brunt of the layoffs, it is tough to nail down an exact number of layoffs and their cost. In European countries, there are still strong trade unions, and it is more difficult for IBM to make layoffs. There are rules and processes, and it cannot be done quickly or easily. Nonetheless, IBM said it plans to record a pre-tax charge of between $1.3 billion and $1.7 billion in the second quarter to cover the restructurings, and it expects the benefits of that restructuring to start affecting its numbers in a positive way during the second half of this year.

IBM hosted a conference call with analysts last Thursday morning to discuss the restructuring it plans to undertake. In that call, Mark Loughridge, IBM's chief financial officer, said that IBM's EMEA operations would account for anywhere from 65 to 70 percent of the layoffs and resource reductions in the restructurings and that of the $300 million to $500 million in cost savings that the company expected to realize from the changes would be realized from spending cuts in EMEA. He said further that Global Services would account for about 70 to 80 percent of the payoffs and savings in the worldwide restructuring. From these numbers, whatever IBM's woes are, it has mostly to do with Global Services, and mostly in Europe.

That said, other sources indicate that IBM was apparently disappointed by revenues and profits in its xSeries line. The mainframe was not, at least directly, the culprit in the first quarter miss, and Big Blue had been expecting, thanks to the normal mainframe cycle, a dip in zSeries sales. And with iSeries sales only up 1 percent in the quarter (and down significantly from 2003's levels), a faster uptake of the new eServer i5 line would have been helpful to IBM's revenue and profit picture in the quarter.

The consolidations in Europe, explained Loughridge, involve the consolidation of services and other operations that are not geographically dependent into centers of excellence and integrated delivery centers within Europe; IBM is expected to move these centers into high growth and/or low-cost regions. IBM will consolidate jobs by function and standardize those functions across all geographies, which it says will allow it to offer better service and cut costs. Managers who get the sack will be offered positions in these centers of excellence or in other customer-facing positions. Pricing decisions, marketing programs, sales cadence, and other factors will be moved into field sales and support teams. It is now obvious how IBM is going to get 10,000 to 13,000 people to voluntarily leave: it will change their jobs from management to sales and tech support, and most people will not be able to or willing to make the jump. (By the way, layoffs in the United States will not be voluntary.) And to keep from disrupting existing sales, Loughridge said that there will be no change in sales territories, territory assignments, or layoffs of sales reps are part of this restructuring. As far as customers are concerned, nothing will change. Loughridge did indicate that it will be using a mix of IBMers, contractors, and partners to deliver services, which seems to imply that IBM will be using more contractors and partners and will offload work or not as conditions dictate.

While the cost savings from the restructurings will result in an extra $300 million to $500 million dropping to the bottom line in 2005, Loughridge says that IBM expects savings in the full 2006 year to be on the order of two to three times this--or between $600 million and $1.5 billion, if you do the math. That's a pretty broad swing in savings. But what is clear is that IBM will be able to pay back the restructuring charges it incurs in fairly short order. The question now is this: are conditions going to get worse, and how deep could the cuts be if they do? In the early 1990s, when IBM was faltering, it made much deeper cuts, but it kept doing them again and again, which the Street, investors, and customers really did not like at all.