The Four Hundred--international Business (machines)

The top brass of IBM held their semi-annual audience with the Wall Street analyst community last week. 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 go to it last week, 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 securities analyst meeting was Chairman and CEO Sam Palmisano, who appeared at a customer event with 100 customers in San Francisco a few 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:

Harreld said something very interesting in describing this chart. "Customers let vendors make money where they have the highest needs." This is absolutely true. By business value, IBM means the kind of deep consulting that brings IT expertise that IBM's Global Services, Systems Group, and Software Group have, and marrying it to the kind of business process consulting that IBM gained when it bought the consulting arm of its accounting auditors, PricewaterhouseCoopers, last year.

This change in the IT market is why IBM's own head count looks less like that of a computer manufacturer than you might expect. IBM has a total of 345,000 employees worldwide. Some 10,000 of them are sales people dedicated to pushing products by industry. Joyce hinted that, in the future, IBM may stop reporting its financials by product category and may only talk about the solutions it pushes in aggregate into each industry. Steve Mills, general manger of Software Group, will shift from a product sales approach to an industry approach starting in January. The Systems Group and its reseller channel have taken this approach for quite some time. Sun Microsystems, one of IBM's rivals, shifted to a "solutions selling" mode in Europe last year, and is just now taking it worldwide. That selling approach takes a lot longer, according to people inside Sun, but it yields more revenues and profits over the long haul. Dell and HP are still more direct sells than IBM or Sun, but they are adapting to this new world.

After acquiring 30,000 consultants with the PricewaterhouseCoopers deal, IBM now has 45,000 business process experts, who recommend technologies and processes for running businesses. The Services Group has another 140,000 service experts, who implement and support systems and their applications. That leaves another 150,000 employees who do everything from sweep the floors to answer the phones to build and package solutions in IBM's factories. Those ratios between the kinds of employees at a company are interesting. They may be the kind of ratios all companies will face.

Here's why. If you believe Ginni Rometty, the managing partner of IBM's Business Consulting Services practice within Global Services, a constant cycle of re-engineering is something that CEOs are coming to realize will be their only hope of remaining competitive. Rometty's organization surveyed 300 CEOs this month, and 80 percent said cutting costs is interesting, but the real priority is finding sustainable revenue growth to drive profits. (Cost cutting is a one-off, after all.) Some 70 percent of these CEOs said they want current reengineering projects to create the revenues and yield the cost savings that allow them to fuel further reengineering strategies that push revenues and profits further. Notice how the cycle is not so much about launching new product lines and entering new markets as about improving your competitive position in your own market.

It is a lot harder to talk about this "business value" product than to talk about a hard drive or a CPU. It is also harder to figure out what such consulting services are worth. The answer in almost all cases will be, "Well, how big is your problem, and how much money can you spend to fix it?" Doug Elix, general manager of Global Services, said as much to the Wall Street analysts. I don't know about you, but this kind of vague product and even vaguer pricing makes me plenty uncomfortable. But it has some interesting possibilities, and some of them are good.

Rometty says that business transformation outsourcing, or BTO, which means letting IBM get deep and personal into your private business affairs to help you streamline and improve it, is a $150 billion opportunity for 2004 that is growing at 12 to 15 percent at a compounded annual growth rate in different sectors. IBM is focusing on customer relationship management transformation (which it says is a $9 billion opportunity, growing at 15 percent), human resources transformation ($38 billion opportunity, growing at 12 percent), finance and administrative transformation ($20 billion opportunity, growing at 13 percent), and procurement transformation ($21 billion opportunity, growing at 15 percent). Deep knowledge of industries and the independent software vendors that create applications in this market are what drive this BTO space, says Rometty. And the pricing can be different from what we are used to. Under a big finance and administration deal that IBM signed with oil giant BP, IBM is tweaking BP's financial systems and processes and receives a fee that is equal to 0.25 percent of BP's top line revenue each year. If IBM helps BP make more money, IBM makes more money. At drug-maker Aventis, the IT budget has decreased by about 15 percent in the past four years, but a deep partnership between Big Blue and Aventis has enabled IBM to grow its share of the IT budget from 18 to 44 percent over that time. The so-called "business value" consulting services portion of the IBM piece of the budget has grown from a sliver to a quarter of what IBM gets from Aventis. This money represents, among other things, paying experts from IBM Research to help Aventis tweak algorithms for searching among molecules for candidates for new drugs to fight diseases.

What seems obvious to me, after listening to IBM all afternoon and for the past 18 months about e-business on demand and then simply "on demand," is that IBM is going to partner with the biggest businesses of the world, to help them be killer competitors, and to make lots of dough selling inside smarts to these industry players wherever trade secret provisions in contracts do not prevent it. IBM is, in a sense, changing from a manufacturer of computers--which process data and sifts for patterns--to a vector of ideas and a force for change itself. This is not the computer business, although computers are a crucial element of what IBM is talking about.

The question is, where do small business and midrange businesses fit in? I'm not even sure if it is a question of "can you partner with IBM?" It may be a question of being big enough for IBM to partner with you. I have this sinking feeling that you had better be a business, with a capital B, if you want to get on Big Blue's radar and ride this transformation wave.